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Severe penalties for not reporting cash, ‘cash equivalent’ incentives as income
Wellness incentive cash payments and “cash equivalents”—ranging from gift cards to subsidized gym memberships—are not excludable from taxation as a medical benefit, the IRS is reminding employers.
The IRS recently issued a chief council advice (CCA) tax memorandum that addressed confusion over the taxation of incentives for participating in worksite wellness programs. In
CCA 201622031, the IRS held that reportable gross income for an employee includes:
The tax memorandum “signals that the IRS is looking at these issues,” said Garrett Fenton, an attorney with Miller & Chevalier in Washington, D.C., and it underscores how important it is for employers to ensure that they are compliant with all tax withholding and reporting requirements under the tax code.
Wellness program incentives sometimes have “flown under the radar with employers,” Fenton noted, and there may be insufficient communication between HR, which typically oversees wellness programs, and the CFO’s office, responsible for tax reporting.
Often, “there is the mistaken thinking that if an incentive is part of a wellness program, it should be excludable under tax code Section 105 or Section 106 as a medical benefit, but that’s not the case,” Fenton said.
“The general rule states that any award or prize given by an employer is taxable to an employee as wage, to be included on their W-2 and subject to federal tax withholdings, as well as Social Security and Medicare taxes,” Robert Frutchey, CPA, a health benefits consultant with Brentwood, Tenn.-based Cowan, a benefits brokerage and consultancy,
posted online. “This really can sap the motivation out of any award,” he warned.
There are a few exceptions that make these otherwise taxable awards nontaxable, Frutchey noted. “The one that best applies to wellness programs is the ‘de minimis award’ rule,” he said. “The IRS states that a de minimis award is one of nominal value and is provided infrequently. Most importantly, these awards can be excluded from an employee’s wage.”
But employers may wrongly assume that a $25 or $50 gift card is de minimis and that the IRS isn’t going to care about it. “What [the tax memorandum] hammers home is that there is no de minimis exception for cash or a cash equivalent gift,” Fenton said. “It doesn’t matter if it’s a $1 gift card in theory. It would be taxable and subject to withholding and reporting if you’re distributing those types of gift cards to employees.”
The memorandum specifically mentions payments of gym membership fees, which must be included as taxable income.
Penalties for failing to report cash and cash equivalent incentives as income can be severe, Fenton cautioned. “The real risk is that an employer that fails to include the taxable incentive in wages as they should, in box 1 of Form W-2, could be looking at information reporting penalties assessed per employee per return, which can get pretty steep,” he pointed out. Also, if employers fail to provide withholding on taxable incentives, “you’ve got potential penalties there as well,” Fenton said.
The IRS also could pursue employees who received but never paid taxes on these incentives, creating employee relations issues.
T-Shirts and Trinkets
Certain benefits, however, can be excludable from taxation as de minimis, which the IRS alert acknowledges, including logo-branded T-shirts and other items that are administratively burdensome to value.
With regard to “squeezable stress balls, water bottles, trinkets and other small giveaways, especially when they have logos on them, you could argue these are administratively difficult to value and qualify as a de minimis exception,” Fenton said.
A related issue the IRS has yet to address but that could trip up employers, he added, involves providing de minimis giveaways—“whether a T-shirt, keychain or what have you”—to employees who enroll in group medical coverage through an employer’s cafeteria plan. Said Fenton, “There could be an argument that the employee has effectively purchased that item with pretax dollars through the cafeteria plan, which could be problematic” from a tax standpoint, “although the IRS has never really addressed it.”
HSA Contributions Not Taxable
Some employers make wellness incentive payments directly to employees' health savings accounts (HSAs). Generally, contributions made by an employer to an HSA of an eligible employee are
excludable from an employee's income and are not subject to federal income tax, Social Security or Medicare taxes.
Stephen Miller, CEBS, is an online editor/manager for SHRM.
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