Section 125 Wellness Plans: The 2026 IRS Compliance Risk

Section 125 wellness plans are a fast-growing add-on that promoter firms sell to employers as a way to hand employees extra tax-free cash, funded entirely by the FICA savings from the plan itself. The pitch sounds like the same math behind a standard Section 125 cafeteria plan. The tax result is not the same, and the IRS has now said so twice in writing.

This guide explains what a Section 125 wellness plan actually is, why the IRS considers most of them noncompliant, and what an employer should check before the next payroll run.

Key facts (2026):

• IRS Chief Counsel Advice 202323006 (June 2023) found that a $1,000 monthly "wellness" cash payment was taxable wages because it was not tied to a real medical expense (IRS, 2023).
• IR-2024-65 restated the same warning to employers and promoters directly (IRS, 2024).
• A payout is tax-free only if it reimburses an unreimbursed medical expense under Internal Revenue Code Section 213(d), a narrow category that excludes gym memberships, general coaching and most screenings taken alone (IRC Section 213(d), 2026).
• If a plan fails, the IRS position is that all payments under it, including any that did cover real medical costs, become includible income (IRS Chief Counsel Advice 202323006, 2023).
• A failed plan can require corrected W-2 and Form 941 filings for every open year, typically the last 3 years, plus employer and employee FICA at 7.65% each (IRS Publication 15, 2026).

What Is a Section 125 Cafeteria Plan Wellness Benefit?

A Section 125 cafeteria plan wellness benefit is an add-on that pays employees a fixed cash amount, often $1,000 or more a month, for taking part in a health or wellness activity, funded pre-tax through the employer's existing cafeteria plan. The activity can be a biometric screening, a short coaching call or a symptom questionnaire.

The sales pitch is simple. Employees elect a small pre-tax deduction for a fixed-indemnity insurance policy bundled into the plan. Because employees rarely file a claim, most of that premium comes back to them as a "wellness" payout. The employer's FICA savings on the pre-tax deduction is supposed to fund the whole arrangement at close to zero net cost.

This is a different product from a standard employee wellness program. Summit Health Benefits' employee wellness programs guide covers gym stipends, coaching and biometric screenings run as ordinary fringe benefits. A Section 125 wellness plan is a specific insurance and tax structure, and the Section 125 indemnity fusion and supplemental health plan guide covers the mechanics of the underlying fixed-indemnity policy in more depth.

Why Does the IRS Say Section 125 Wellness Plan Payouts Are Taxable?

The IRS says most Section 125 wellness plan payouts are taxable because they are not reimbursements for a real, unreimbursed medical expense under IRC Section 213(d). A cash payment for simply completing an activity is wages, not a medical reimbursement, per Chief Counsel Advice 202323006.

CCA 202323006 examined a plan that paid employees $1,000 a month in "tax-free cash" for wellness participation. The IRS concluded the payment was taxable wages because the employee did not have to show any actual, unreimbursed 213(d) medical expense to receive it. The agency reissued the same warning in IR-2024-65, aimed squarely at the promoters marketing these arrangements to employers.

Table: What makes a wellness payout taxable vs. tax-free under IRC Section 213(d)

Worked example: what a failed plan costs an employer

Take a hypothetical 40-employee company that ran a Section 125 wellness plan for 2 plan years, paying an average of $500 a month per employee in wellness cash with no expense substantiation.

1. Total payouts over 2 years: 40 employees x $500 x 24 months = $480,000.
2. Employer FICA owed on the reclassified wages: 7.65% of $480,000 = $36,720.
3. Employee FICA the employer may need to pursue or absorb: another 7.65%, or $36,720.
4. Corrected filings: amended Forms W-2 and 941 for every quarter in both years, per IRS Publication 15 correction procedures.

The FICA math alone can wipe out several years of the FICA savings the plan promised. It does not include potential penalties, interest or the cost of unwinding the plan with 40 confused employees.

How Do I Know if My Company's Wellness Plan Is at Risk?

You know your company's wellness plan is at risk if payouts do not require employees to submit a real medical expense, or if the plan pays a fixed amount regardless of what the employee actually spent. Both are exactly what the IRS flagged in CCA 202323006.

Run through this checklist with your current vendor or broker:

1. Does the plan require substantiation? A compliant plan needs a real receipt or claim tied to an IRC Section 213(d) medical expense before it pays anything.
2. Is the payout amount fixed regardless of the expense? A $1,000 flat payment paid the same way whether the employee spent $40 or $0 is the pattern the IRS flagged.
3. What does the enrollment form actually promise? If employees were told the payout is "tax-free income" rather than a medical reimbursement, that is a warning sign in itself.
4. Who is the insurer, and are they aware of CCA 202323006? Ask your vendor directly how the plan addresses the 2023 and 2024 IRS guidance in writing.
5. How far back does exposure reach? Ask your payroll provider or CPA how many quarters of Forms 941 would need correction if the plan were reclassified.

What Should an Employer Do Instead of a Risky Wellness Plan?

An employer should replace a risky Section 125 wellness plan with either a standard Section 125 premium-only or full cafeteria plan, or a wellness program that pays through ordinary taxable wages instead of a pre-tax indemnity structure. Both avoid the CCA 202323006 exposure entirely.

A standard cafeteria plan under Summit Health Benefits' model still delivers the FICA savings math without relying on a fixed-indemnity payout. Summit's Section 125 cafeteria plan guide and FICA tax savings guide cover the compliant version of this savings, and Summit's admin fee model is built around it.

Employees who already have a wellness plan deduction they do not remember choosing, or who want out of one, are asking their employers about this more often as the IRS guidance gets more attention. A short email to HR is usually the fastest way to get a straight answer.

Free copy-paste email for HR to send affected employees

Subject: Update on our wellness benefit plan

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Hi team, we are reviewing our current wellness benefit plan against recent IRS guidance (Chief Counsel Advice 202323006 and IR-2024-65). If you have questions about how your wellness deduction or payout works, or want to opt out while we complete this review, please reach out to HR directly. We will follow up once the review is complete.

Frequently Asked Questions

Sources

IRS Chief Counsel Advice 202323006 (June 9, 2023); IRS News Release IR-2024-65 (2024); Internal Revenue Code Section 213(d); IRS Publication 15, Employer's Tax Guide (2026); IRS Publication 15-B, Employer's Tax Guide to Fringe Benefits (2026).