I recently worked with a large employer to transition their voluntary benefits (VB) from a traditional payroll deduction model to a more efficient split direct deposit model.  Most employers that are choosing to shift to a split direct deposit model are doing so because it allows them to eliminate the monthly billing and reconciliation chores that frustrate most HR departments when it comes to voluntary benefits.  But, when I asked this large group why they were switching to a direct deposit model, the answer was not just billing issues; it was because their broker had recommended they cease pre-taxing VB because of the tax implications now imposed by the IRS.

IRS rulings about the taxability of voluntary benefits paid for with pre-tax dollars through a Section 125 plan have always been an issue.  But today, the move away from pre-taxing of VB is stronger than ever, led by the large broker houses, consultants, and the good old IRS.

A recent IRS memorandum from the Office of Chief Counsel states the following as it pertains to the taxability of payments from fixed indemnity health plans (i.e., voluntary benefits).  Here is an excerpt from the memorandum:

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