341 / What are the tax consequences for amounts paid by an employer to highly compensated employees under a discriminatory self-insured medical expense reimbursement plan?

The first situation occurs when a benefit is available to a highly compensated individual but not to all other participants, or that otherwise discriminates in favor of highly compensated individuals. In this situation, the total amount reimbursed under the plan to the employee with respect to that benefit is an excess reimbursement.

The second situation occurs when benefits are available to all other participants and are not otherwise discriminatory and where a plan discriminates as to participation. Here, excess reimbursement is determined by multiplying the total amount reimbursed to the highly compensated individual for the plan year by a fraction. The numerator is the total amount reimbursed to all participants who are highly compensated individuals under the plan for the plan year; the denominator is the total amount reimbursed to all employees under the plan for such plan year. In determining the fraction, no account is taken of any reimbursement attributable to a benefit not available to all other participants.²

Multiple plans may be designated as a single plan for purposes of satisfying nondiscrimination requirements. An employee who elects to participate in an optional HMO offered by the plan is considered benefited by the plan only if the employer’s contributions with respect to the employee are at least equal to what would have been made to the self-insured plan and the HMO is designated, with the self-insured plan, as a single plan. Regulations do not suggest how to determine contributions to a self-insured plan.

Unless a plan provides otherwise, reimbursements will be attributed to the plan year in which payment is made which means they will be taxed in an individual’s tax year in which a plan year ends.

Amounts reimbursed for medical diagnostic procedures for employees, but not dependents, performed at a facility that provides only medical services are not considered a part of a plan and do not come within these rules requiring nondiscriminatory treatment.³

Contributory Plan

Reimbursements attributable to employee contributions are received tax-free, subject to inclusion if the expense was previously deducted ( Q 334). Amounts attributable to employer contributions are determined in the ratio that employer contributions bear to total contributions for the calendar years immediately preceding the year of receipt, up to three years. If a plan has been in effect for less than a year, then such determination may be based upon the portion of the year of receipt preceding the time when the determination is made, or such determination may be made periodically (such as monthly or quarterly) and used throughout the succeeding period.⁴ For example, if an employee terminates his services on April 15, 2025, and 2025 is the first year the plan has been in effect, such determination may be based upon the contributions of the employer and the employees during the period beginning with January 1 and ending with April 15, or during the month of March, or during the quarter consisting of January, February, and March.

Withholding

An employer does not have to withhold income tax on an amount paid for any medical care reimbursement made to or for the benefit of an employee under a self-insured medical reimbursement plan within the meaning of IRC Section 105(h)(6).⁵