Employer reimbursements to employees for salary-reduction amounts used to pay health insurance premiums were not excludible.

• Author: Fiore, Nicholas J.

Employer M provides health coverage for its employees through a group health insurance policy. The coverage is accident or health coverage for purposes of excluding employer-provided accident or health coverage under Sec. 106(a).

M has a payroll arrangement under which employees' salaries are reduced, and M applies the salary-reduction amounts to the payment of the health insurance premiums for employees. Thus, employees receive lower salaries in exchange for employer-provided health coverage.

In addition, M makes "reimbursement" payments to employees for the health insurance premiums in amounts that cause employees' after-tax pay from M to be the same as if there were no salary reduction and no reimbursement payments. M takes the position that both the salary reduction and the reimbursement payments are excluded from employees' gross income and not subject to FICA or FUTA taxes.

The salary reduction used to pay for health insurance premiums under M's payroll arrangement could be done with or without employee elections. For example, M could make a unilateral decision to reduce employees' salaries and use those amounts to provide health insurance to employees. Alternatively, M could offer employees the choice under a Sec. 125 cafeteria plan to reduce their salaries to receive employer-provided health insurance.

Analysis

In general, under Sec. 106(a), an employee's gross income does not include employer-provided coverage paid under an accident or health plan. Under that section, an employee may exclude premiums paid for accident or health insurance coverage by an employer. Also, under Sec. 105(b), an employee may exclude amounts received through employer-provided accident or health insurance, if those amounts reimburse expenses incurred by the employee for medical care (of the employee, his spouse or dependents) for personal injuries or sickness.

To the extent amounts are excluded from gross income under Sec. 105(b) or 106(a), they are also excluded from income tax withholding under Sec. 3401. In addition, amounts paid to reimburse expenses incurred by an employee for medical care (of the employee, his spouse or dependents) for personal injuries or sickness are also excluded from FICA and FUTA taxes under Secs. 3121(a) and 3306(b).

Under Sec. 125, an employer may establish a cafeteria plan that permits an employee to choose among two or more benefits, consisting of cash (generally, salary) and qualified benefits, including accident or health...