IRS Clears the Air on Taxation of Fixed-Indemnity Benefits: What Employers Need to Know
The Internal Revenue Service (IRS) has finally provided long-awaited clarity on the tax treatment of fixed-indemnity benefit payments, and the message is clear: wellness payments that are not tied to actual medical expenses are taxable wages.
For employers who have been approached by promoters offering “double-dip” fixed-indemnity wellness plans that promise significant payroll tax savings, this guidance serves as a critical warning. This comprehensive guide explains what the IRS has said, why these arrangements are problematic, and what employers should do to stay compliant.
What Are Fixed-Indemnity Wellness Plans?
Fixed-indemnity insurance is a type of health plan that makes predetermined cash payments to insured individuals on a per-period or per-incident basis[citation:9]. These payments are triggered by specific health-related events—such as a doctor visit, hospital confinement, or participation in wellness activities—but the benefit amount is fixed and does not depend on actual medical costs incurred.
Under the arrangements that have drawn IRS scrutiny, employees pay premiums through pretax salary reductions under a Section 125 cafeteria plan[citation:5]. In return, the plan pays employees fixed cash benefits—often $1,000 per month—for completing simple health or wellness activities, such as getting a flu shot or completing a health risk assessment[citation:5][citation:9].
The promoters of these plans have marketed them as a way to convert taxable wages into tax-free health benefits, reducing payroll taxes for both employers and employees[citation:2]. But the IRS has now made clear that these promises are too good to be true.
The IRS Chief Counsel Memorandum: CCA 202323006
On June 8, 2023, the IRS Office of Chief Counsel released Chief Counsel Advice Memorandum 202323006 (CCA 202323006), which directly addressed the tax treatment of wellness indemnity payments made under employer-funded fixed-indemnity insurance policies[citation:4].
The memorandum analyzed a typical arrangement where:
- An employer provided comprehensive health coverage to employees
- Employees could voluntarily enroll in a fixed-indemnity wellness policy
- Employees paid $1,200 monthly premiums through pretax salary reductions via a Section 125 cafeteria plan[citation:4]
- The policy paid a $1,000 wellness benefit for participating in health-related activities (limited to one payment per month)[citation:4]
- The policy also paid benefits for each day the employee was hospitalized[citation:4]
Under the terms of this plan, employees could receive the wellness benefit even if the qualifying activity cost them nothing out-of-pocket (e.g., because the activity was covered by their comprehensive health insurance or was offered at no cost)[citation:4].
The IRS’s Key Conclusions: Wellness Payments Are Taxable Wages
The IRS reached three primary conclusions in CCA 202323006.
1. Wellness Indemnity Payments Are Included in Gross Income
The IRS determined that wellness indemnity payments are includible in the employee’s gross income under Section 105(a) because the premiums were paid with pretax dollars, making them attributable to employer contributions[citation:4][citation:9].
The IRS further concluded that the exclusion under Section 105(b)—which applies to amounts paid to reimburse employees for medical expenses—did not apply. Why? Because the wellness payments were made regardless of whether the employee incurred any medical expenses[citation:4][citation:9]. Under Treasury Regulation Section 1.105-2, the Section 105(b) exclusion “does not apply to amounts which the taxpayer would be entitled to receive irrespective of whether or not he incurs expenses for medical care”[citation:9].
In short: no unreimbursed medical expenses means no tax-free treatment.
2. Wellness Payments Are Subject to FICA, FUTA, and Income Tax Withholding
The IRS also concluded that the wellness indemnity payments constitute “wages” for purposes of:
- Federal Insurance Contributions Act (FICA) (Social Security and Medicare taxes)
- Federal Unemployment Tax Act (FUTA)
- Federal Income Tax Withholding (FITW)[citation:5][citation:9]
The IRS analyzed and rejected several potential exceptions. The payments did not qualify as sick pay because they were not tied to an absence from work. They were not received under a workers’ compensation law. And they were not payments for medical or hospitalization expenses in connection with sickness or accident disability[citation:4][citation:9].
3. The Triple Tax Advantage Does Not Apply
Perhaps most importantly, the IRS made clear that the “double dip” or “triple dip” tax advantages promoted by plan vendors do not exist. The payments are not exempt from income tax, FICA, or FUTA simply because they are routed through a fixed-indemnity policy[citation:8].
Why the IRS Is Cracking Down: The “Double Dip” Problem
According to The CPA Journal, the “double dip” refers to a plan in which both premiums and benefit payments are purportedly exempt from taxation—a proposition that is naturally enticing to employers and employees alike[citation:8].
As one legal analysis explains, under a typical double dip arrangement:
“An employee takes an $800 pretax salary reduction under an IRC section 125 cafeteria plan. The Plan then reimburses $720 if the employee completes a simple health-related activity, like a medical survey. This $720, now considered a nontaxable reimbursed medical expense, is added back to the paycheck. At the end of the transaction, employees are left with more in their paycheck, while employers benefit from reduced tax obligations.”[citation:8]
The problem, as the IRS has now firmly established, is that this structure does not comply with the tax code. The benefits are not reimbursements for actual medical expenses—they are simply a return of the employee’s own wages, relabeled as tax-free health benefits.
The Proposed Regulations: What Almost Changed
Following the release of CCA 202323006, the Treasury Department announced plans to amend regulations to “clarify” the treatment of fixed-indemnity plans. On April 3, 2024, proposed regulations were published that would have provided that indemnity plan benefits are taxable if either:
- The plan is funded with pretax contributions, or
- Benefits are paid without regard to the actual amount charged for medical care[citation:8]
However, in response to numerous comments, the Treasury Department withdrew the proposed regulations in April 2024, indicating a need to further develop guidance[citation:8]. The withdrawal stated that the government’s concerns “have recently escalated” and pledged that “IRS compliance efforts regarding exclusions from gross income under section 105(b) … will continue”[citation:8].
Important takeaway: The withdrawal of the proposed regulations does not mean the IRS approves of these arrangements. In fact, the IRS explicitly warned employers not to view the withdrawal as a safe harbor[citation:2].
Red Flags: How to Spot a Problematic Fixed-Indemnity Plan
According to legal experts at Steptoe LLP, employers should be wary of any plan that exhibits the following red flags[citation:2][citation:3]:
- Promises of substantial payroll tax savings from “wellness” cash benefits
- Fixed monthly payments made without proof of actual medical expenses
- Reliance on CPT codes or activity “check-the-box” attestations in lieu of substantiation of medical expenses
- Testimonials or assurances implying IRS “blessing” of the arrangement
- Legal opinions not addressed to your organization that disclaim reliance
The Groom Law Group notes that this is the fourth CCA the IRS has released on this topic (following CCAs 201622031, 201703013, and 201719025), demonstrating that this is an area of continued IRS focus[citation:4].
Potential Penalties for Noncompliance
Employers who adopt problematic fixed-indemnity plans face significant risks. According to Mondaq, if challenged by the IRS, employers may face[citation:2]:
- Back taxes and unpaid FICA and Medicare taxes
- Accuracy-related penalties up to 20% of underpaid taxes
- Compounding interest on all amounts due
- Potential fiduciary liability under ERISA (if plan participants sue)[citation:2]
The Tax Adviser warns that “the line between legal tax minimization and illegitimate schemes is not always clear, leaving some businesses at risk for significant civil and, in some cases, criminal penalties”[citation:8].
What About Traditional Fixed-Indemnity Plans?
It is important to distinguish between the problematic wellness arrangements and traditional fixed-indemnity plans. Traditional fixed-indemnity plans—such as hospital indemnity insurance, cancer-only policies, and critical illness insurance—are designed to provide replacement income for workers dealing with illness or injury[citation:7][citation:8].
According to the Society of Actuaries, these traditional noncoordinated benefits (NCBs) “are designed to pay for extraordinary medical expenses not covered by major medical insurance, like copays, deductibles, and travel for medical care”[citation:7].
However, even traditional fixed-indemnity plans have faced scrutiny, and proposed regulations would have applied similar rules to all fixed-indemnity arrangements[citation:7]. The key distinguishing factor is whether the benefit payment is tied to actual incurred medical expenses or is paid regardless of expenses.
For employers offering traditional fixed indemnity coverage, the Grant Thornton analysis suggests that these benefits may also face increased IRS scrutiny[citation:5].
What Employers Should Do Now
Given the IRS’s clear position, employers should take the following steps:
1. Review Existing Wellness Plans
If your organization currently offers a fixed-indemnity wellness plan that pays benefits without requiring proof of actual medical expenses, consult with tax counsel to assess compliance risks.
2. Avoid Promoter Claims of IRS Approval
According to legal experts, “We are unaware of the IRS blessing any of these arrangements, and any assertions to the contrary should be closely scrutinized”[citation:2]. Do not rely on promoter-provided legal opinions.
3. Consider Alternative Tax-Advantaged Benefits
For employers seeking tax-advantaged ways to support employee wellness, consider compliant alternatives such as:
- Health Savings Accounts (HSAs) paired with high-deductible health plans
- Health Reimbursement Arrangements (HRAs) that reimburse actual medical expenses
- Wellness programs that offer de minimis benefits (e.g., water bottles or T-shirts)
- Employer contributions to comprehensive health coverage
Learn more about conducting a benefits audit to ensure your wellness offerings are compliant.
4. Consult Qualified Tax Advisors
Before implementing any fixed-indemnity arrangement, have your own counsel or tax advisor review the exact facts. According to Treasury regulations, “Taxpayers may avoid tax penalties if they act in good faith and reasonably rely on an opinion issued by an independent advisor that addresses all relevant facts”[citation:2]. Promoter materials and generic legal opinions will not suffice.
Conclusion: IRS Has Spoken—Wellness Payments Are Taxable
The IRS has now issued multiple Chief Counsel Memoranda, proposed regulations (later withdrawn but signaling intent), and consistent public statements making clear that fixed-indemnity wellness benefit payments are taxable wages when not tied to actual medical expenses[citation:4][citation:5][citation:8].
Employers who have been approached by promoters offering “double dip” tax savings should proceed with extreme caution. The promised tax benefits do not exist, and the risks of back taxes, penalties, and interest are substantial.
As Mondaq concludes: “Employers should avoid arrangements that purport to convert taxable wages into tax-free ‘wellness’ cash payments. As the saying goes, if it sounds too good to be true, it probably is.”[citation:2]
Please note: This blog is for informational purposes only and is not a substitute for professional tax or legal advice. Always consult with a qualified tax professional regarding your specific situation.
Key Takeaways
- The IRS Chief Counsel Memorandum 202323006 concludes that wellness indemnity payments under fixed-indemnity policies are taxable wages subject to income tax, FICA, and FUTA[citation:4][citation:5]
- Wellness payments are not eligible for the Section 105(b) exclusion because they are paid regardless of whether the employee incurs medical expenses[citation:4]
- The so-called “double dip” tax savings promoted by plan vendors do not exist—benefits are not tax-free simply because premiums were paid pretax[citation:8]
- Red flags include promises of substantial payroll tax savings, fixed monthly payments without proof of expenses, and claims of IRS approval[citation:2]
- Noncompliance risks include back taxes, penalties up to 20%, interest, and potential ERISA fiduciary liability[citation:2]
- The IRS has issued four CCAs on this topic (201622031, 201703013, 201719025, and 202323006), signaling continued enforcement focus[citation:4]
- Proposed regulations were withdrawn in April 2024, but the IRS explicitly warned that the withdrawal is not a safe harbor and compliance efforts will continue[citation:8]
- Traditional fixed-indemnity plans (hospital indemnity, cancer, critical illness) may also face increased scrutiny[citation:7]
- Employers should consult independent tax counsel before implementing any fixed-indemnity wellness arrangement[citation:2]
- Resources: CCA 202323006 (PDF), IRS.gov
This comprehensive guide was published on May 21, 2026. Sources include IRS Chief Counsel Advice 202323006, Grant Thornton, Groom Law Group, Steptoe LLP, Mondaq, The CPA Journal, The Tax Adviser, and the Society of Actuaries.
