Employee Benefits-IRS Says That Cash Settlement Of (Nontaxable) Health Benefits Is Taxable

In Letter No. 201319015, the Internal Revenue Service (“IRS”) faced a case in which the employer was providing cash, in lieu of the health benefits that it should have provided. The IRS said that, even though the health benefits themselves may have been excludable from gross income, the cash payments are not. These payments are regular wages reported on Form W-2.

The IRS noted that lump-sum payments to taxpayers in settlement of lawsuits against former employer concerning employer’s proposed termination of contributions to hospital-medical benefits plan did not fall within provisions of the Code section 106, which excludes contributions by employer to accident or health plans from gross income, since the statute did not provide exemption for payments made by employer directly to employees. It said that, based on case law, a payment that is specifically made subject to taxation is not rendered exempt from tax simply because it is made in settlement of an obligation which, had it been paid, would not have been taxed.