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Update On Issue of Taxation of Fixed Indemnity Health Benefits

Update On Issue of Taxation of Fixed Indemnity Health Benefits
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by Jason Cogdill on 25 May, 2017 with Add new comment

In a previous blog post, we communicated an IRS memorandum addressing the taxation of supplemental benefits that qualify as “fixed indemnity” health plans. There has been no formal change or update since that development. However, in doing some research on a related issue, we learned that there may be soon modification or clarification of the prior guidance from the IRS.

The language pasted below is from our most trusted legal reference resource, Employee Benefits Institute of America. If you are an entity in need of best in class compliance materials on any topics, we recommend EBIA to you. The EBIA editors are attorneys who have experience working directly with the IRS and Treasury officials.

From EBIA’s Cafeteria Plans manual (comment in italics added for clarity):

A 2016 IRS Chief Counsel Advice memorandum appears to send a conflicting message, seemingly concluding that (if premiums are paid pre-tax by an employee) the entire amount of any benefits paid under a fixed indemnity health policy would be taxable because the amount of payment does not correlate with the amount of medical expenses incurred. The memorandum is inconsistent with the (previously issued) regulation and guidance, which would allow benefits paid under a pre-tax funded fixed indemnity health policy to be received tax-free up to the amount of the otherwise unreimbursed medical expenses. (If fixed indemnity payments are never considered to be a reimbursement for medical expenses—even when triggered by health-related events likely to result in medical expenses, such as hospitalizations or office visits—the previous guidance would have been unnecessary.) IRS officials have since informally commented that they will be reviewing this aspect of the memorandum, and that it may have overstated the taxability of fixed indemnity benefits.

Given all considerations, we stand by the previous recommendation that the best practice for employers is to post-tax these benefits. That approaches prevents any issues with taxation and has other advantages (Section 125 qualifying events not needed to make change, as well as potential change in ERISA applicability). However, for those employers pre-taxing now or those who implement new benefits and are not interested in doing it post-tax, they certainly have that option and will not incur any significant risk based on current factors.

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Jason Cogdill

Jason Cogdill

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