Complying With IRS Wellness Program Regulations

Workplace wellness programs offer benefits designed to promote employee health. The Internal Revenue Service (IRS) plays a part in their regulation by establishing rules that determine the tax consequences for both employers and employees. This guide focuses on these federal tax implications and how to maintain compliance with IRS regulations.

Defining a Tax-Compliant Wellness Program

A wellness program’s tax compliance rests on the IRS’s definition of “medical care.” Under Internal Revenue Code (IRC) Section 213, medical care includes amounts paid for the diagnosis, cure, mitigation, treatment, or prevention of disease. This definition is the standard the IRS uses to evaluate wellness benefits. If a reward does not meet this definition, it is considered a taxable fringe benefit unless a specific exclusion applies.

Expenses for an individual’s general health, such as a standard gym membership, do not qualify as medical care under this definition. Therefore, if an employer pays for such a membership, the value is taxable income to the employee. Understanding this distinction is important when designing wellness offerings, as it directly impacts the tax treatment of the benefits.

The structure of a wellness program is also a factor. A participatory wellness program does not require an individual to meet a health-related standard to earn a reward, such as attending a seminar. In contrast, a health-contingent program requires achieving a health outcome, like lowering cholesterol, to receive a reward.

A program’s tax treatment is also affected by whether it is part of the employer’s group health plan. When integrated, benefits qualifying as medical care are excluded from an employee’s income under IRC Sections 105 and 106. If a wellness program is a standalone benefit, its rewards are more likely to be scrutinized as individual fringe benefits and deemed taxable.

Tax Treatment of Wellness Program Rewards

The taxability of wellness rewards depends on their form. Cash rewards, including bonus checks, and cash equivalents like general-use gift cards, are treated as taxable wages. This means they are subject to federal income tax withholding and payroll taxes, such as Social Security and Federal Unemployment Tax Act (FUTA) taxes.

A common incentive involves reducing an employee’s health insurance premium payment. These premium reductions or rebates are excluded from an employee’s gross income. The IRS views this reward as a reduction in the cost of health coverage, not as a direct payment to the employee.

Some rewards may be considered “de minimis” fringe benefits under IRC Section 132. A de minimis benefit is property or service with such a small value that accounting for it is unreasonable. Examples include a company water bottle or a t-shirt. However, cash or cash equivalents, regardless of amount, can never be a de minimis benefit and are always taxable.

Benefits that directly provide medical care are not taxable to the employee. This includes employer-provided smoking cessation programs or health screenings. In contrast, benefits supporting general health but not treating a specific disease are usually taxable. A gym membership is a common example, and its cost must be included in an employee’s income unless prescribed to treat a diagnosed medical condition.

From the employer’s perspective, the costs associated with running a wellness program are tax-deductible. These expenses, including the fair market value of rewards provided to employees, are considered ordinary and necessary business expenses. This allows the employer to deduct the full cost of the program, whether the rewards are taxable to the employee or not.

Interaction with Health Savings and Reimbursement Accounts

Integrating wellness programs with tax-advantaged health accounts requires careful planning. For employees with a Health Savings Account (HSA), a wellness program could constitute “disqualifying coverage.” An individual must be covered by a high-deductible health plan (HDHP) and have no other health coverage to be eligible for HSA contributions. A program providing significant medical benefits before the HDHP deductible is met can render an employee ineligible.

To avoid this issue, wellness programs can be structured to provide only preventive care, which is permitted before the HDHP deductible is met. Employers can also offer rewards as contributions directly into an employee’s HSA. These employer contributions are not taxable to the employee but do count toward the annual HSA contribution limit. For 2025, the limit is $4,300 for self-only coverage and $8,550 for family coverage.

Wellness rewards can also be integrated with Flexible Spending Arrangements (FSAs) and Health Reimbursement Arrangements (HRAs). Employers can contribute reward money into an employee’s health FSA or HRA, and these contributions are tax-free to the employee. When contributed, funds become subject to the rules of that account, such as the FSA use-it-or-lose-it rule or the HRA requirement to substantiate all reimbursements.

Employer Reporting and Documentation Requirements

When a wellness program provides taxable rewards, the employer has a clear reporting responsibility. The fair market value of these benefits must be included in the employee’s gross income, reported in Box 1 of Form W-2. This income is also subject to payroll taxes, so the value must be included in Box 3 for Social Security wages and Box 5 for Medicare wages.

To ensure compliance, employers must maintain thorough records. A written plan document that outlines the terms of the wellness program is needed. This document should detail the program’s structure, the rewards offered, and the criteria for earning them.

Employers should also keep precise records of all rewards distributed, noting the type and value for each employee. For taxable rewards, documentation must show how the value was calculated and reported. For benefits excluded from income, records should substantiate that exclusion, such as proof that a screening was for disease prevention.