IRC Section 104(a)(3), Treasury Regulations, and Supporting Guidance
Section 104 addresses the taxation of compensation for injuries or sickness. Subsection (a)(3) specifically addresses benefits received through accident or health insurance.
(a) In general. Except in the case of amounts attributable to (and not in excess of) deductions allowed under section 213 (relating to medical, etc., expenses) for any prior taxable year, gross income does not include—
(1) amounts received under workmen's compensation acts as compensation for personal injuries or sickness;
(2) the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness;
(3) amounts received through accident or health insurance (or through an arrangement having the effect of accident or health insurance) for personal injuries or sickness (other than amounts received by an employee, to the extent such amounts (A) are attributable to contributions by the employer which were not includible in the gross income of the employee, or (B) are paid by the employer);
Source: 26 U.S.C. § 104(a). Current through Pub. L. 118-67.
Benefits from accident or health insurance are excluded from gross income UNLESS they are attributable to employer contributions that weren't taxed to the employee. The inverse: if the employee paid the premiums with after-tax dollars, benefits ARE excludable.
The Treasury Regulations provide authoritative interpretation of the statute. Section 1.104-1(d) specifically addresses the after-tax premium principle.
Section 104(a)(3) excludes from gross income amounts received through accident or health insurance for personal injuries or sickness (other than amounts received by an employee, to the extent such amounts are attributable to contributions of the employer which were not includible in the gross income of the employee, or are paid by the employer).
If an individual purchases a policy of accident or health insurance out of the individual's own funds, amounts received thereunder for personal injuries or sickness are excludable from gross income under section 104(a)(3).
If an employer purchases a policy of accident or health insurance for an employee, or if an employee purchases a policy with employer contributions that were not includible in the employee's gross income, the amounts received under such policy for personal injuries or sickness are not excludable under section 104(a)(3) but may be excludable under section 105.
Source: 26 C.F.R. § 1.104-1(d)
This Revenue Ruling addresses a critical question: what happens when fixed indemnity payments exceed actual medical expenses?
Issue: Whether amounts received under a health and accident policy in excess of medical expenses are excludable from gross income.
Facts: Taxpayer purchased a health and accident policy with after-tax funds. The policy paid fixed daily amounts for hospitalization. The payments received exceeded the taxpayer's actual medical expenses.
Holding: Amounts received under a health and accident insurance policy for personal injuries or sickness are excludable from gross income under section 104(a)(3) of the Code, even though such amounts exceed the medical expenses incurred, provided the premiums for such policy are paid by the taxpayer and not by the taxpayer's employer.
The exclusion under section 104(a)(3) is not limited to amounts received as reimbursement for medical expenses. The exclusion applies to all amounts received through accident or health insurance for personal injuries or sickness when the premiums are paid by the individual.
Source: Rev. Rul. 69-154, 1969-1 C.B. 46
This ruling establishes that Section 104(a)(3) benefits are NOT limited to actual medical expense reimbursements. Fixed indemnity payments—including amounts that exceed actual expenses—are fully excludable when premiums are paid with after-tax dollars. This is the foundation for wellness program benefit treatment.
In 2017, the IRS Chief Counsel explicitly confirmed the after-tax premium principle:
"However, to the extent that premiums are paid with after-tax dollars, payments by the plan are excluded under § 104(a)(3), without regard to the amount of any medical expense incurred by the event upon which the payment is conditioned."
Source: IRS Chief Counsel Advice 201703013, released January 20, 2017
This statement confirms that as of 2017, the IRS recognized that after-tax premium funding supports tax-free benefits under Section 104(a)(3)—and that the "excess benefit" limitation does not apply to such policies.
Together, these authorities establish:
The PTE Gold Book provides comprehensive analysis of Section 104(a)(3), all supporting Treasury Regulations and Revenue Rulings, and detailed application to dual-premium wellness programs.