Balancing Tax Compliance, Benefits Equity, and Workforce Retention in 2024
Employers offering welfare benefits—ranging from healthcare plans, cafeteria plans, disability insurance, dependent care benefits, and wellness incentives—must navigate an evolving compliance landscape while ensuring that their workforce, particularly hourly employees, receives meaningful support.
Tax regulations governing employer-sponsored benefits are complex and frequently scrutinized by the IRS. At the same time, equity gaps in benefits access continue to disproportionately impact low-wage, hourly employees, creating workforce instability and retention challenges.
In this post, we’ll explore how employers can align tax compliance strategies with equitable benefits offerings to enhance employee engagement while mitigating legal and financial risks.
Taxation & Compliance: Key Considerations for 2024
1. Section 125 Cafeteria Plans: Maximizing Pre-Tax Benefits
Employers can allow employees to pay for health and welfare benefits on a pre-tax basis through Section 125 cafeteria plans, reducing taxable income. However, to maintain compliance:
- A written plan document is required—without one, pre-tax elections become taxable wages.
- Election changes must be irrevocable unless triggered by a qualifying life event (e.g., marriage, birth, job loss).
- Nondiscrimination testing must ensure highly compensated employees (HCEs) and key employees don’t disproportionately benefit.
🔹 Real-World Impact:
An employer was penalized for failing to test its cafeteria plan under IRS Section 125 rules. The plan provided higher employer contributions for executives, violating nondiscrimination requirements. The result? Additional taxable wages for HCEs and IRS penalties. (Read more at MarketWatch)
✅ Employer Action Steps:
✔ Ensure a written cafeteria plan document is in place.
✔ Conduct nondiscrimination testing annually.
✔ Educate employees on qualified life event rules for mid-year election changes.
2. Nondiscrimination Testing: Avoiding Tax Penalties on Employer Benefits
Welfare benefit plans—including self-funded health plans, group-term life insurance, and dependent care assistance programs (DCAPs)—must comply with IRS nondiscrimination rules.
- Self-Funded Health Plans (IRC §105): Plans cannot favor executives in eligibility or benefits. Violations mean HCEs may have to pay taxes on employer contributions.
- Group-Term Life Insurance (IRC §79): Up to $50,000 of employer-provided coverage is tax-free—unless the plan discriminates in favor of key employees.
- DCAPs (IRC §129): Employer-paid dependent care benefits exceeding IRS thresholds become taxable for HCEs if discrimination occurs.
🔹 Real-World Impact:
A company failed its DCAP nondiscrimination test, leading to executives paying taxes on previously tax-free dependent care benefits. Many employers overlook DCAP compliance, exposing high earners to surprise tax bills. (Read more at IRS.gov)
✅ Employer Action Steps:
✔ Conduct annual nondiscrimination testing for self-funded health plans, DCAPs, and group-term life.
✔ Avoid tiered employer contributions that favor executives.
✔ Educate HR teams on how failure to comply impacts key employees.
3. Taxability of Wellness Incentives: IRS Cracks Down on Abusive Practices
Many companies offer wellness incentives—but not all are tax-free.
- Taxable Wellness Benefits:
- Cash or gift cards → subject to income tax & FICA
- Fixed indemnity wellness programs (pre-tax employee contributions with non-taxable payouts) → IRS considers these taxable wages
- Non-Taxable Wellness Benefits:
- Premium discounts, HRA contributions, employer-paid gym memberships (if tied to a group plan)
🔹 IRS Scrutiny on “Fixed Indemnity Wellness Programs”
The IRS is cracking down on certain employer wellness programs marketed as “tax-free cash reimbursements” for employees. In 2017, the IRS ruled that these payments are taxable wages, increasing employer audit risks. (Read more in IRS Memo 2017-30)
✅ Employer Action Steps:
✔ Review wellness incentives for tax implications.
✔ Ensure cash-based rewards are reported as taxable income.
✔ Avoid IRS-flagged fixed indemnity programs.
Bridging the Compliance & Benefits Equity Gap
Employers that prioritize both tax compliance and workforce equity can strengthen employee retention while avoiding costly IRS penalties.
✅ Key Takeaways & Action Steps:
✔ Ensure IRS Compliance for Pre-Tax Benefits
- Maintain Section 125 plan documents.
- Conduct annual nondiscrimination testing.
✔ Increase Benefits Affordability for Hourly Employees
- Introduce tiered employer contributions that favor lower-wage workers rather than executives.
- Offer low-cost supplemental health benefits (e.g., telemedicine, employer-paid preventive care).
✔ Educate Employees on Benefits & Taxation
- Many employees don’t understand their taxable benefit obligations.
- Provide clear payroll guidance on taxable vs. non-taxable perks.
✔ Enhance Financial Stability for Hourly Employees
- Increase transparency on how compensation is determined.
- Offer financial wellness programs covering budgeting, retirement planning, and savings tools.
By integrating tax compliance strategies with benefits equity initiatives, employers can create sustainable, compliant, and competitive benefits programs that attract and retain talent—particularly in industries where turnover is high.
Final Thoughts
Employers face two competing challenges—staying compliant with evolving IRS regulations while ensuring hourly workers receive fair and competitive benefits. Those that proactively align compliance strategies with workforce needs will emerge as leaders in both compliance and employee retention.
Atria helps businesses navigate benefits compliance and workforce strategy—if your organization needs tailored solutions, we’re here to help.
Get in touch with Atria today to optimize your benefits strategy.