rr-06-36.pdf

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Part I

Section 105- Amounts Received Under Accident and Health Plans (Also Section 106-
Contributions by Employers to Accident and Health Plans)

Rev. Rul. 2006-36

ISSUE

Are amounts paid to an employee under a reimbursement plan excludable from the
employee’s gross income under § 105(b) of the Internal Revenue Code (the Code) if the
plan provides that amounts may be paid as § 213(d) medical benefits to a designated
beneficiary (other than the employee’s spouse or dependents or an employee)?

FACTS

Employer sponsors a reimbursement plan (the Plan) that reimburses an employee
solely for substantiated medical care expenses (as defined in § 213(d)). The Plan
provides reimbursements up to an annual maximum dollar amount for the coverage
period and reimburses medical expenses only to the extent that the expenses have not
been reimbursed from any other plan. Under the Plan, each employee’s unused
reimbursement amount available at the end of each plan year is carried forward for use
in later plan years. The Plan reimburses the substantiated medical care expenses of
both current and former employees (including retired employees), their spouses and

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dependents (as defined in §152, determined without regard to § 152(b)(1), (b)(2), and
(d)(1)(B)). The Plan also reimburses the substantiated medical care expenses of the
surviving spouse and dependents of a deceased employee. Upon the death of the
deceased employee’s surviving spouse and last dependent, or upon the death of the
employee if there is no surviving spouse or dependents, any unused reimbursement
amount is paid as reimbursement of substantiated medical care expenses of a
beneficiary designated by the employee. The Plan does not include the fair market
value of the coverage for the designated beneficiary in the gross income of the
employee. The Plan treats the reimbursement as taxable to the designated beneficiary.

The Plan is paid for solely by Employer and is not provided pursuant to a salary-
reduction election or otherwise under a § 125 cafeteria plan. Neither the employee nor
any other person has the right, currently or for any future year, to receive any benefit
other than the reimbursement of substantiated medical care expenses incurred by the
employee, his or her spouse and dependents or the employee’s designated beneficiary.

LAW AND ANALYSIS

Section 61(a)(1) provides that, except as otherwise provided in Subtitle A, gross income
includes compensation for services, including fees, commissions, fringe benefits, and
similar items. Section 1.61-21(a)(3) and (4) of the of the Income Tax Regulations states
that a fringe benefit provided in connection with the performance of services shall be

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considered to have been provided as compensation to the person performing such
services. Thus, a fringe benefit may be taxable to a person even though that person did
not actually receive the fringe benefit. If a fringe benefit is furnished to someone other
than the service provider, such benefit is considered as furnished to the service provider
and use by the other person is considered use by the service provider.

Section 106 provides that the gross income of an employee does not include employer-
provided coverage under an accident or health plan. Section 1.106-1 of the regulations
provides that the gross income of an employee does not include contributions which the
employee’s employer makes to an accident or health plan for compensation (through
insurance or otherwise) for personal injuries or sickness to the employee or the
employee’s spouse or dependents.

Section 105(a) provides that, except as otherwise provided in § 105, amounts received
by an employee through accident or health insurance for personal injuries or sickness
shall be included in gross income to the extent such amounts (1) are attributable to
contributions by the employer which were not includible in the gross income of the
employee, or (2) are paid by the employer.

Section 105(b) states that except in the case of amounts attributable to (and not in
excess of) deductions allowed under § 213 (relating to medical expenses) for any prior
taxable year, gross income does not include amounts referred to in § 105(a) if such
amounts are paid, directly or indirectly, to the taxpayer to reimburse the taxpayer for

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expenses incurred by the taxpayer for the medical care (as defined in § 213(d)) of the
taxpayer or the taxpayer's spouse or dependents (as defined in § 152, determined
without regard to § 152(b)(1), (b)(2), and (d)(1)(B)).

Section 1.105-2 of the Income Tax Regulations provides that only amounts that are paid
specifically to reimburse the taxpayer for expenses incurred by the taxpayer, spouse or
dependents for the prescribed medical care are excludable from gross income. Section
1.105-2 further provides that payments to or on behalf of the taxpayer’s spouse or
dependents shall constitute indirect payment to the taxpayer. Section 1.105-2 also
states that “. . . section 105(b) does not apply to amounts which the taxpayer would be
entitled to receive irrespective of whether or not he incurs expenses for medical care.”
Thus, if an employee has the opportunity to receive a payment irrespective of whether
any medical expenses have been incurred by the employee or the employee’s spouse
or dependents, the payment is not excludable from gross income under § 105(b) even if
the employee (or his or her spouse or dependents) incurred medical expenses during
the year.

Notice 2002-45, 2002-2 C.B. 93, describes the tax treatment of health reimbursement
arrangements (HRAs) excludable under § 105(b). The notice explains that an HRA is
an arrangement that is paid for solely by the employer and not pursuant to a salary
reduction election or otherwise under a § 125 cafeteria plan. An HRA reimburses the
employee for medical care expenses (as defined in § 213(d)) incurred by the employee
or by the employee’s spouse or dependents, and provides reimbursements up to a

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maximum dollar amount with any unused portion of that amount at the end of the
coverage period carried forward to subsequent coverage periods.

Notice 2002-45 also states that to qualify for the exclusion from gross income under §
105(b), an HRA may only provide benefits that reimburse expenses for medical care as
defined in § 213(d). An HRA does not qualify for the exclusion under § 105(b) if any
person has the right to receive cash or any other taxable or non-taxable benefit under
the arrangement other than the reimbursement of medical care expenses. If any person
has such a right, currently or for any future year, all payments to all persons made from
the arrangement in the current year are included in gross income, even amounts paid to
reimburse medical care expenses of the employee, spouse or dependents.

Situation 3 of Rev. Rul. 2005-24, 2005-16 I.R.B. 892, describes a plan that, after the
death of an employee and the employee’s surviving spouse and dependents, pays all or
a portion of the unused reimbursement amount in cash to a beneficiary or beneficiaries
designated by the employee, and if no beneficiary is designated, to the deceased
employee’s estate. Rev. Rul. 2005-24 holds that an amount (including an amount paid
to reimburse medical expenses) paid from a plan that provides for the payment of the
unused reimbursement amount in cash or other benefits is not excludable from the
employee’s gross income under §105(b). Rev. Rul. 2005-24 does not specifically
address reimbursement of § 213(d) medical expenses incurred by a non-spouse or non-
dependent. Nevertheless, the ruling also states that it applies to any purported
employer-provided medical reimbursement arrangement that provides for the receipt by

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the employee or any other person of cash or any other taxable or non-taxable benefit
other than the reimbursement of medical care expenses of employees and their
spouses and dependents. This principle applies to amounts paid for reimbursement of
medical expenses to designated beneficiaries other than the employee’s spouse or
dependents.

The Plan described in this ruling does not meet the requirements of § 105(b) and §
1.105-2. Because a beneficiary who is not the employee’s spouse or dependent may
receive some or all of the medical reimbursements under the Plan, amounts paid under
the Plan are not excludable under § 105(b) even if those amounts are paid to reimburse
the medical expenses of the employee or the employee’s spouse or dependents.
Because the benefit is provided in connection with the performance of services by the
employee, the benefit is considered provided to the employee and must be included in
the employee’s gross income. See § 1.61-21(a)(3) and (4).

HOLDING

Amounts paid to an employee under a reimbursement plan are not excludable from
gross income under § 105(b) if the plan permits amounts to be paid as § 213(d) medical
benefits to a designated beneficiary (other than the employee’s spouse or dependents
of the employee). None of the payments made from the reimbursement plan during the
plan year to any person, including amounts paid to reimburse the medical expenses of
an employee or the employee’s spouse or dependents, is excludable from the gross

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income.

EFFECT ON OTHER DOCUMENTS

Rev. Rul. 2005-24, 2005-16 I.R.B. 892, Rev. Rul. 2002-41, 2002- 2 C.B. 75, and Notice
2002-45, 2002-2 C.B. 93 are amplified.

EFFECTIVE DATE
For reimbursement plans containing a provision on or before August 14, 2006 stating
that upon the death of a deceased employee’s surviving spouse and last dependent, or
upon the death of the employee, if there is no surviving spouse or dependents, any
unused reimbursement amount will be paid as a reimbursement of substantiated
medical care expenses of a beneficiary designated by the employee, this revenue ruling
is effective with respect to that provision for plan years beginning after December 31,
2008.

DRAFTING INFORMATION
The principal author of this revenue ruling is Shoshanna Tanner of the Office of Division
Counsel/Associate Chief Counsel (Tax Exempt and Government Entities). For further
information regarding this revenue ruling, contact Elizabeth Purcell at (202) 622-6080
(not a toll-free call).