White Paper · Regulatory Outlook

Executive summary

The largest question a sponsor asks about a fixed indemnity benefit is not how it works but whether the Internal Revenue Service will respect it. The question is fair, and the honest answer is more reassuring than the rumor that prompts it, but only for a sponsor who reads the record accurately.

The Service has issued a series of chief counsel advice memoranda addressing arrangements that pay a benefit on participation in an activity rather than on a documented medical expense. Those memoranda are the source of most of the unease in the category. Read carefully, they draw a line rather than condemn a category. The arrangements the Service questioned share a specific feature: they paid without regard to any incurred medical cost, on activity participation rather than on a substantiated medical event. That feature, not the fixed indemnity form itself, is what drew scrutiny.¹

This paper sets out what the Service has actually said, what specifically triggered its concern, the line its own reasoning draws between a defensible design and one that recharacterizes wages, how a benefit should be triggered to stay on the defensible side, and where the sponsor's real exposure lies. One question at the edge remains genuinely open, and this paper states it as open rather than papering over it. The thesis is that the line is real and knowable, and a sponsor who understands it can build with confidence.

Section 1 · The record

What the IRS has actually said

A sponsor evaluating category risk needs to separate what the Service has issued from what that guidance means, because the two are routinely conflated. What the Service has issued is a series of chief counsel advice memoranda, most recently C.C.A. 202323006 in 2023, with predecessors reaching back to 2016.²

A chief counsel advice is not law. It originates when a field agent asks the Office of Chief Counsel about a specific set of facts, and the response reflects one office's interpretation applied to one fact pattern. It is expressly non-precedential and may not be cited as precedent, not even by the Service.³ A federal court has set one aside and construed the statute from its own text.⁴ These memoranda show the Service's reasoning and signal where examination attention may fall, but a benefit is measured against the statute, not against a memorandum.

Section 2 · The fact pattern

What actually triggered scrutiny

The memoranda are most useful read for their facts. In the arrangement the Service examined, an employee made a large pre-tax election and then received a fixed payment for completing a wellness activity, made without regard to whether any medical expense was incurred. The benefit was triggered by participation, not by a documented medical event.⁵

Because the payment bore no relationship to any incurred medical cost, the Service reasoned that the Section 105(b) exclusion, which reaches amounts that reimburse Section 213(d) medical care, did not apply to it. On those facts, that conclusion follows from the statute. The scrutiny attached to the trigger. It did not attach to fixed indemnity as a category, and it did not attach to the use of a Section 125 election as the funding mechanism.⁶

Section 3 · The distinction

The line the IRS drew

The Service's own reasoning, followed to its source, rests on settled ground: the distinction between two things the Code treats separately, what is included in gross income, and what is treated as wages.

Gross income, under Section 61(a), is income from whatever source derived. Wages are narrower. For income-tax withholding, Section 3401(a) defines wages as remuneration for services performed, and the parallel FICA and FUTA definitions carry the same core meaning. The two are not interchangeable: an amount can be includable in gross income without being wages, because wages require that the payment be remuneration for services performed.⁷

This distinction governs the fixed indemnity question. When a benefit pays an amount that exceeds the employee's unreimbursed medical expenses, the excess is includable in gross income. That result is settled, and has been for decades under the excess-benefit rule of Revenue Ruling 69-154, which holds that where indemnity benefits exceed the medical expenses actually incurred, the excess is included in income while the portion reimbursing Section 213(d) care remains excluded.⁸

The distinction is not subtle, and a sponsor can locate any design on the correct side of it by asking a single question: what triggers the payment.

Section 4 · The design answer

How a benefit should be triggered

The line converts directly into a design rule. A benefit that pays on a documented Section 213(d) medical event sits on the defensible side; a benefit that pays on activity participation does not. Everything else follows from honoring that trigger.

Three features, all drawn from the authorities: a documented Section 213(d) trigger, carrier-borne insurance risk, and genuine excepted-benefit independence.⁹

A design with these features is the structure Optiv Advantage occupies. It pays on documented medical events, it is funded through a Section 125 election described separately as the funding mechanism, and the insurance risk sits with an A-rated, state-licensed carrier. The design does not pay on activity participation, and it does not describe its benefit as fully exempt from tax, because the excess over reimbursed medical care is includable and the design reconciles it.¹⁰ The strength of the position is not a clever reading of the statute. It is that the design honors the same line the Service's own reasoning draws.

Section 5 · The settled ground

Where the exposure actually lies

A sponsor deserves a precise account of what it is exposed to, separating what is settled from what is genuinely open. Most of the exposure is settled and modest.

The settled exposure is the excess benefit. When a benefit pays more than the employee's unreimbursed medical expenses, the excess is includable in the employee's gross income and is reconciled and reported by the employee, who holds the facts the reconciliation requires. That is the excess-benefit rule, and it is not a defect in the design; it is how the design is supposed to work.¹¹

The same mechanism answers the genuinely empty month. If an employee truly incurs no qualifying expense in a month, that amount is not excluded by default; it enters the annual reconciliation like every other benefit dollar. If qualifying expense elsewhere in the year offsets it, nothing is includable on its account; if not, it is part of the includable excess the employee reports. A structure that instead paid every month regardless, and treated those payments as excluded, would be paying amounts the employee is entitled to receive irrespective of whether expenses were incurred, which is precisely what the Section 105(b) regulation places outside the exclusion.¹³

Section 5 · The frontier

The one question that stays open

The open question sits one step further out. Whether the includable excess, beyond being gross income, is also wages subject to withholding and to FICA and FUTA is a question no court has decided for an arrangement that pays on a substantiated medical event. The stronger reading of the statute is that it is not: a benefit paid because a medical event occurred is not payment for a service performed.¹⁴

For the contrary result to prevail, the question would have to be litigated; a court would have to adopt the wage treatment the Service has asserted only in non-precedential memoranda; it would have to read the wage statutes against the ordinary meaning of remuneration for services; and it would have to do so after Loper Bright removed the deference that once would have eased the agency's reading.¹⁵