Pre-tax health insurance "reimbursements/loans" are taxable.

• Author: Packard, Pamela

In Rev. Rul. 2002-80, the IRS concluded that amounts paid to an employee as "advance reimbursements" or "loans," without regard to whether the employee has already suffered a personal injury or sickness, or incurred medical expenses, are not excludible from the employee's gross income. (This ruling amplifies Rev. Rul. 2002-3, on "reimbursements" of employee pre-tax contributions for health insurance; see Neuhauser and Gibson, Tax Clinic, "Reimbursements of Pre-Tax Health Insurance Contributions Are Taxable" TTA, May 2002, p. 298.)

In the more recent ruling, two employers designed their health plans so that a share of the insurance cost is contributed by the employee. Such contributions are pre-tax contributions made through salary reductions and are not subject to FICA and FUTA taxes. The employer applies the salary reduction amounts to the payment of the group health insurance policy during the year. To minimize the additional cost to the employee, the employer pays the employee amounts to equate the employee's after-tax pay with the pay had the additional salary reduction not occurred. In situation one, these payments are treated as advance reimbursements; in situation two, as loans.

Situation 1. M provides health coverage for its employees through a group health insurance policy that qualifies for the exclusion under Sec. 106(a). M has a payroll arrangement under which it reduces its employees' salaries and applies the salary reduction to the payment of the health insurance premiums. Thus, an employee receives a lower salary in exchange for employer-provided health coverage.

M makes advance-reimbursement payments in amounts that cause an employee's after-tax pay to be the same as if there were no additional salary reductions and no advance-reimbursement payments. During the year, the employee submits uninsured medical claims to M, who offsets the employee's advance-reimbursement account. To the extent an employee does not have uninsured medical expenses equal to the advanced reimbursements, M treats the excess advanced-reimbursement amounts as forgiven and as additional taxable compensation. M's position is that the salary-reduction and advance-reimbursement payments are excludible from its employees' gross income and not subject to FICA or FUTA.

Situation 2. The facts are the same as in Situation 1, except M "loans" money to the employee, which causes the employee's after-tax pay to remain essentially unchanged. The loans (which may or...