These days, it seems that every major employer maintains some form of wellness program. The goal of these programs is simple: encourage employees to make healthier lifestyle choices and thereby control health-care costs. But wellness programs confront myriad legal restrictions. Employers are generally aware of the rules that prohibit discrimination based on age, disability, genetic information, and health factors. Often overlooked, however, are the tax implications to both employers and employees of certain wellness-program designs.
The following example looks at a wellness program designed to encourage employees to stop smoking, and shows how differences in design can have different tax implications.
HIPAA Excise-Tax Implications
Let’s say an employer wants to impose a health-care premium surcharge on employees who smoke. Nondiscrimination rules under the Health Insurance Portability and Accountability Act (HIPAA) generally prohibit health plans from imposing different co-pays, deductibles, or other cost-sharing provisions on the basis of any health factor (such as health status, medical condition, and medical history). A health plan that imposes a premium surcharge on employees who smoke is subject to these nondiscrimination rules because the surcharge is based on a health factor (nicotine addiction is considered to be a medical condition).
In order to satisfy HIPAA nondiscrimination rules, the smoker surcharge generally may not exceed the amount of the employee-only coverage by more than 20%. In other words, if standard employee-only coverage is $500 per month in 2012, the smoker surcharge could not be more than $100 per month.
If an employee has a nicotine addiction and can demonstrate that it would be unreasonably difficult to stop smoking, the employee must be offered a reasonable alternative way to avoid the surcharge. One example of a reasonable alternative would be to require the employee to attend a smoking-cessation program. An employee who opts for that alternative would qualify for the lower premium amount even if after completing the program, the employee continues to smoke. Moreover, all plan materials must disclose the alternative, and employees must be able to qualify for the discount at least once a year.
If the smoker-surcharge program does not satisfy the HIPAA nondiscrimination rules — for example, if the employer does not offer a reasonable alternative way to avoid the premium surcharge — the employer owes the Internal Revenue Service an excise tax of $100 per day per affected person. That tax is capped at the lesser of $500,000 or 10% of the employer’s health-care costs. Failure to report the excise tax delays the three-year limitations period on the IRS’s ability to assess taxes.
Income and Employment Tax Implications
The HIPAA nondiscrimination rules and the related excise tax do not apply to wellness plans that reward participation rather than achievement of a particular health standard. For example, an employer could pay for employees to complete a smoking-cessation program, or provide a gift card to employees who complete the program, as a way to encourage employees to stop smoking. Although that would avoid the potential excise tax associated with failure to comply with HIPAA nondiscrimination rules, it nonetheless has tax implications.
Income and employment tax issues arise when a wellness program provides rewards, such as gift cards, to employees. As a general rule, the value of a reward is treated as taxable wages and subject to payroll taxes (i.e., Social Security and Medicare taxes and federal/state income-tax withholding) unless a specific exemption allows the reward to be provided on a tax-free basis. There is no exemption as such under federal tax laws simply because a reward is not paid in cash or because it is designed to promote employees’ general health.
In most cases, wellness rewards need to qualify as an employer-provided health benefit or “de minimis” fringe benefit (which excludes cash or cash equivalents) to be provided on a tax-free basis. For example, if the employer pays the cost of a smoking-cessation program, it may do so on a tax-free basis through the employer’s health plan. On the other hand, if the employer provides a gift card to those employees who complete the program, the gift card may be considered a “cash equivalent” and treated as taxable wages.
Because the employee rewards under wellness programs are often considered nominal, many employers overlook the tax implications. However, employees generally view wellness-plan rewards as nontaxable benefits, so the triggering of income inclusion is likely to be an unwelcome surprise. Furthermore, rewards that are taxable generally are subject to employment-tax withholding, even noncash rewards in some cases. Employers may have residual tax liability if the rewards are provided without proper tax withholding.
Meanwhile, be aware that in addition to HIPAA and the various other employment-law considerations, there may also be serious tax-law implications associated with the design and implementation of a wellness program. Failure to comply with the relevant tax rules can be costly, and failure to deliver a benefit to employees in a tax-favored manner could, at best, cause morale problems and, at worst, undermine the viability of the program.
Elizabeth Drake and Gary Quintiere are attorneys with Miller & Chevalier in Washington, D.C., practicing in the areas of employee benefits and executive compensation. They help clients develop workable solutions to difficult and sensitive issues related to retirement, health-and-welfare, and executive-compensation programs.