Is Hospital Indemnity Insurance Taxable? How the IRS Treats Your Payout

The tax code excludes from income most amounts received through accident or health insurance. That exclusion, in Internal Revenue Code section 104(a)(3), does not apply to amounts attributable to employer contributions that were not taxed to you, or paid by the employer. IRS Chief Counsel has explained that salary reduction under a section 125 cafeteria plan is treated as an employer contribution, not an employee contribution.

The IRS follows the same split for disability benefits: if you paid the full cost after tax, benefits are not income; if premiums went through a cafeteria plan pre-tax, they are considered paid by your employer and benefits are fully taxable.

Section 105(b) excludes employer-funded amounts that reimburse medical care. But IRS Chief Counsel Advice 202323006 says that exclusion is limited to amounts paid solely to reimburse medical expenses. It does not apply to amounts you would receive whether or not you had medical expenses.

Hospital indemnity pays a fixed amount per admission or day. You get the same check whether your bill is $500 or $50,000. That is why pre-tax funded benefits are generally taxable to the extent they exceed your actual unreimbursed medical costs tied to that payment.

Many hospital indemnity plans pay a small wellness benefit, such as $50 or $100 for a screening. The IRS has focused on these.

In CCA 202323006, released June 2023, employees paid premiums through pre-tax salary reduction for a fixed indemnity policy that paid a $1,000 wellness benefit for certain health activities. The IRS concluded those payments were wages to the extent the employee had no unreimbursed medical expenses tied to them. They were subject to FICA, FUTA and federal income tax withholding. Groom Law Group noted this was the fourth CCA on the topic.

This targets wellness arrangements more than true hospital stay benefits, but the same reasoning applies to any fixed payment funded with pre-tax dollars.

In July 2023, Treasury and the IRS proposed regulations (REG-120730-21) saying benefits paid without regard to actual medical expenses, when premiums were paid pre-tax, would not be excluded under section 105(b), and would be treated as wages. They also proposed that payments be substantiated to be excluded.

The tri-agency final rule issued March 28, 2024 did not finalize that tax portion. Treasury and the IRS said they needed more time and would address it in future guidance, and that not finalizing it did not mean they agreed with commenters. The same rule added a consumer notice for fixed indemnity coverage starting with plan years on or after January 1, 2025.

Generally no for individuals. IRS Publication 502 lists policies that pay you a guaranteed amount while hospitalized for sickness or injury among insurance premiums you cannot include as medical expenses. See our full page on whether hospital indemnity insurance is tax deductible, and whether hospital indemnity insurance is pre-tax at work. Self-employed buyers should read hospital indemnity for self-employed individuals.

For most people, after-tax is the better trade. Premium savings are small, while a hospital claim can be large. If your employer gives you the choice, ask HR how the plan is set up.

For filing the claim itself, see how to file a hospital indemnity claim.

Only if the premiums were paid with pre-tax or employer money, and then generally only to the extent the payout exceeds related unreimbursed medical expenses. If you bought your own policy with after-tax money, or paid after-tax through work, the payout is generally yours tax-free, however you spend it. That is one reason many buyers choose an individual plan or after-tax payroll deduction. Compare options on hospital indemnity insurance plans and see typical payouts on how much hospital indemnity pays.