December 17, 2013

At Last Minute, IRS Gives Gay Couples Health Care Tax Break

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Thanks to last-minute action by the IRS, legally married same-sex couples can claim tax benefits this year if they’re enrolled in a flexible spending account, health care savings account or cafeteria plan.

The IRS – responding to the Supreme Court’s ruling in June invalidating part of the Defense of Marriage Act – said plans also are able to allow a midyear election change for participants marrying a same-sex spouse after the so-called Windsor decision.

In August, the government said same-sex couples will be viewed as married for federal tax purposes, regardless of whether their marriages were recognized by the state in which they lived.

Carol Calhoun, a Washington, D.C., based attorney and former IRS official, said employees can use benefits remaining in their 2013 FSA accounts for same-sex spousal benefits, even in the case of FSAs set up as self-only FSAs.

“This information obviously needs to be communicated to those responsible for processing FSA benefits,” she said in a post on her firm’s website.

Employers, she wrote, also can now correct inadvertent overwithholding or underwithholding due to the recognition of an employee’s marital status, “but only if they act quickly to do so before the end of the year.”

The IRS notice will affect the amount reportable as income on W-2s, she said, so it’s important for HR departments to be aware of the new guidance as soon as possible.

Retirement plan sponsors are still awaiting IRS guidance on whether they will be compelled to retroactively apply the DOMA decision in calculating spousal and other benefits to same-sex partners.

Here are excerpts from the latest notice, offered by the IRS in Q&A form:

Question: If a cafeteria plan participant was lawfully married to a same-sex spouse as of the date of the Windsor decision, may the plan permit the participant to make a mid-year election change on the basis that the participant has experienced a change in legal marital status?

Answer: Yes. A cafeteria plan may treat a participant who was married to a same-sex spouse as of the date of the Windsor decision (June 26, 2013) as if the participant experienced a change in legal marital status for purposes of Treas. Reg. § 1.125-4(c).

Accordingly, a cafeteria plan may permit such a participant to revoke an existing election and make a new election in a manner consistent with the change in legal marital status. For purposes of election changes due to the Windsor decision, an election may be accepted by the cafeteria plan if filed at any time during the cafeteria plan year that includes June 26, 2013, or the cafeteria plan year that includes December 16, 2013.

A cafeteria plan may also permit a participant who marries a same-sex spouse after June 26, 2013, to make a mid-year election change due to a change in legal marital status.

Q: May a cafeteria plan permit a participant with a same-sex spouse to make a midyear election change under Treas. Reg. § 1.125-4(f) on the basis that the change in tax treatment of health coverage for a same-sex spouse resulted in a significant change in the cost of coverage?

A: A change in the tax treatment of a benefit offered under a cafeteria plan generally does not constitute a significant change in the cost of coverage for purposes of Treas. Reg. § 1.125-4(f). Given the legal uncertainty created by the Windsor decision, however, cafeteria plans may have permitted mid-year election changes under Treas. Reg. § 1.125-4(f) prior to the publication of this notice.

Q: When does an election made by a participant in connection with the Windsor decision take effect? A: An election made under a cafeteria plan with respect to a same-sex spouse as a result of the Windsor decision generally takes effect as of the date that any other change in coverage becomes effective for a qualifying benefit that is offered through the cafeteria plan.

With respect to a change in status election that was made by a participant in connection with the Windsor decision between June 26, 2013 and Dec. 16, 2013, the cafeteria plan will not be treated as having failed to meet the requirements of section 125 or Treas. Reg. § 1.125-4 to the extent that coverage under the cafeteria plan becomes effective no later than the later of (a) the date that coverage under the cafeteria plan would be added under the cafeteria plan’s usual procedures for change in status elections, or (b) a reasonable period of time after Dec. 16, 2013.

The rules set forth (in the questions above) are illustrated by the following examples:

Example 1. Employer sponsors a cafeteria plan with a calendar year plan year.

Employee A married same-sex Spouse B in October 2012 in a state that recognized same-sex marriages. During open enrollment for the 2013 plan year, Employee A elected to pay for the employee portion of the cost of self-only health coverage through salary reduction under the cafeteria plan. Employer permits same-sex spouses to participate in its health plan. On Oct. 5, 2013, Employee A elected to add health coverage for Spouse B under Employer’s health plan, and made a new salary reduction election under the cafeteria plan to pay for the employee portion of the cost of Spouse B’s health coverage. Employer was not certain whether such an election change was permissible, and accordingly declined to implement the election change until the publication of this notice.

After publication of this notice, Employer determines that Employee A’s revised election is permissible as a change in status election in accordance with this notice. Employer enrolls Spouse B in the health plan as of Dec. 20, 2013, and begins making appropriate salary reductions from the compensation of Employee A for Spouse B’s coverage beginning with the pay period starting Dec. 20, 2013. The cafeteria plan is administered in accordance with this notice.

Example 2. Same facts as Example 1, except that Employee A submitted the election to add health coverage for Spouse B under Employer’s cafeteria plan on Sept. 1, 2013. Prior to publication of this notice, Employer implemented the election change and enrolled Spouse B in the health plan as of Oct. 1, 2013, and began making appropriate salary reductions from the compensation of Employee A for Spouse B’s coverage beginning with the pay period starting Oct. 1, 2013. The cafeteria plan was administered in accordance with this notice.

Q: How does the Windsor decision affect the tax treatment of health coverage for a same-sex spouse in the case of a cafeteria plan participant who had been paying for the cost of same-sex spouse coverage on an after-tax basis?

A: In the case of a cafeteria plan participant who elected to pay for the employee cost of health coverage for the employee on a pre-tax basis through salary reduction under a cafeteria plan and also paid for the employee cost of health coverage for a same-sex spouse under the employer’s health plan on an after-tax basis, the participant’s salary reduction election under the cafeteria plan is deemed to include the employee cost of spousal coverage, even if the employer reports the amounts as taxable income and wages to the participant. Accordingly, the amount that the participant pays for spousal coverage is excluded from the gross income of the participant and is not subject to federal income or federal employment taxes. This rule applies to the cafeteria plan year including Dec. 16, 2013, and any prior years for which the applicable limitations period under section 6511 has not expired. 

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