The Rule Treasury Did Not Finish, and Why It Is Still the Test

If you have been in this industry more than a year, you have heard someone say the IRS tried to kill wellness reimbursement plans in 2023 and failed. Sometimes it is said with relief. Sometimes it is a sales line. I have heard it from administrators, from brokers, and more than once from people who should know better. I want to walk through what actually happened, because the version most of us carry around is wrong, and the wrong version is now a liability in at least two states.

Start with the rule that already exists

The regulation that governs when a health plan payment is tax-free under Section 105(b) was written in 1956. It says the exclusion applies only to amounts “paid specifically to reimburse the taxpayer for expenses incurred by him for the prescribed medical care,” and that it does not apply to amounts the taxpayer “would be entitled to receive irrespective of whether or not he incurs expenses for medical care.” (Groom Law Group)

Read that twice. It has been the law for seventy years. A plan that pays an employee a fixed amount every month for completing a wellness activity, whether or not they had a medical expense, was already outside the exclusion before anyone at Treasury drafted a word in 2023. The IRS has said so repeatedly in Chief Counsel memoranda since 2016, most pointedly in CCA 202323006, dated May 9, 2023 and released June 9, 2023, which concluded that wellness indemnity payments funded through a Section 125 salary reduction are includible in income, and are wages for FICA, FUTA, and withholding, where the employee has no unreimbursed medical expense related to the payment. (IRS CCA 202323006)

Treasury had also already asked Congress to fix this by statute. The FY2023 Greenbook, released in March 2022, and the FY2024 Greenbook, released in March 2023, each carried a proposal titled “Clarify Tax Treatment of Fixed Indemnity Health Policies” that would have amended Section 105(b) so the exclusion applies “only to the amount paid directly or indirectly for a specific medical expense,” with any fixed payment made “without regard to the actual cost of the medical expenses the employee incurred” treated as wages subject to FICA and FUTA. (FY2023 Greenbook, FY2024 Greenbook) Both years Treasury scored it as having no revenue effect, which is Treasury’s way of saying it believed current law already produces this result. Congress did not pick it up either year.

What Treasury proposed

On July 12, 2023, Treasury and the IRS, together with Labor and HHS, published a large joint rule on short-term insurance and fixed indemnity coverage. The IRS docket was REG-120730-21, and it ran at 88 FR 44596. Inside it was a rewrite of that 1956 regulation. (Federal Register, July 12, 2023)

The proposed text said Section 105(b) “applies only to amounts which are paid specifically to reimburse the taxpayer for section 213(d) medical care expenses that have been incurred by the taxpayer and that are substantiated by the plan,” and that payments under a fixed indemnity policy “or any plan that pays amounts regardless of the amount of section 213(d) medical care expenses actually incurred, are not payments for medical care under section 105(b) and are included in the employee’s gross income under section 105(a).” (Federal Register, July 12, 2023)

Here is what that changed. The old rule said “irrespective of whether or not.” The new rule said “regardless of the amount.” And the new rule added that the plan has to substantiate the expense. That is the entire delta. The 1956 text already stopped plans that pay when there is no expense. The 2023 text would have stopped plans that pay a fixed amount when there is some expense but the payment has nothing to do with its size. The preamble said substantiation normally happens before payment but must happen “at least within a reasonable period thereafter,” and that anything not excluded would be wages subject to FICA, FUTA, and withholding. (Groom Law Group)

What happened in April 2024

On April 3, 2024, the agencies published the final rule, T.D. 9990, at 89 FR 23338. They finalized the short-term insurance definition and a new consumer notice for fixed indemnity policies. They did not finalize the Section 105(b) rewrite. (Federal Register, April 3, 2024)

This is the part everybody skips. Treasury explained why. Commenters argued that only the amount above the medical expenses tied to the event should be taxable. Many commenters asked how employment taxes would be collected, how the amounts would be reported on a W-2, and how substantiation would work. Treasury said it intends “to address these issues in more detail in future guidance” and was “not finalizing the proposed amendments to 26 CFR 1.105-2 at this time.” Then it wrote two more sentences that should be taped to the wall of every administrator in this business.

“No inference should be drawn regarding whether or the extent to which the Treasury Department or the IRS agree with any comments on the scope of section 105(b) of the Code based on this decision.”

“IRS compliance efforts regarding the exclusion from gross income under section 105(b) of the Code will continue to assist taxpayers to satisfy their existing tax responsibilities.” (Federal Register, April 3, 2024)

That is not a failure. That is an agency saying it paused over mechanics, did not change its mind about the statute, and would keep enforcing the rule already on the books. The docket was never withdrawn.

What has happened since

The IRS is auditing. On September 29, 2026, Morgan Lewis reported that the IRS “has begun to audit fixed indemnity health/wellness benefit plans” marketed on payroll tax savings, relying on the 2024 preamble and the guidance stream going back to 2016, with employers exposed to under-withheld tax, penalties, and interest. (Morgan Lewis) An examiner does not need a finalized regulation. The examiner needs the 1956 text, the Chief Counsel memos, and the reading Treasury put in writing in 2023.

The states moved. South Carolina and West Virginia now license wellness reimbursement administrators, and South Carolina’s mandatory employer disclosure has to say that “federal tax guidance in this area continues to evolve.” (SC Code 38-105-30(D)) I wrote about those laws last week. The point for today is that a state legislature read the same preamble and concluded the question is open. If your proposal says otherwise, a regulator who reviews your marketing before it ships is going to notice.

Treasury has gone quiet. The 2026–2027 Priority Guidance Plan, released September 29, 2026, lists 121 projects and nothing under Section 105. The only health item is a single line reading “Guidance on health care related tax matters.” (IRS 2026–2027 Priority Guidance Plan) I would not read anything into that either way. The joint rule never ran through the IRS plan to begin with. The places a revival would show up first are the Greenbook each spring and the Unified Agenda entry for RIN 1545-BQ28.

Why the proposed rule is still the test

Here is where I land, and it is the reason I bothered writing this.

The 2023 text is the clearest statement in writing of how the IRS reads Section 105(b). It did not become law, but it tells you exactly what an examiner is looking for: a reimbursement tied to the amount of a real 213(d) expense, substantiated by the plan, paid to someone who actually incurred it. If a program meets that standard, it meets the 1956 standard too, because the 1956 standard is looser. If a program cannot meet the 2023 standard, it is relying on the gap between “whether or not” and “regardless of the amount,” and that gap is exactly where the audits are aimed.

So when you evaluate an administrator, do not ask whether the regs failed. Ask whether the plan would pass the rule that did not get finished. Does every reimbursement trace to a documented expense? Is it capped at what the employee actually paid after other coverage? Does a month with no expense pay nothing? Is substantiation collected before payment or within a defined window after? Is there a payment schedule anywhere in the design that could be described as fixed regardless of amount? Five questions, and you will know more about the program than its sales deck will tell you.

Three phrases to retire

“The regs failed.” They were paused, with an express instruction not to read anything into the pause.

“Congress rejected the IRS proposal.” Treasury asked Congress in the FY2023 and FY2024 Greenbooks to change the statute. (FY2024 Greenbook) No bill was introduced, no committee met, no vote occurred. The proposal was simply not carried into the FY2025 Greenbook in March 2024, the same month Treasury was finishing the rule discussed above. (FY2025 Greenbook) Silence is not rejection.

“The IRS backed off.” The agency said compliance efforts would continue, and two years later it is auditing.

Here is what to say instead, and it is the only version that survives an employer’s CPA, a state examiner, and a plaintiff’s lawyer: Treasury proposed a tightening in 2023, did not finalize it in 2024, said no inference should be drawn, and said enforcement would continue. The rule in force today is the 1956 regulation, which already excludes payments made whether or not an expense was incurred.

That is less satisfying than “the regs failed.” It is also true, and in this business being the person who knows the true version is the whole job.