Cafeteria Plans Need to Move Fast to Take Advantage of Year-End IRS Guidance

(Posted on December 16, 2013 by )

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On June 26, 2013, the Supreme Court issued the Windsor decision, striking down a provision in the federal Defense of Marriage Act which had precluded recognition of same-sex marriages.  In September, the Internal Revenue Service (“IRS”) announced that same-sex couples legally married in a state that recognized such marriages would now be treated as married for purposes of federal taxation, regardless of whether their marriages were recognized by their state of residence.  The IRS announcement was made retroactive, meaning that such marriages will be recognized back to their inception.

The IRS has issued Notice 2014-1, which provides guidance on the application of the new rules to cafeteria plans.  However, in many instances employers will need to move quickly to take advantage of relief granted.

Summary

  • Effective immediately, employers can feel free to permit employees in same-sex marriages to change their elections under cafeteria plans to reflect their marriages, even in the case of marriages that took place prior to 2013.
  • Employees can use benefits remaining in 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.
  • Employers have the opportunity to correct inadvertent over withholding or under withholding 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.  While employees will have ways to correct over withholding or under withholding on their own, the potential employee relations issues of requiring them to do so should be considered.
  • Many of the provisions of the Notice will affect the amount reportable as income on 2013 Forms W-2.  Thus, it is important for those responsible for preparing such forms to be aware of the new guidance as soon as possible.

Background

A cafeteria plan (a plan that allows an employee a choice between cash and tax-favored benefits) can allow an employee to change an election based on, among other events, marriage during the year.  Before the Supreme Court decision, a cafeteria plan could not provide tax-favored benefits to the same-sex spouse of an employee.  After the Supreme Court decision, an employer could clearly permit a newly married employee to change elections based on the marriage.  But it was unclear whether an employer could permit an employee who married before 2013 to change elections in 2013 based on the Supreme Court decision.

In addition, dependent care plans and health savings accounts (“HSAs”) have maximum limits on that amount which can be set aside.  Two employees who believed (based on the law in effect before the Supreme Court decision) that they would be treated as single may each have elected to set aside amounts for these benefits that now, on a combined basis, exceed the maximum allowable.

Finally, given that the Notice is only being issued in December, it may be impracticable for employers to make necessary plan amendments by the end of the year.  The Notice permits amendments to be made retroactively on or before the last day of the first plan year beginning on or after December 16, 2013. Such an amendment may be effective retroactively to the first day of the plan year including December 16, 2013, provided that the cafeteria plan operates in accordance with the guidance under the notice.

The Notice has different effects based on the type of plan, and what the employer has done so far:

Health Insurance

Employee had health coverage for a same-sex spouse before June 26, 2013

In this situation, the coverage may have been provided under a domestic partner policy, and the employer may not have known whether the employee was legally married to his or her domestic partner.  In recognition of the difficulty for employers, the Notice provides that if the employer receives notice of the marriage by the end of the cafeteria plan year that includes December 16, 2013, it has two options.  It can either adjust withholding for the remaining pay periods of the year to take account of the over withholding due to treating health benefits as taxable in prior periods.  Or it can simply continue treating the premiums for spousal coverage as after-tax.  If the employer chooses the second option, the employee will still not be taxable on the value of the spousal coverage, so the over withholding will be applied to other taxes owed or will form the basis for an income tax refund.

Employee had a same-sex spouse before June 26, 2013, but did not have health coverage for the spouse

An employee may not initially have elected coverage for his or her spouse due to the onerous tax consequences of doing so, and may have elected such coverage in light of the Supreme Court decision.  Normally, a change in the cost or tax consequences of a benefit cannot be the basis for a change in an employee’s election.  However, the Notice indicates that an employee in this situation will be considered to have made the new election based on marriage, even if the marriage occurred before 2013, if the election is made at any time before December 31, 2013.

Flexible Spending Accounts

Employee has elected coverage for a same-sex spouse after June 26, 2013

As with health insurance, elections to participate in a health, dependent care, or adoption assistance flexible spending account (“FSA”) will be treated as being on account of marriage, even if the marriage took place before 2013.  Thus, a plan will not lose tax-favored status if it has already been permitting employees with same-sex spouses to make mid-year election changes.

Employee has a same-sex spouse, but did not elect FSA coverage for the spouse

In this case, depending on the terms of the plan, it may be too late for the employee to elect FSA coverage for this year. The IRS Notice did not permit retroactive elections to increase the amount set aside under an FSA.  However, the employee will be permitted to use any remaining 2013 FSA funds for spousal benefits, even if the FSA was set up as a self-only plan.

HSAs and Dependent Care Assistance Programs

If two individuals in a same-sex marriage have combined contributions to HSAs and/or dependent care programs that exceed the maximum, there are two options.  First, contributions for one or both of them can be reduced for the remainder of the year to avoid the over contribution.  To the extent this is not done, any excess HSA contribution may be distributed from the HSA of one or both spouses no later than the tax return due date for the spouses.  Any excess dependent care benefits will simply be treated as income to the employee.

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