FICA Wellness & SIMERP: Tax Savings vs. Compliance Risk

In a competitive labor market, employers are understandably looking for ways to stretch benefit dollars while enhancing the employee value proposition. Recently, we have seen a renewed marketing activity around so-called "FICA savings" arrangements that promise to reduce employment taxes while maintaining or even increasing employees' take-home pay. 

Prefer a quick overview? Watch our Employer Compliance in Focus video for a concise breakdown of FICA wellness and SIMERP arrangements, how the IRS views these tax-saving structures, and key compliance considerations employers should review before adopting or renewing a program.

These programs sound attractive. Many are presented as a way to convert taxable wages into tax-favored health benefits, generating payroll tax savings for both the employer and employees. However, the IRS has repeatedly scrutinized arrangements that attempt to recharacterize taxable compensation as tax-free accident or health plan benefits, particularly where payments are made without regard to actual unreimbursed medical expenses.   

The bottom line: Traditional fixed indemnity coverage can be a legitimate benefit, but arrangements marketed primarily as payroll tax savings vehicles deserve careful review before implementation.  

Understanding the Appeal 

Many of these programs are built around some combination of:  

• A Section 125 cafeteria plan; 
• A fixed indemnity or self-funded health-related benefit arrangement; 
• A wellness program or health engagement activity; and 
• Recurring cash payments to employees after they complete relatively simple wellness-related tasks. 

Common examples of triggering activities may include: 

• Completing a health assessment 
• Watching an educational video 
• Participating in a wellness coaching session 
• Speaking with a healthcare professional; or  
• Completing a preventive care or wellness activity 

The marketing pitch is often straightforward: employees make pre-tax salary reductions, receive tax-free wellness or indemnity payments, and end up with the same, or even better, net take-home pay. Employers, in turn, may be told they can reduce FICA taxes without materially changing their overall compensation structure.  

That promise is also what makes these arrangements sensitive.  The federal tax rules do not allow every payment made through or alongside a health plan to be treated as tax-free.  

Traditional Fixed Indemnity Coverage vs. FICA Savings Arrangements 

Traditional fixed indemnity insurance has long existed as a legitimate supplemental health benefit. A traditional fixed indemnity policy pays a predetermined amount when a covered event occurs, regardless of the actual medical charges incurred. For example, a policy might pay $100 per day during a hospital stay.  

However, the tax treatment of benefits depends heavily on how the coverage is funded.  

After-Tax Employee-Paid Coverage 

If employees purchase fixed indemnity coverage with after-tax dollars, benefits may generally be received tax-free.  IRS guidance commonly distinguishes this after-tax structure from arrangements funded by employer contributions or pre-tax salary reductions.  

Employer-Funded or Pre-Tax Coverage 

The analysis changes when premiums are paid by the employer or through employee pre-tax salary reductions. In that case, benefits generally are tax-free only to the extent they reimburse actual medical care expenses that the employee incurred, and that were not otherwise reimbursed. For example, if an employee incurs $30 of unreimbursed medical expenses and receives a $200 fixed indemnity payment, only $30 may be excludable; the remaining $170 would generally be taxable. 

This is the key compliance concern with many FICA reduction wellness and SIMERP-style programs: employees may receive fixed cash payments for completing wellness activities, regardless of whether they incurred any unreimbursed medical expenses.  

What the IRS Has Been Saying 

The IRS has consistently scrutinized arrangements designed primarily to create payroll tax savings rather than provide true health coverage. 

Several IRS memoranda have addressed benefit structures in which employees received payments funded through employer contributions or pre-tax salary reductions without a connection to actual unreimbursed medical expenses. In each instance, the IRS concluded that the payments were generally taxable wages subject to income tax withholding and employment taxes.  

The IRS's position is based on a fundamental principle: not every payment made under an accident or health plan automatically qualifies for tax-favored treatment. To exclude benefits from income, the payments generally must reimburse actual qualifying medical expenses.  

Compliance Risks Extend Beyond Taxes 

FICA exposure is often the headline issue, but it is not the only consideration. Depending on the structure, a wellness, fixed indemnity, or SIMERP-style arrangement may also raise issues under:  

• Affordable Care Act (ACA) market reform rules 
• ERISA 
• COBRA 
• HIPAA and wellness program rules 
• Health FSA rules 
• Cafeteria plan documentation and operation 
• Form W-2 reporting 

IRS guidance has also noted that employers participating in these types of arrangements may face back income and employment tax assessments and reporting penalties if payments were improperly excluded from wages.  

The Bottom Line 

Employers do not need to avoid all fixed indemnity or wellness-related benefits. Properly designed programs can play a valuable role in an overall benefits strategy. But arrangements marketed as generating FICA savings by converting taxable wages into tax-free wellness or indemnity payments should be reviewed carefully. 

When payments are funded with employer dollars or pre-tax salary reductions and are made without regard to actual unreimbursed medical expenses, IRS guidance has consistently viewed those payments as taxable income and employment-tax wages. Employers considering these programs should evaluate the tax, payroll, and employee benefits compliance implications before signing on. 

Connect with a OneDigital Benefits Consultant to review your current program and assess the tax, payroll, and compliance implications before adopting or renewing a fixed indemnity or wellness-related arrangement.