The Employee Benefits practice group is pleased to present the Benefits Developments Newsletter for the month of January, 2017. Click through the links below for more information on each specific development or case.

IRS Expresses View on the Tax Treatment of Cash Payments Under Employer-Sponsored Fixed Indemnity Wellness Plans

Last month, in a Memorandum dated December 12, 2016, the Office of Chief Counsel of the Internal Revenue Service issued important guidance regarding the taxation of benefits (including wellness benefits) that are paid under employer-sponsored “fixed indemnity” health plans that qualify as accident and health plans under section 106 of the Internal Revenue Code. In the Memorandum, the IRS concludes that benefits paid under such plan are taxable when the premiums are paid with before-tax employer contributions, or before-tax employee contributions through a cafeteria plan. The Memorandum can be found here.

The guidance includes examples similar to the following:

Example 1

Facts. An employer provides all employees, regardless of enrollment in other comprehensive health coverage, with the ability to enroll in coverage under a fixed indemnity health plan. Premiums for the coverage are paid with after-tax contributions (i.e., the amount of the premium is included in employees’ gross income and wages for federal tax purposes). Under the policy, employees receive $100 for each medical office visit, and $200 for each day in the hospital, without regard to the amount of medical expenses otherwise incurred by the employee.

Conclusion. In this situation, the IRS concludes that because the premiums for the fixed indemnity health plan are included in the employee’s gross income and wages (i.e., the employee is taxed on the value of the coverage), the benefits received are excluded from the employee’s gross income and wages.

Example 2

Facts. The same facts as Example 1, except that the employer provides the coverage to the employees at no cost to the employee.

Conclusion. In this example, the IRS concludes that because the premiums for the fixed indemnity health plan are paid with amounts that are not included in the employee’s gross income and wages, the benefits are included in the employee’s gross income and wages, regardless of the amount of any medical expenses incurred by the employee upon which the payment is conditioned.

Example 3

Facts. The same facts as Example 1, except that the employees electing to participate in the fixed indemnity health plan pay premiums on a before-tax basis by salary reduction through a § 125 cafeteria plan; therefore, the amount of the salary reduction is not included in compensation income at the time the salary would otherwise have been paid.

Conclusion. The IRS’s conclusion is the same as in Example 2 because the premiums for the fixed indemnity health insurance are paid with amounts that are not included in the employee’s gross income and wages.

Example 4

Facts. An employer provides all employees, regardless of enrollment in other comprehensive health coverage, with the ability to enroll in coverage under a “wellness plan.” Employees electing to participate in the wellness plan pay for the coverage with before-tax contributions through the employer’s § 125 cafeteria plan; therefore the amount of the salary reduction is not included in compensation income at the time the salary would otherwise have been paid. Under the wellness plan, employees receive $100 for completing a health risk assessment, $100 for participating in certain prescribed health screenings, and $100 for participating in other prescribed preventive care activities, without regard to the amount of medical expenses otherwise incurred by the employee.

Conclusion. In this example, the IRS concludes that because the employee contributions are paid with amounts that are not included in the employee’s gross income and wages, the wellness payments are included in the employee’s gross income and wages, regardless of the amount of any medical expenses incurred by the employee upon which the payment is conditioned.

Example 5

Facts. The same facts as Example 4, except that the wellness plan pays employees a fixed indemnity cash payment benefit each pay period (for example, equal to a percentage of the salary payable for the pay period) for participating in the wellness plan, without regard to the amount of medical expenses otherwise incurred.

Conclusion. Same as Example 4.

The IRS guidance is a much needed response to the seeming proliferation of fixed indemnity and wellness program designs, like the designs in Examples 2 – 5, that purport to qualify as “medical care” which, as a general rule, is provided to employees and their dependents on a tax-free basis as to both the value of the coverage (i.e., employer-paid premiums) and receipt of benefits. In this Memorandum, the IRS makes it clear that fixed indemnity coverage is more akin to “income replacement” insurance (e.g., disability insurance) than medical insurance. Like disability insurance benefits, the cash payments that are received under the plans in Examples 2-5 are not tied to or coordinated with the cost of medical care, and can be spent in any way the employee chooses. If an employer sponsors a fixed indemnity plan that operates like one of the arrangements in Examples 2-5, and does not include the benefits received in the employee’s wages, the employer should engage the promoter of the arrangement, its broker or consultant, or its counsel in a dialogue to determine next steps.

IRS Chief Counsel Advice Addresses Meaning of "Substantial Risk of Forfeiture" Under Code Section 409A

Section 409A of the Internal Revenue Code (“Section 409A”) generally provides that if certain requirements related to the timing of elections, distributions, and funding are not met at any time during a taxable year, amounts deferred under a nonqualified deferred compensation plan for that year and all previous taxable years are currently includible in the service provider’s gross income to the extent not subject to a substantial risk of forfeiture and not previously included in gross income. Amounts includible in gross income under Section 409A are also subject to a 20% additional income tax and potentially a premium interest tax.

In the case of a calendar year taxpayer, if an amount is paid to the taxpayer no later than March 15 of the year following the year the amount is no longer subject to a substantial risk of forfeiture, then the amount is exempt from Section 409A. Under the Section 409A regulations, the addition of a risk of forfeiture is generally disregarded. Thus, salary deferrals are generally not viewed as being subject to a substantial risk of forfeiture. However, if the amount subject to a risk of forfeiture is materially greater than the present value the service provider otherwise could have elected to receive absent such risk of forfeiture, then the amount may be viewed as subject to a substantial risk of forfeiture.

A recent Chief Counsel Advice (“CCA”) addressed an arrangement where an employee entered into an agreement to defer $15,000 of the employee’s salary that otherwise would have been paid to the employee in 2015. The deferred amount under the agreement is to be paid in a single lump sum on January 1, 2018, but only if the employee continues to provide services to the employer through December 31, 2017. Under the agreement, the employer agreed to match 25% of the employee’s salary deferrals.

The CCA concludes that, because the present value of the amount deferred on behalf of the employee is 25% greater than the amount the employee otherwise could have elected to receive absent the risk of forfeiture, all amounts deferred under the agreement are treated as being subject to a substantial risk of forfeiture through December 31, 2017. Since the deferred amounts are to be paid January 1, 2018, amounts payable under the agreement should be exempt from Section 409A. (CCA 201645012)

Walmart Settles Same Sex Benefit Dispute

Cote v. Walmart Stores, Inc. (D. Mass.) proposed settlement

Walmart recently settled a class action lawsuit claiming the company unlawfully discriminated against current and former gay and lesbian employees by not offering medical benefits to same sex spouses from 2011 through 2013. The proposed settlement is for $7.5 million and must be approved by a federal judge. The class action claimed that Walmart violated Title VII of the Civil Rights Act, the Equal Pay Act, and the Massachusetts Fair Employment Practices Law. The complaint alleged that Walmart violated these federal and state laws because its prior policy constituted a sex-based classification, sex-based stereotyping, and sex-based associational discrimination. Walmart began offering same sex spousal coverage in 2014. Cote v. Walmart Stores, Inc. (D. Mass.) proposed settlement.

Court Halts ERISA Suit Regarding Welfare Fund’s Benefit Caps

Soehnlen v. Fleet Owners Insurance Fund (6th Cir. 2016)

Superior Dairy, Inc., its president-CEO, and union steward, brought a suit against the Fleet Owners Insurance Fund (the “fund”), a multi-employer welfare benefit plan, alleging, among other things, that the fund violated the Employee Retirement Income Security Act of 1974 (“ERISA”) by imposing annual and lifetime benefit limits in violation of the Patient Protection and Affordable Care Act of 2010 (“ACA”). The Sixth Circuit Court of Appeals, in affirming a district court ruling, held that, regardless of whether the benefit caps existed, the plaintiffs lacked standing to sue because they did not demonstrate an injury-in-fact. The court explained that an injury-in-fact must be (1) concrete and particularized and (2) actual or imminent, not speculative or hypothetical. Here, the court found that the plaintiffs argued in “extreme generalities,” failing to demonstrate any actual or real risk of harm. Simply arguing that the benefit caps existed without more, the plaintiffs could not satisfy the concreteness prong of the injury-in-fact showing. Accordingly, the plaintiffs lacked standing to sue the fund under ERISA for monetary and injunctive relief. Plaintiffs also brought fiduciary breach claims under ERISA against the fund’s trustees, alleging that they exposed the plan to possible future enforcement action and liability of $15 million in the future. The court similarly dismissed this allegation for lack of standing, finding that the plaintiffs had not shown any actual or imminent harm to the fund. The court found that alleging a speculative risk of an enforcement action, rather than showing that a penalty was imposed, paid, or at least contemplated, was too speculative to demonstrate an injury-in-fact. Soehnlen v. Fleet Owners Insurance Fund (6th Cir. 2016).