335 / Are benefits provided under an employer’s noninsured accident and health plan excludable from an employee’s income?

Thus, a provision for disability pay in an employment contract has been held to satisfy the condition.³

It is not necessary for tax purposes that a plan be in writing or that an employee’s rights to benefits under the plan be enforceable. For example, an employer’s custom or policy of continuing wages during disability, generally known to employees, has been held to constitute a plan.⁴

If an employee’s rights are not enforceable, the employee must have been covered by a plan or a program, policy, or custom having the effect of a plan when the employee became sick or injured, and notice or knowledge of the plan must have been readily available to the employee.⁵ For there to be a plan, an employer must commit to certain rules and regulations governing payment and these rules must be made known to employees as a definite policy before accident or sickness arises; ad hoc payments at the complete discretion of an employer do not qualify as a plan.⁶

The plan must be for employees. A plan may cover one or more employees and there may be different plans for different employees or classes of employees.⁷ A plan that is found to cover individuals in a capacity other than their employee status, even though they are employees, is not a plan for employees ( Q 346). Self-employed individuals and certain shareholders owning more than 2 percent of the stock of an S corporation are not treated as employees for the purpose of determining the excludability of employer-provided accident and health benefits ( Q 347).⁸

In addition, uninsured medical expense reimbursement plans for employees must meet nondiscrimination requirements for medical expense reimbursements to be tax-free to highly compensated employees ( Q 336).

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Planning Point: The most important concept surrounding Section 105 plans is legitimate employment between spouses or any other named employee. This issue is closely scrutinized by the IRS, and it is absolutely vital that the relationship be in existence. Fabricated relationships are absolutely discouraged. Therefore, having the following items in place helps to ensure the plan operates smoothly and the tax advantages are maximized:

1. Written employment agreements;


2. Logs of hours worked by employees; and


3. Established cash (salary) compensation payment amounts and schedules.

In addition, it is recommended to:

1. Name the insured (it is preferred that the insurance policy be in the employee’s name);


2. Maintain separate checking accounts (one for business use and the second for personal use); and


3. Pay for medical expenses (all medical expenses for the family should be paid by the employee from his or her personal account), and the employee should document all payments.

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