@abaptista
Although tax season has come and gone, I wanted to reiterate that your payroll department is mistaken in showing premiums paid to an Aflac policy in Box 12 of your W-2 with a code of W.
You said, " ADP ... reported that most companies follow this same method." Based on my experience in answering thousands of HSA questions here on the TurboTax support forum, very few companies report premiums for Aflac policies with a code of W in Box 12 - and the ones that do are mistaken.
Please read the following where I add more links that demonstrate my conclusion.
The issue is whether premiums paid by or through the employer for a fixed indemnity health plan can be considered contributions to an HSA (health savings account), and therefore be reported on the employee’s W-2 in box 12 with a code of W.
What is a fixed indemnity health plan? It is – in the words of Aflac, one of the best-known suppliers of fixed indemnity health plans – “[s]upplemental insurance [which] is additional coverage that you can use to help with the out-of-pocket expenses that may not be covered by your major medical insurance. Have you ever had expenses not covered by your major medical plan? That’s where Aflac comes in.” See https://www.aflac.com/what-we-do/default.aspx
In other words, a fixed indemnity health plan pays the policyholder a “fixed” amount for each covered event, without regard to the expense incurred by the policyholder. “Normal” health insurance reimburses the policyholder based on the expense incurred by the policyholder.
On the other hand, an HSA is “a trust created or organized in the United States as a health savings account exclusively for the purpose of paying the qualified medical expenses of the account beneficiary, but only if the written governing instrument creating the trust meets the following requirements…” (See Section 223(d)(1) of the US Tax Code at https://www.law.cornell.edu/uscode/text/26/223).
A trust is created under the laws of the state in which the taxpayer resides. In the case of an HSA, the trust is generally created (depending on the laws of the state) when the HSA is initially funded.
Clearly, a fixed indemnity health plan like Aflac is NOT a trust organized under the laws of the state in which the taxpayer resides, but is – in Aflac’s own words - “insurance”.
How are contributions to an HSA made by or through an employer reported?
“You must report all employer contributions (including an employee's contributions through a cafeteria plan) to an HSA in box 12 of Form W-2 with code W.” See page 11 of 2020 General Instructions for forms W-2 and W-3 - https://www.irs.gov/pub/irs-pdf/iw2w3.pdf.
“Code W—Employer contributions to a health savings account (HSA).
Show any employer contributions (including amounts the employee elected to contribute using a section 125 (cafeteria) plan) to an HSA.” See page 20 of 2020 General Instructions for forms W-2 and W-3 - https://www.irs.gov/pub/irs-pdf/iw2w3.pdf.
How are premiums for health plans paid by or through an employer reported?
Aflac itself states that premiums paid by or through the employer for certain Aflac policies should be reported in box 12 using code DD on the W-2. See https://www.aflac.com/health-care-reform/key-issues/w2-reporting-of-employer-sponsored-health-care.a.... This is consistent with the IRS instructions found in 2020 General Instructions for forms W-2 and W-3 - https://www.irs.gov/pub/irs-pdf/iw2w3.pdf on page 21:
“Code DD—Cost of employer-sponsored health coverage. Use this code to report the cost of employer-sponsored health coverage.”
This appears to refer to Aflac policies that are part of the employee compensation package.
However, many employers also offer optional benefits under the umbrella of Section 125 in the U.S. Tax Code. In this case, the Aflac coverage is optional, because the employee is free to select which benefit that he/she wants of which an Aflac fixed indemnity policy may be one.
Section 125 benefits are either not reported on the W-2 or are optionally reported in Box 14 on the W-2 with a category for the benefit (generally, something like “SEC125”). There is no required description for categories in Box 14. If a category appears in Box 14 of the employee’s W-2 that the employee does not understand, he/she should ask the employer what the category refers to.
Note the language above: “Show any employer contributions (including amounts the employee elected to contribute using a section 125 (cafeteria) plan) to an HSA.” Some employers are apparently confused by the language in this paragraph. They read this as saying that ALL Section 125 premium payments are reported in Box 12 with a code of W. But, clearly, the language of the IRS instructions refers ONLY to contributions to an HSA being reported in Box 12 with a code of W.
In summary, fixed indemnity health policies such as from Aflac are not HSAs (Health Savings Accounts) under the terms of Section 223 of the U.S. Tax Code; therefore, premiums paid for such health policies must not be reported on the employee’s W-2 in box 12 with a code of W. Instead, such premiums should be reported either in Box 12 with a code of DD or reported in Box 14 with a category such as “SEC125” or not reported at all, depending on the policy.
Employers who mistakenly enter the premiums for fixed indemnity health policies in Box 12 with a code of W will cause problems for employees if they are audited, and in many cases, will cause the employee’s tax return to be incorrectly generated in most tax software.
