A properly structured Section 125 wellness plan is compliant. The arrangements the IRS has challenged fail specific, identifiable tests, and knowing which ones is more useful than any reassurance a vendor could offer you.
In Chief Counsel Advice 202323006, released on June 8, 2023, the IRS addressed an employer-funded fixed-indemnity wellness policy and concluded that the payments were taxable where the employee had no unreimbursed medical expenses connected to them. In IR-2024-65, issued on March 6, 2024, it warned employers about promoters misrepresenting general health and wellness expenses as medical care. Both documents are short, public, and worth reading before you sign anything.
This page sets out what those documents actually said, the tests a compliant plan passes, and the specific questions to put to your own tax counsel.
What did the IRS actually challenge in CCA 202323006?
The IRS challenged indemnity payments made where no medical expense had been incurred.
The arrangement in question was an employer-funded, insured, fixed-indemnity wellness policy. An employee made a pre-tax salary reduction, and the policy then paid a fixed amount on the occurrence of a wellness event, whether or not the employee had any unreimbursed medical expense connected to it. The IRS concluded that where an employee receives a payment without a related unreimbursed medical expense, the payment is not excludable. It is income, and it is subject to FICA, FUTA and federal income tax withholding.
The problem in that arrangement was not Section 125. It was that nothing of substance sat between the salary reduction and the payment back.
One procedural note your counsel will already know: a Chief Counsel Advice is not precedential and cannot be cited as authority. It is useful because it shows how the IRS reasons about these structures on examination, which is the situation that actually matters to an employer.
What did IR-2024-65 add?
A different failure mode, and a warning about how these arrangements get sold.
The March 2024 release reminded employers and plan administrators that personal expenses for general health and wellness are not medical care under Section 213(d), and are therefore not reimbursable on a tax-free basis through health FSAs, HSAs, HRAs or MSAs. Its concern was companies repackaging nutrition and general-wellness spending as qualified medical expenses.
It also made an observation about how these arrangements get sold, which the next section takes head-on.
Read together, the two documents draw one line. Payments are excludable when, and only when, they relate to real medical care that has been incurred and substantiated. The line is substantiation, not structure.
What should we make of the opinion letter?
Read it, then set it aside and read the plan documents. Here is why.
IR-2024-65 notes that promoters of non-compliant arrangements “typically provide seemingly credible materials that often include a legal opinion on the validity of the tax savings generated.” We do supply a tax-counsel opinion letter, so the observation applies to us as much as to anyone selling in this category. Pretending otherwise would be the wrong answer.
Here is the honest position.
An opinion letter is evidence, not proof. It tells you that a named attorney, with their license attached to the document, reviewed a specific structure and reached a conclusion. That is worth something, and it is worth considerably less than your own counsel reaching their own conclusion. It is why the letter is addressed to your advisor rather than to you.
What actually distinguishes a compliant plan is not the paperwork that arrives with it. It is whether reimbursement follows care that was delivered and substantiated. Every test set out on this page can be checked against the plan documents themselves, with no reference to anyone’s opinion. If your counsel would rather ignore the opinion letter entirely and work from the plan documents, that is the better review, and we will send those first.
What makes a Section 125 wellness plan compliant?
Three things, and all three have to be present.
Real care, actually delivered. There has to be a genuine medical-care benefit that employees receive. Not a notional entitlement, not a credit, and not a payment triggered by enrollment alone. Qualified medical care is defined at Internal Revenue Code Section 213(d), and that definition is the boundary.
Substantiation that the care occurred. The plan has to know, and be able to demonstrate, that the care it is reimbursing was actually provided. This is precisely what was missing in the arrangements the IRS challenged. Automated substantiation is acceptable and often stronger than paper claims, but it has to exist and it has to be documented.
Reimbursement governed by a plan document. The reimbursement side is not governed by the cafeteria plan. It is governed by a separate Self-Insured Medical Expense Benefit Plan, operating under Treasury Regulation Section 1.105-11, with its own document, its own terms, and its own cap on the value it will reimburse.
A plan that satisfies all three is doing what Section 105 and Section 213(d) contemplate. Those three tests are the whole of it, and they are checkable against the plan documents.
How is this different from the arrangements the IRS challenged?
Care is actually delivered, and reimbursement follows it.
In the arrangements the IRS addressed, an employee could receive a payment with no related medical expense at all. That is what made the payment income. Here, reimbursement is tied to documented Section 213(d) care that was provided and substantiated, capped by a plan document, under a separate plan governing the benefit. Remove the care and there is nothing to reimburse.
The exclusion is not something the structure creates. It exists because Congress wrote it. Section 125 was enacted in the Revenue Act of 1978 and is the same provision that carries every employer health premium, every flexible spending account and every payroll-deducted health savings account contribution in the country.
The question worth asking is not whether the framework is legitimate. It is whether a given plan uses it correctly.
What happens if the IRS disagrees after we implement?
Two separate things carry that risk, and it is worth keeping them apart.
The first is the plan architecture. Documented care, substantiation, and two plan documents doing two distinct jobs are what make the position defensible in the first place. That is not a promise of an outcome, it is a description of how the structure is built.
The second is contractual, and it is worth reading rather than summarizing. The Client Services Agreement sets out what each party indemnifies the other for, what falls outside the liability cap, and which responsibilities sit with the employer. Those provisions are specific, and they are not all in the direction a vendor conversation might suggest.
We send the agreement to your counsel before any commitment. Indemnification is not what makes a plan compliant in any case. The architecture does that, and the architecture is checkable on its own terms.
Who carries the risk, us or the vendor?
Read the agreement, specifically the indemnification and limitation of liability sections, and have your counsel read them too.
Risk allocation in this category is rarely what a sales conversation implies, in either direction, and the agreement is the only thing that binds anyone. Ask what each party indemnifies the other for, what is carved out of the liability cap, and which obligations sit with the employer. We will send the agreement to your counsel before any commitment, and we would rather they read the actual allocation than take a characterization of it from us.
Does this affect our employees’ FSA or HSA?
No. The arrangement is not competitive with other Section 125 elections.
An employee can participate while continuing to fund a flexible spending account or a health savings account, and eligibility is underwritten individually. If an employee’s existing elections would create a conflict, that surfaces during eligibility rather than after enrollment.
What should our tax counsel review before we sign?
Five documents, and a competent advisor will want all of them.
- The Section 125 cafeteria plan document and summary plan description.
- The Self-Insured Medical Expense Benefit Plan document, including the reimbursement cap and the substantiation method.
- The Client Services Agreement, particularly the indemnification and limitation of liability sections.
- The outside tax-counsel opinion letter, which addresses CCA 202323006 and IR-2024-65 directly.
- The independent CPA opinion prepared for an existing client of roughly three thousand employees.
There is also published third-party treatment of this structure worth putting in front of counsel: Peter A. Karl III, JD, CPA, “20 Questions about Establishing a Health & Wellness Program in the Workplace,” The CPA Journal, January 2021. It is independent of any vendor, and it is the kind of source a skeptical advisor will weigh differently from marketing material.
We will send all of it to your counsel on request, before any commitment.
What this is not
Worth stating plainly, because these are the structures the IRS has actually pursued.
- Not a fixed monthly payment made regardless of whether care occurs.
- Not a cash bonus, inducement, or participation reward.
- Not a reimbursement of insurance premiums.
- Not a wellness indemnity policy paying a flat benefit per activity.
- Not a guarantee of any particular tax result for any particular employer.
Frequently asked questions
Is a Section 125 wellness plan legal?
Yes, when it reimburses documented Section 213(d) medical care that has actually been delivered and substantiated, under a plan document that governs the reimbursement. Arrangements that pay fixed amounts regardless of care have been challenged by the IRS and treated as taxable wages.
What is CCA 202323006?
A Chief Counsel Advice memorandum released by the IRS on June 8, 2023, addressing an employer-funded fixed-indemnity wellness policy. The IRS concluded that payments were includable in income, and subject to FICA, FUTA and withholding, where the employee had no unreimbursed medical expense related to the payment. A Chief Counsel Advice is not precedential, but it shows how the IRS reasons on examination.
What is IR-2024-65?
An IRS news release issued on March 6, 2024, reminding employers that personal general health and wellness expenses are not medical care under Section 213(d) and cannot be reimbursed tax-free through health FSAs, HSAs, HRAs or MSAs. It also warned that promoters of these arrangements often supply legal opinions supporting the tax savings, which is a point we address directly above.
Has the IRS challenged this specific structure?
The compliance partner administering this plan has been operating this structure for more than a decade. That is a statement about track record, not a prediction, and your counsel should form their own view.
Do employees have to do anything to stay eligible?
Yes. Employees must enroll, complete onboarding, and remain opted in to program communications. Completing one qualifying activity per year is the ongoing requirement. Engagement supports awareness and action; it does not determine reimbursement eligibility, which is governed separately by the plan documents.
Can we run this alongside our existing benefits?
Yes. It sits alongside major medical, flexible spending accounts, health savings accounts and existing wellness offerings rather than replacing any of them.
What to do next
If you are evaluating this seriously, these three are worth doing in order.
Have your counsel take twenty minutes with our compliance partner. They have administered this structure for more than a decade and can answer your advisor’s questions live. Most counsel find twenty minutes on a call saves several hours of document review, and we would rather they ask hard questions early than form a view from a PDF. Ask us to set it up.
Get the plan documents before the opinion letter. As above, the documents are the better review. We send them to your counsel on request, before any commitment.
Request the Finance and Legal Pre-Read. It is written for a CFO and outside counsel rather than for a benefits buyer, and it is designed to be forwarded rather than summarized.
What to send your CFO
If you are the one walking this into a finance meeting, here is the short version to paste.
Employees make a pre-tax election toward documented preventive medical care, which reduces taxable wages and the employer FICA owed on them. Reimbursement is governed by a separate plan document and follows care that was actually delivered and substantiated, capped at a set monthly value. It models to more than $750 per enrolled employee per year, at no implementation fee and no capital outlay, sized against our own census. Risk allocation is set out in the services agreement, which I have asked them to send to our counsel.
Then attach the Finance and Legal Pre-Read, and offer them the call above. The question a CFO asks first is almost never about the health program.
This page is educational and is not tax or legal advice. The plan structure and covered care behind the program are administered by Alively’s compliance partner; the Alively app is wellness software, not medical care. Employers should have the plan documents and supporting opinions reviewed by their own tax counsel before launch.