IRS Issues Proposed Regulations on Tax Treatment of Certain Health Insurance Payments
The IRS recently issued proposed regulations REG-120730-21 clarifying the tax treatment of certain health insurance payments.
The proposed regulations clarify the Sec. 105(b) exclusion from gross income does not apply to amounts received by an employee from accident or health insurance that pays an amount or distributes a benefit without regard to the actual amount of Sec. 213(d) medical expenses, where the premiums for coverage were paid on a pre-tax basis. Under this rule, amounts that would not be excluded from an employee's gross income are wages subject to FICA, FUTA and income tax withholding.
In addition, the proposed regulations clarify that for amounts to be excluded from income under Sec. 105(b), the payment or reimbursement must be substantiated. The IRS noted some have interpreted the existing language to mean that substantiation is not required.
Sec. 105(b) excludes benefits obtained from employer-provided accident or health insurance if those amounts are paid to reimburse an employee for expenses incurred for medical care of the employee, the employee's spouse, the employee's dependents, or the employee’s children aged 26 or younger irrespective of whether they are dependents.
In the proposed regulations’ preamble, the IRS explained that it interprets Sec. 105(b) "to not apply to benefits paid without regard to the actual amount of incurred and otherwise unreimbursed section 213(d) medical expenses. Because payment of these amounts is not a reimbursement of section 213(d) medical expenses, the amount of reimbursement is immaterial, with the result that the payment is not excluded from gross income under section 105(b) of the Code. The benefits would, therefore, be included in the taxpayer's gross income."
According to the preamble, this interpretation applies even when the taxpayer uses the money to pay medical expenses: "For example, even if a benefit payment is used to reimburse an employee's medical expenses, if the amount of the payment is not tied to the amount of the expense incurred and the employee is entitled to keep any amounts by which the benefit payment exceeds the incurred expenses, that would indicate that the benefit is not actually a reimbursement for medical expenses.”
The IRS has said it is proposing these amendments in response to questions about the proper tax treatment of arrangements, commonly sold as fixed-indemnity excepted-benefits coverage or specified-disease excepted-benefits coverage, that characterize income replacement benefits or other cash benefits as amounts paid for reimbursement of medical care, even though those amounts are paid without regard to the actual amount of any incurred, and otherwise unreimbursed, medical expenses.
The IRS stated the amendments would apply as of the later of the date of publication of the final regulations or Jan. 1, 2024.