If you are reading this, someone at your company probably likes the economics of a wellness program that pays for itself, and someone else, probably in Legal or at your broker, has raised a hand and said “the IRS is cracking down on these.”
Both people are right. So this page takes the question seriously: is a Section 125 wellness plan IRS-compliant? The honest answer is that compliance is not a property of the label. It is a property of the structure. Section 125 itself is one of the oldest, most heavily used provisions in the benefits world. The IRS has indeed challenged a wave of arrangements marketed under wellness language. And the same rulings the IRS used to strike those arrangements down are a checklist that a properly built plan is designed to satisfy. The job of this page is to show you the difference, specifically enough that your counsel can verify it rather than take it on faith.
Start with what Section 125 actually is
Section 125 of the Internal Revenue Code was enacted in the Revenue Act of 1978. It is the cafeteria-plan framework that lets employees pay for qualified benefits with pre-tax dollars, and you already run your company on it. Every employer-sponsored health premium, every FSA election, every HSA payroll contribution flows through Section 125. Nobody calls those a loophole.
A Section 125 wellness program points that same framework at qualified preventive care. Employees make pre-tax elections toward a documented medical-care benefit, taxable wages drop, and FICA drops with them, for the employee and for the employer’s matching share. That is the entire funding mechanism, and it is why the program models to more than $750 per enrolled employee per year to the employer’s P&L at $0 capital outlay. The mechanism is not the compliance question. What the plan does with reimbursements is.
What the IRS has actually struck down
The concern your advisors are raising is real, and it has names: Rev. Rul. 2002-3, Rev. Rul. 2002-80, and CCA 202323006, plus the 2024 consumer alert (IR-2024-65). Read them closely and the pattern is remarkably consistent. The IRS targets arrangements where:
- Employees receive flat, per-event payouts (say, $50 for completing a health assessment) regardless of any actual unreimbursed medical expense.
- Pre-tax contributions simply come back to the employee, a circular flow of wages relabeled as tax-free wellness.
- The “plan” is a fixed-indemnity insurance product dressed up as medical reimbursement.
- No bona fide Section 213(d) medical care is actually delivered, and there are no real plan documents or substantiation controls behind the payments.
Every one of those is a case of something being called medical reimbursement when, on inspection, it is not. That is the test. Not the vocabulary on the brochure.
The five requirements of a compliant Section 125 wellness plan
Here is the checklist a defensible plan has to satisfy, and the one your counsel should apply:
- A bona fide written plan document compliant with Section 125.
- A uniform election process with no impermissible cash conversion.
- Substantiation of Section 213(d) medical expenses before any reimbursement.
- No guaranteed or automatic return of funds. No circular flow of wages.
- Nondiscrimination compliance under Section 125 rules.
In a properly built program, the Section 125 election is paired with a Self-Insured Medical Reimbursement Plan, or SIMRP, under Treas. Reg. 1.105-11, and a Preventive Care Management Program (PCMP) that documents the covered care. The architecture matters: the Section 125 election and the Section 105 reimbursement are two separate plan functions with separate legal roles. The election is a contribution mechanism, not a promise of reimbursement. The reimbursement covers eligible, substantiated, unreimbursed 213(d) medical care under the plan’s own schedule, not a refund of what the employee put in. The two amounts can coincide because both independently reference the same documented value of the covered care, not because one is reverse-engineered from the other. That distinction is precisely what separates the compliant structure from the circular-flow schemes the IRS keeps striking down.
What substantiation looks like in practice
“Substantiated” is where weak programs go to die, so it is worth being concrete. In the program Alively offers, reimbursements are paid only when the plan’s controls are satisfied: eligibility is verified against a plan-defined class, the covered care is actually delivered and documented, records exist at the plan-administrator level, and unreimbursed-expense controls prevent duplicate or non-medical payments.
We do not run that machinery ourselves, and that is by design. The plan architecture and the covered care are run by our compliance partner, with a decade of experience doing this at scale. They own the plan documents, the substantiation, the payroll integration, and the audit indemnification. Alively’s job is the part your employees actually feel: the app, the wearable, the one small daily action that keeps people engaged. The covered care is defined narrowly and on purpose in the plan documents, not in the app and not in generic wellness content.
Boring? Completely. That is what audit-defensible looks like.
Don’t take the vendor’s word for it. Take the paper.
Any vendor can say “fully compliant.” A serious one hands your counsel the materials to verify it. Our partner’s structure travels with a written outside tax-counsel opinion (which directly addresses CCA 202323006 and IR-2024-65), an independent CPA opinion issued for a roughly 3,000-employee government entity that implemented the program, a peer-reviewed CPA Journal treatment of the SIMRP structure (January 2021), and a point-by-point response to the WTW guidance that warned about non-compliant lookalikes. The architecture has been in market for over a decade with no adverse IRS determination to date. And participating employers are contractually indemnified against audit exposure related to the program, without monetary cap, surviving termination.
None of that replaces your own counsel’s review. It is what makes that review fast.
The real takeaway for employers
The IRS crackdown is not a reason to avoid Section 125 wellness plans. It is a reason to insist on the compliant version, because the enforcement wave is clearing the field of exactly the schemes that made buyers nervous. Federal policy is moving toward prevention, not away from it: the framework is four decades old, and CMS’s new ACCESS Model and its companion lifestyle-medicine funding are the government’s own bet that roughly $1 of prevention avoids $30 of sick spend. The employers who learn to tell the compliant structure from the lookalike will run a benefit that funds itself while their competitors are still forwarding scary headlines to each other.
Bring your counsel. That is not a hurdle in the process. That is the point.
Frequently asked questions
Is a Section 125 wellness plan legal?
Yes, when properly structured. Section 125 has been in the Internal Revenue Code since 1978 and carries most employer benefits today. Compliance turns on the plan’s structure: a bona fide plan document, substantiated Section 213(d) expenses, no circular flow of wages, and nondiscrimination testing.
What is the IRS cracking down on with wellness plans?
Fixed-indemnity and “wellness pay” schemes: flat payouts regardless of actual medical expenses, circular refunds of pre-tax contributions, and programs with no real medical care or substantiation behind them. The controlling authorities are Rev. Rul. 2002-3, Rev. Rul. 2002-80, and CCA 202323006.
Is this the “double dipping” arrangement the IRS warned about?
A compliant plan is built specifically to avoid it. Double dipping means the pre-tax contribution and the benefit payment are both treated as exempt in a circular flow. In a compliant SIMRP structure, reimbursements cover only substantiated, unreimbursed 213(d) medical care and are never a refund of the election.
What should our tax counsel review before we launch?
The Section 125, SIMRP, and PCMP plan documents, the substantiation workflow, the treatment under CCA 202323006 and the 2002 revenue rulings, payroll and W-2 handling, and the scope of the vendor’s indemnification. Those materials, plus the legal opinion letter and CPA opinions, should be provided up front.
This page is educational and is not tax or legal advice. The plan structure and covered care described here are administered by Alively’s compliance partner; the Alively app is wellness software, not medical care. Employers should have the plan documents, the legal opinion letter, and the supporting CPA materials reviewed by their own tax counsel before launch.