09 February 2017

Payments Under Fixed Indemnity Health Plans May Be Taxable Under New IRS Memorandum

A new IRS Memorandum finds that payments under many employer-provided fixed indemnity health plans may be taxable.  Fortunately, there is a work around to avoid this tax result.

What is an employer-provided fixed indemnity health plan?

An employer-provided fixed indemnity health plan is typically a voluntary, employee-pay-all benefit provided to employees through an insurance policy.  The policy pays a flat dollar amount (such as $100 or $200) per medical visit or day of hospitalization in the event the employee experiences a serious medical condition like cancer or is admitted to the hospital.

The Tax Issue

Since the benefit is paid regardless of whether the payment actually reimburses the employee for uninsured health expenses, there has always been a concern that the payments are taxable.

The Memorandum from the IRS Office of Chief Counsel clarifies this rule and provides that if the premium for the employer-provided fixed indemnity health plan is paid for by the employer or is paid by the employee on a pre-tax basis, then any benefit payments are taxable.  The question then becomes how to withhold and report when the benefits are paid by the insurance carrier rather than the employer.  While there are rules on how to handle withholding and tax reporting in the case of insured disability benefits, no such rules yet exist for fixed indemnity benefits.

On the other hand, if the employee pays the entire premium for the fixed indemnity coverage on a post-tax basis, any benefit payments are tax-free.  While the benefit may be less attractive if it is purchased on an after-tax basis, clearly this approach is preferable because it avoids these tax consequences.

If you have any questions, please contact the author or any member of the Employee Benefits Practice Group.