Symetra’s response to the IRS Memo regarding tax treatment of benefits

On January 20, 2017, the Office of Chief Counsel of the IRS issued a field assistance memorandum (Memo) addressing the tax treatment of fixed indemnity health plans. The Memo seems to conclude that all benefits paid under such plans are taxable if the premiums are paid with pre-tax employer contributions or pre-tax employee salary reduction contributions through a cafeteria plan. This conclusion is inconsistent with current controlling law under Internal Revenue Code Section 105, which allows benefit amounts paid under a pre-tax funded fixed indemnity health policy to be received tax free, but only up to the amount of otherwise unreimbursed medical expenses.

This advisory provides a summary of Symetra’s position with respect to the impact of the Memo.¹ We are confident that, despite the Memo’s overly broad conclusions, it does not disturb existing law regarding the tax treatment for our fixed indemnity health products.

Why did the IRS issue the Memo? 
The Memo was issued in response to a request by IRS field agents to provide assistance and guidance to address certain abusive practices associated with hybrid wellness/self-funded health indemnity coverage arrangements under review by the IRS (e.g., arrangements that provided disproportionally large self-insured indemnity benefits triggered by discretionary non-medical events such as calling a fitness trainer.)  

What is the existing law? 
Sections 105 and 106 of the Internal Revenue Code (IRC) provide the general tax rules for the taxation of employer (including pre-tax salary reduction) funded medical insurance. Specifically, employer-funded medical insurance is exempt from tax in two ways

• First, with respect to funds used to pay premium, IRC Sec. 106 provides that when an employer pays employee premiums for accident or health coverage, employees can exclude the amount from gross income. In addition, under IRC Sec. 162, the employer can take a deduction for such premiums as a business expense. Similarly, when an employee pays premium via salary reduction (also treated as employer paid) the premium amount is excluded from the employee’s gross income.
  
  
• Second, with respect to the value of policy benefits received, IRC Sec. 105(b) provides that benefits received by the employee can be excluded from the employee’s gross income to the extent such amounts represent direct or indirect reimbursement for expenses actually incurred for medical care. A separate section (IRC Sec. 104 (a) (3)) provides a similar tax exclusion for policy benefits when employees pay for coverage on an after-tax basis.

How do the general tax rules for medical insurance apply to fixed indemnity insurance?

Fixed indemnity health insurance is included in the definition of medical insurance even though such products pay a fixed benefit without regard to the amount of expense incurred (e.g., because the benefit is not limited to the amount of out-of-pocket cost). IRC Sec. 105(b) is applicable even though such amounts may be paid without proof of the amount of the actual expenses incurred, as provided in Treas. Reg. 1.105-2.

The IRS specifically addressed fixed indemnity medical benefits in a 1969 Revenue Ruling (Rev. Rule 69-154), which clarified, consistent with tax regulations under Section 105 (Treas. Reg. 1.105-2), that fixed indemnity benefit payments are treated as reimbursement to the extent the benefit is triggered by a medical expense and does not exceed the expense incurred. Accordingly, the exclusion from taxable income is limited to the amount of unreimbursed medical expense only. 

How does this apply to Symetra’s fixed indemnity health insurance products?
Symetra’s fixed indemnity health products require a triggering medical event, such as a doctor’s office visit, before a benefit is paid. We believe this continues to satisfy the correlation between benefit payment and the occurrence of medical care required by existing law, in order to support exclusion of some portion of the benefit from gross income.

Why is there no mention in the Memo about these prior rulings under existing law?
We cannot know for sure. Perhaps the IRS was so focused on the specific programs under review that it stated the rules in overly broad terms.  

What are the next steps for the Memo?
The Memo was issued to provide internal assistance and guidance to the IRS staff. Technically, it is not law. There have been some informal statements that its overly broad conclusion may be revisited. In any event, without more formal guidance (e.g., in the form of a regulatory change binding on all taxpayers) it remains an informal position and not law. 

Does Symetra suggest any change in how its policies are implemented, such as allowing only post-tax premium contributions?
Symetra cannot provide tax or legal advice. Nonetheless, we do not believe it is appropriate to restrict the policyholder’s choice regarding the funding of premium payments. Policyholders should consult their employee benefit advisers if they wish to re-evaluate whether they exclude or include the value of premium payments or benefits received in an employee’s gross wages.  

Does Symetra plan any further action?
Symetra will continue to monitor developments in the law and will evaluate operational practices as necessary.