Compliance and IRS audit readiness for Section 125/105/213(d) preventive health plans (employer guide)

CFOs, HR leaders, brokers/PEOs, and general counsel are asking a fair question: “Is this legal, or is this a scheme?”

That question isn’t paranoia—it’s prudent governance—and the kind of question you’d want answered before an IRS office inquiry, an outside audit, or a diligence process.

In the last few years, the IRS and mainstream advisor community have signaled growing skepticism (including evolving IRS guidance and how the market reads it) toward certain benefit designs that market themselves as “wellness” programs but function, in practice, like cash rewards (or near-cash) payments routed through payroll. That skepticism is a big reason you’ll see the same phrase repeated in boardroom conversations and broker diligence calls:

“Wellness benefit payments taxable wages.”

This article is designed to calm fears with clarity—not hype. It explains, at a principle level:

• what the IRS is flagging in certain “wellness payment” and fixed-indemnity wellness plans designs
• what IRS CCA 202323006 is commonly understood to mean (plain English)
• how to think about Section 125 cafeteria plan mechanics and Section 105 / Section 213(d) medical expenses
• what “audit readiness” really looks like (documentation, governance, operational feasibility)

If you’re new to Oaceus, you can start with our overview on the Oaceus home page and our preventative health plan introduction on the Oaceus 360 PHP page.

Start here: what the IRS is scrutinizing (in plain English)

Most employers want to improve access to care, support preventative health, and reduce financial stress—good goals. Many also want better medical care access through structured wellness programs and better navigation to other health coverage options.

The compliance problems tend to show up when a program’s economic story becomes “tax outcome first,” especially when the employee experience resembles:

• “contribute pre-tax” (including required employees contributions or premium sharing)
• “do a few activities” (often health screenings or check-ins)
• “receive predictable cash payments” (i.e., cash rewards)

When a program looks like compensation being re-labeled as a benefit, employers can inherit:

• payroll tax exposure (employment taxes and withholding)
• operational risk (inconsistent administration, including edge cases like a second employer situation)
• employee trust issues if “tax-free” expectations change
• reputational risk with counsel, boards, and lenders

If you want the memo that triggered many of these conversations, read: IRS CCA 202323006 in plain English.

What IRS CCA 202323006 said (high level, no legalese)

IRS CCA 202323006 is a Chief Counsel Advice memo that analyzed a specific fact pattern commonly described as a “fixed indemnity wellness” arrangement.

At a simplified level:

• an employee paid premiums (often framed like health insurance premiums) for a fixed-indemnity policy using pre-tax salary reduction under a Section 125 cafeteria plan
• the policy paid fixed “wellness” amounts when the employee completed certain activities
• the IRS analysis focused on whether those payments were excludable from income

The key concept most advisors take from the memo is:

• to the extent employees receive wellness-related payments without unreimbursed medical expenses related to the payment, those payments may be included in income and treated as wages subject to employment taxes (i.e., included in taxable income, and potentially reportable through payroll).

If you want a deeper, employer-friendly walkthrough of the fact pattern and why it leads to wages treatment, see: If wellness payments are wages: what payroll, HR, and finance need to know.

Medical benefit vs. taxable cash: the cleanest way to think about it

Executives don’t need to memorize tax code sections. They do need a clean mental model:

• Reimbursement is about paying back an incurred expense (and typically requires discipline and substantiation for eligible medical expenses and a defensible tax-free reimbursement position).
• Rewards are about paying someone because they did something (often treated like compensation, including typical employee rewards such as gift cards or cash rewards, generally at fair market value).

Where Section references come in:

• Section 213(d) is commonly referenced as the baseline concept for what counts as “medical care.”
• Section 105 is commonly discussed in connection with employer medical reimbursement concepts (including what can and cannot be excluded from gross income, and how gross income reimbursements can become a compliance issue when they’re not true medical reimbursements).
• Section 125 is the cafeteria plan mechanism that can allow pre-tax salary reduction for qualified benefits (on a pre-tax basis)—but it doesn’t magically convert cash-like payments into non-taxable benefits.

If you want the plain-English “line drawing” explanation with examples, read: Is it a medical benefit or taxable cash? How the IRS draws the line.

Where “wellness plan audit risk” tends to spike

Employers tend to inherit higher wellness plan audit risk (or “Section 125 wellness plan audit risk”) when one or more of these are true:

• the program is marketed as “tax-free cash” or “guaranteed savings” (language that can sound like “IRS clarifies taxation” when, in reality, facts and administration control)
• employee-facing payments are fixed or predictable and not clearly tethered to medical expenses
• payments are triggered by services already covered by major medical (creating “double dipping” concerns)
• withholding and employment taxes are treated as an afterthought
• documentation and governance are light, vague, or inconsistent—especially if you’re seeing heightened IRS audit activity in your industry

For a plain-English explanation of “double dipping” (and why it raises scrutiny), see: What “double dipping” means in wellness and fixed-indemnity offers.

What “audit readiness” looks like (without templates or a DIY blueprint)

A mistake in this market is to think audit readiness is a sentence you put on a slide.

Audit readiness is a system—a combination of documentation, disciplined administration, and conservative governance. It also includes practical data protection posture and operational controls (sometimes supported by data automation) so payroll and benefits teams can execute consistently.

At a principle level, audit readiness looks like:

• documentation and governance: clear plan purpose, clear ownership, consistent recordkeeping (and the ability to answer questions from an IRS office or state agency)
• plan discipline: the program operates the way it is described (substance over labels)
• administrative feasibility: payroll can actually execute the required treatment with the data it receives (including when an employer payment must be treated as wages)
• conservative communications: no “IRS-proof,” no “guaranteed savings,” no “tax-free cash back”
• operational readiness: HR can support enrollment/eligibility workflows (including edge processes like employee registration cobra notices and status changes) without ad-hoc exceptions

If you want an audit-readiness deep dive that stays non-templated and non-DIY, read: Audit readiness for Section 125/105 health benefits.

The diligence questions CFOs, HR, brokers, and counsel should ask

You don’t need to ask vendors for “secret sauce.” You need principled evidence of governance.

Ask questions like:

• “Is employee-facing value a reimbursement of medical care, or a reward?”
• “What is the tax theory for excluding any employee-facing payments from wages—and does it rely on minimis fringe benefit arguments, medical substantiation, or something else?”
• “How do you prevent ‘double dipping’ concerns when services are already covered under major medical or other comprehensive arrangements (i.e., comprehensive health coverage and other health coverage)? ”
• “If anything is wages, who owns withholding and employment taxes—and how is that administered?”
• “What documentation and governance artifacts exist at a high level to support audit readiness?”
• “What do you do with non-213(d) items that employees may assume qualify (e.g., gym membership fees)?”

If incentives are part of the story, you may also want: Are wellness incentives taxable? Cash, gift cards, and ‘rewards’ explained.

FAQs

1) Are wellness incentives taxable?

Often, yes—especially when incentives are cash rewards (or cash equivalents) paid as rewards. The exact treatment depends on facts and design, so your payroll tax advisor should review it, including whether amounts should be included in taxable income.

2) Could our plan be audited?

Any employer plan can be reviewed. Audit risk rises when a program’s economic story resembles “pre-tax in, tax-free cash out,” and when payroll handling, documentation, and communications are not aligned—especially if you’re trying to position an employer-funded wellness program like compensation avoidance.

3) What does “wellness benefit payments taxable wages” mean?

It means the employee-facing payment may need to be treated like compensation—taxable, reportable, and subject to employment taxes and withholding (i.e., treated as wages through payroll).

4) Does CCA 202323006 ban wellness programs?

No. It is commonly read as a warning about specific risk patterns—particularly where fixed payments are not tied to unreimbursed medical expenses and are paired with pre-tax premium payment.

Some employers also ask whether older or adjacent IRS materials matter (e.g., references like IRS Chief Council Advice Memorandum 201703013 cited in some advisor discussions). The key is still the same: facts, documents, and administration.

5) What should I ask my CPA or ERISA counsel?

Ask them to evaluate your facts and documents and to focus on: classification (reimbursement vs reward), payroll feasibility, and governance/documentation that supports audit readiness—consistent with current IRS guidance.

6) Where can employees learn how their data is handled?

Employers and employees should review vendor privacy posture and data protection controls. Oaceus publishes an Online privacy policy and a data request form.

If you’re evaluating preventive health strategies that reference Section 125 cafeteria plan mechanics, Section 105 / Section 213(d) medical expenses, and “tax-advantaged” language, the safest posture is:

• be curious and disciplined
• avoid “too good to be true” claims
• keep the discussion grounded in medical purpose, reimbursement discipline, and administration reality
• invest in audit readiness through documentation and governance

If you want a high-level conversation about employer risk management and preventative health infrastructure, start here: Contact Oaceus or learn about our mission on the About Oaceus page.

• Category: Compliance & Audit Safety