Taxation on Wellness Benefits

By Paul Miller, vice president of tax at StayWell

Changing individual behavior—and sustaining the change long-term—is hard. That’s why many successful employer-sponsored workplace well-being programs motivate healthy change with smart incentives and rewards.

There are many types of wellness incentives, and the requirements to earn them are just as varied. For example, employees who regularly reach their daily step goal may earn a gift card, while those who participate in a weight management program may receive a free gym membership. Employers should be aware that certain financial incentives like premium discounts, cash rewards, and other incentives can come at a price for employers in terms of tax liability.

For employees, these incentives may be taxable income. As the employer, it’s your responsibility to report employee income and withhold the appropriate taxes.

[Employers: Download our regulatory changes white paper to get additional tips on incentive program compliance.]

Wellness incentive tax facts

Wellness incentives are generally subject to the same federal tax rules as any other employee rewards or prizes. Unless a specific tax exemption applies to the incentive, the amount of the incentive (or its fair market value) must be included in an employee’s gross income and is subject to:

  • Federal taxes, including:
    • Federal income tax withholding (FITW)
    • Social Security/Medicare tax (FICA)
    • Federal unemployment insurance (FUTA)
  • State and local taxes, including:
    • State income tax withholding (SITW)
    • State unemployment insurance (SUTA)
    • Local income/earnings tax

Even if an employer uses a third-party wellness vendor to administer a wellness program, it’s the employer’s responsibility to report the incentive as income on the employee’s Form W-2 and withhold the appropriate taxes.

Wellness incentive tax exemptions

There are exceptions, of course, to the general rule that financial incentives are taxable income to employees. The two main tax exemptions that apply to wellness incentives are:

  • Exclusions for medical care, under Internal Revenue Code Sections 105 and 106
  • Employee fringe benefits, under Internal Revenue Code Section 132

In 2016, the IRS addressed certain areas of taxability related to wellness program benefits through a notice referred to as Office of Chief Counsel Internal Revenue Service Memorandum 201622031.

So which wellness incentives are are typically taxable?

Incentive description Typical result*
Cash and cash equivalents (including gift cards)

Taxable income

Low-value items (e.g., health snacks, water bottles, T-shirts, branded products)

Nontaxable fringe benefit (An employer may be able to exclude these items as a nontaxable de minimis fringe benefit, depending on the benefit's value and frequency)

Gym or health club memberships

Taxable income, unless exception applies (The membership fees are taxable, unless the membership qualifies as medical care prescribed by a doctor to treat a specific illness; however, this is uncommon)

Health seminars or classes

Nontaxable fringe benefit (An employer may be able to exclude these items as a nontaxable de minimis fringe benefit, depending on the benefit's value and frequency)

Free health screenings

Nontaxable medical care (An employer can exclude these items as nontaxable medical care expenses)

Group health plan cost-sharing reductions (e.g., premiums, deductibles, copayments)

Nontaxable medical care (An employer can exclude these reductions or waivers as nontaxable medical care expenses)

Employer contributions to a health FSA, HRA, or HSA

Nontaxable medical care (An employer can exclude these items as nontaxable medical care expenses; however, be mindful of any associated with nondiscrimination rules that require employees to be treated equally under the plans)

Reimbursement for a portion of employee pretax contributions to an IRC Section 125 cafeteria plan

Taxable income (The reimbursement is considered "double dipping," creating taxable income for the employee)

Get more tips on wellness incentive program compliance. Download our What recent regulatory changes mean for well-being programs white paper, or watch our The Art and Science of Incentive Design webinar recording.

*The content of this blog is for informational purposes only and should not be relied on for tax, financial, or legal advice. Consult your own tax and legal advisors regarding tax implications as they relate to your business and the structure of your wellness program.