In today’s complex healthcare environment, compliance is paramount. Flex Health takes a proactive approach to ensure all aspects of its program adhere to relevant regulations and IRS guidelines. This article explores the compliance landscape of Section 125 and how Flex Health navigates it effectively.

To maintain compliance as a Section 125 program, several factors apply:

1. Fully Funded and Fully Insured: Partnering with an underlying group policy carrier is essential to remove liability and further extend employer-employee trust.
2. Department of Insurance License: Any health or wellness policy that employees pay for should be licensed and approved by the Department of Insurance in all 50 states.
3. Section 106(a) Compliance: This section allows for the exclusion of contributions toward and employer-provided coverage under an accident or health plan from an employee’s gross income.
4. Section 105(b) Compliance: This provision enables the exclusion of amounts received through employer-sponsored health programs from taxable income.
5. Section 213 Compliance: Allows employees to deduct certain medical expenses not covered by their health insurance
6. Revenue Ruling 69-154: An IRS rule from 1969 concluding that fixed indemnity payments from an insurance policy paid on a pre-tax basis are not taxable so long they are not an “excess benefit” (great than the beneficiaries unreimbursed medical expenses).

A self-funded Section 125 program or wellness plan does not use a carrier or insurance policy at its core. Self-funded programs receive pre-tax contributions directly from employees, co-mingling these funds to cover the cost of several healthcare vendors associated with the program, and later reimburse employees directly for their contributions. 

While self-funded plans can offer more lucrative tax savings, they often present severe compliance challenges:

• Limited Compatibility: Due to their murky compliance nature, self-funded plans are often incompatible with 200+ employee companies.
• Increased Audit Risk: As a result of the nature of the payments involved, self-funded plans expose companies to a greater risk of scrutiny and IRS audits.
• Self-funded plans are not fully funded or insured and don’t have approval from the Department of Insurance to operate as an insurance policy.
• Payment Tax Classification: Because employees are receiving a reimbursement rather than a claim/indemnity payment through the program, the taxability and whether these payments fall under Section 105(b) enters a gray area.

The May 9th, 2023 IRS memorandum/Chief Counsel Advice (CCA) has been a topic of discussion in the industry. The CCA focused on the taxability of employer-sponsored “wellness” plans. The CCA concludes that wellness indemnity payments under such policies are includible in the employee’s gross income if the employee has no unreimbursed medical expenses related to the payment.

It is important to keep in mind that an IRS CCA is not tax law, legally binding, or formal IRS code, but merely an IRS employee’s interpretation of the tax code. The interpretation has been met with criticism from tax experts as well as numerous firms brought under legal counsel by Flex Health. Below is a summary of these legal analyses and the flaws identified within the interpretation.

For one, the CCA incorrectly uses worker’s comp law to state that indemnity payments are taxable wages. The interpretation classifies various non-wage payments as wages simply due to the payment method (payroll systems for example) which is problematic and inconsistent with established tax principles.

Additionally, the CCA appears to deviate from long-standing IRS guidance, particularly Revenue Ruling 69-154, which established the “excess benefit” rule dating back to 1969. The “excess benefit” rule states states that only the amount exceeding actual medical expenses should be included in gross income. When employees receive indemnity payments from a carrier that total to less than the pre-tax premiums paid, this holds true.

The IRS has went to Congress in 2020, 2022, and 2023 in attempts to amend Section 105(b), each time getting turned down. Amending Section 105(b) would apply to the tax status of other Section 125 programs like Aflac and Colonial, putting them out of business. Although unlikely, if the IRS succeeds, employers would be able to continue running such programs until January of 2026.

As a compliance-first organization, Flex Health maintains a robust framework in following Section 125 regulations, avoiding the pitfalls of self-funded programs, navigating concerns from the IRS May 2023 CCA, and continually seeking legal counsel to ensure the highest level of adherence.

The key is Flex Health operates as an indemnity program, which helps mitigate the murky compliance waters around self-funded Section 125 plans. Flex Health is a fully funded and fully insured program, partnered with underlying group policy carriers. Employees are paying pre-tax premiums to a policy approved by the Department of Insurance and receiving claim payments (not reimbursements) directly from the carrier. These monthly claim payments total ~84% of the pre-tax premiums, are below the “excess benefit” threshold, and are only received if the employee completes a CPT-coded activity each month.

Flex Health prioritizes educating employers on legal and tax-related requirements associated with the program as well as backing its facts with legal opinions written by numerous firms. Over 170 companies renew with the program each year because of this approach.