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Compliance Matters: Specified Illness or Fixed Indemnity Plan Premiums – To Tax or Not to Tax?

Don't miss our blog series, Compliance Matters! In the blog below, you'll learn more about the Specified Illness or Fixed Indemnity Plan Premiums. Download this article.

Myth: Specified illness and fixed indemnity plan premiums may not be paid on a pretax basis. These are policies such as critical illness, accident, cancer, etc. which pay a fixed dollar amount for a specific diagnosis, illness, or treatment regardless of the medical expenses the individual incurs.

Fact: Permitted benefits in the 2007 proposed cafeteria plan regulations include:

  • Coverage for a specified disease or illness, including payments at initial diagnosis of the specified disease or illness, and progressive payments of a set amount per month following the initial diagnosis (sometimes referred to as progressive diagnosis payments); and
  • Payment of a fixed amount per day (or other period) of hospitalization.

However, there is a requirement in the Code of Federal Regulations (26 CFR 1.105-2) which may create a potential tax consequence when these benefits are offered pre-tax, therefore the conservative approach is to have specified illness and fixed indemnity plan premiums paid on a post-tax basis.

Most specified illness or fixed indemnity health coverage benefits pay a fixed dollar amount upon the occurrence of specified events, not when an employee incurs medical expenses. According to the rules, when premiums are paid for by the employer or on a pre-tax basis, (i.e. excluded from an employee’s gross income) then the benefit payment amounts received, (e.g. $100 for an office visit) may not exceed the amount of the actual expenses incurred for the medical care. If the amount received is greater than the cost incurred, the excess amount may need to be included in the employee’s gross income.

Example: If an employee participates in a pre-tax premium fixed-indemnity plan which pays $100 for each doctor’s visit but the employee only pays a $40 copay to see the doctor, the $60 may need to be included in the employees’ gross income and wages.

This can be an administrative burden for employers who are unlikely to know whether or when their employees receive taxable payments, because the benefit payment is provided to the employee by the insurance carrier, with no reporting to the employer.

When premiums are paid on a post-tax basis (e.g. included in an employee’s gross income) the benefit payment amounts would not be considered to be income to the employee.

Therefore, employers who are offering specified illness or fixed indemnity benefits on a pre-tax basis, may want to consider including employer-paid premiums in their employee’s gross income or offer the plans on a post-tax basis next plan year. Employers who are uncertain about the tax implications of their specified illness or fixed indemnity benefits should speak with a tax professional or legal counsel.

Additional Resources:

 

This content was written by Michelle Turner, MBA, CEBS, Compliance Consultant, Alera Group Central Region. This blog post intends to provide general information regarding the status of, and/or potential concerns related to, current employer HR & benefits issues. This blog should not be construed as, nor is it intended to provide, legal advice. The opinions expressed herein are based upon the author’s experience as a Compliance Consultant and may not reflect the opinions of your counsel.

The information contained herein should be understood to be general insurance brokerage information only and does not constitute advice for any particular situation or fact pattern and cannot be relied upon as such. Statements concerning financial, regulatory or legal matters are based on general observations as an insurance broker and may not be relied upon as financial, regulatory or legal advice. This document is owned by Alera Group, Inc., and its contents may not be reproduced, in whole or in part, without the written permission of Alera Group, Inc.

This article was last reviewed and up to date as of 01/07/21.

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