Summary: Employers and employees have received further clarification from the IRS on how the U.S. Supreme Court’s decision to recognize same-sex marriage affects cafeteria plans (including flexible spending arrangements [FSAs]) and health savings accounts (HSAs). In IRS Notice 2014-1, released on December 16, 2013, the IRS addresses various implications of the Supreme Court’s June 2013 decision in the U.S. v. Windsor case, in particular, as it relates to health and dependent care FSAs under Internal Revenue Code (IRC) Section 125 cafeteria plans and HSAs under IRC Section 223.
Key Action Items:
- Employers and their counsel need to review IRS Notice 2014-1 to determine its impact on the employer’s particular facts, particularly with respect to existing health plan contribution payment arrangements for health coverage of same-sex spouses, and for FSA and HSA contributions.
- Unfortunately, the IRS guidance has arrived so late in the 2013 cafeteria plan year that, as a practical matter, it will afford virtually no time for large employers to implement options with respect to the balance of the 2013 cafeteria plan year.
- Employees may recover overpayments of income and employment taxes attributable to periods (over 2013 and the previous three years) when employees have paid for same-sex spouse coverage on an aftertax basis.
- Employers that have made an effort to voluntarily communicate the tax law implications of the Windsor decision to employees should consider continuing those efforts with respect to IRS Notice 2014-1.
- Employers should consider reminding employees in same-sex marriages about the general maximum marital contribution rules for their dependent care FSAs and now for HSAs.
Timing: IRS Notice 2014-1 is effective as of December 16, 2013.
Until the U.S. Supreme Court’s June 2013 decision in Windsor found it unconstitutional, Section 3 of the Defense of Marriage Act (DOMA) prohibited the recognition of same-sex marriages for purposes of federal tax law. Prior to the decision, employers could not permit employees to elect coverage of same-sex spouses on a pretax basis under a cafeteria plan unless the spouse otherwise qualified as a tax dependent of the employee.
In Windsor, however, the Supreme Court held that Section 3 of DOMA is unconstitutional because it violates Fifth Amendment principles. Consequently, for federal tax purposes:
- The terms “spouse,” “husband and wife,” “husband” and “wife” include an individual married to a person of the same sex if the individuals are lawfully married under state law, and the term “marriage” includes such same-sex marriage.
- The IRS has adopted a general rule recognizing same-sex marriages validly entered into in a state whose laws authorize same-sex marriage even if the married couple is living in a state that does not recognize the validity of same-sex marriage.
- The terms “spouse,” “husband and wife,” “husband” and “wife” do not include individuals (whether of the opposite sex or the same sex) who have entered into a registered domestic partnership, civil union or other similar formal relationship recognized under state law that is not denominated as a marriage under the laws of that state, and the term “marriage” does not include such formal relationships.
In August 2013, the IRS issued Rev. Rul. 2013-17, which began the process of addressing the retroactive effects of the Windsor decision on taxpayers. The IRS said taxpayers may rely on the positions in Rev. Rul. 2013-17 retroactively with respect to employee benefit plans or arrangements for purposes of filing original returns, amended returns, adjusted returns, or claims for credit or refund of an overpayment of tax concerning employment tax and income tax with respect to employer-provided health coverage or fringe benefits that were provided by the employer and are excludable from income for tax-favored welfare benefits based on an individual’s marital status. Moreover, if an employee made a pretax salary-reduction election for health coverage under an employer’s Section 125 cafeteria plan and also elected to provide health coverage for a same-sex spouse on an aftertax basis under a group health plan, the taxpayer may treat the amounts that were paid by the employee for the coverage of the same-sex spouse on an aftertax basis as pretax salary-reduction amounts.
Subsequently, in IRS Notice 2013-61, the IRS provided special administrative procedures for employers that want to make adjustments or claims for refund or credit of employment taxes paid with respect to the value of same-sex spousal benefits that are excludable from the income and wages of an employee under the Windsor decision, as interpreted by Rev. Rul. 2013-17.
Now, in IRS Notice 2014-1, the IRS has issued a series of 10 questions and answers to provide further guidance on the application of the Windsor decision with respect to certain rules governing the federal tax treatment of cafeteria plans (including FSAs) and HSAs. The key points of this new guidance are summarized below, with reference to the particular Q&A number involved.
Off-Cycle Cafeteria Plan Election Changes
If a cafeteria plan participant was lawfully married to a same-sex spouse on the date of the Windsor decision, the plan may permit the participant to make a midyear election change on the basis that the participant has experienced a change in legal marital status (Q&A 1).
For periods between June 26 and December 31, 2013, a cafeteria plan will not be considered to have violated the IRS’s election change regulations solely because the plan permitted a participant with a same-sex spouse to make a midyear election change under IRS Reg. Section 1.125-4(f), where the plan administrator concluded that the change in tax treatment of spousal health coverage resulting from the Windsor decision represented a significant change in the cost of health coverage (Q&A 2).
A cafeteria plan election for same-sex spouse coverage following the Windsor decision generally takes effect as of the date that any other change in coverage would become effective for a qualifying benefit that is offered through the cafeteria plan (Q&A 3).
If, before the end of the cafeteria plan year that includes December 16, 2013, an employer receives notice that a participant is married to the same-sex spouse for whom the employee has been paying for health plan coverage on an aftertax basis, then the employer must begin treating the amount that the employee pays for the spousal coverage as a pretax salary reduction under the plan no later than the later of:
- The date that a change in legal marital status would be required to be reflected for income tax withholding purposes under IRC Section 3402 (i.e., with an employee’s filing of a Form W-4)
- A reasonable period of time after December 16, 2013
For this purpose, a participant may provide “notice” of the (existing) marriage by (1) making an election under the employer’s cafeteria plan to pay for the employee cost of spousal coverage through salary reduction or (2) by filing a revised Form W-4 representing that the participant is married (Q&A 4).
For a cafeteria plan participant who elected to pay for the cost of employee health coverage for the employee on a pretax basis through salary reduction under a cafeteria plan and also paid for the cost of same-sex spouse coverage on an aftertax 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. Consequently, 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 December 16, 2013, and any prior years for which the applicable limitation period under IRC Section 6511 has not expired (generally, the current year and the three preceding years). Note that a cafeteria plan participant may choose (1) to pay for the same-sex spouse coverage on a pretax basis through the remaining pay periods in the current cafeteria plan year by providing notice of the participant’s marital status to the employer or the cafeteria plan or (2) to continue paying for these benefits on an aftertax basis. In either case, the participant may seek a refund of federal income or federal employment taxes paid on any amounts representing the employee cost of spousal health coverage that were treated as aftertax and may exclude these amounts from gross income when filing an income tax return for the year (Q&A 5).
A cafeteria plan may permit a participant’s FSA, including a health, dependent care or adoption assistance FSA, to reimburse covered expenses of the participant’s same-sex spouse or the same-sex spouse’s dependent(s) that were incurred during a period beginning on a date that is no earlier than (1) the beginning of the cafeteria plan year that includes the date of the Windsor decision on June 26, 2013, or (2) the date of marriage, if later (Q&A 6).
Contribution Limits for HSAs and Dependent Care Assistance Programs
The maximum annual deductible contribution to one or more HSAs for a married couple — either of whom elects family coverage under a high-deductible health plan — is $6,450 for the 2013 taxable year (as adjusted for cost-of-living increases). This deduction limit applies to same-sex married couples who are treated as married for federal tax purposes with respect to a taxable year (that is, couples who remain married as of the last day of the taxable year), including the 2013 taxable year (Q&A 7).
If the combined HSA contributions elected, respectively, by two same-sex spouses exceed the applicable HSA contribution limit for a married couple, contributions for one or both of the spouses may be reduced for the remaining portion of the tax year in order to avoid exceeding the applicable contribution limit. To the extent that the combined contributions to the HSAs of the married couple exceed the applicable contribution limit, any excess may be distributed from the HSAs of one or both spouses no later than the tax return due date for the spouses (i.e., April 15 of the following year, plus extensions) as permitted under IRC Section 223(f)(3). If such excess contributions remain undistributed as of the due date for the filing of the spouse’s tax return (including extensions), they will be subject to excise taxes under Section 4973 (Q&A 8).
The maximum annual contribution to dependent care FSAs for a married couple is $5,000. This limit applies to same-sex married couples who are treated as married for federal tax purposes with respect to a taxable year (that is, couples who remain married as of the last day of the taxable year), including the 2013 taxable year (Q&A 9).
If the combined dependent care FSA contributions elected, respectively, by same-sex spouses exceed the applicable contribution limit for a married couple, contributions for one or both of the spouses may be reduced for the remaining portion of the tax year in order to avoid exceeding the applicable contribution limit. To the extent that the combined contributions to the dependent care FSAs of the married couple exceed the applicable contribution limit, the amount of excess contributions will be includable in the spouses’ gross income (Q&A 10).
If a cafeteria plan document already permits a change in election based on a change in legal marital status, the plan generally will not need to be amended in order to permit a change in status election for a same-sex spouse in connection with the Windsor decision. If, however, an employer will now be permitting election changes that were not previously permitted by the plan document, then the cafeteria plan must be amended to allow such election changes, and that must occur by the end of the plan year that begins on or after December 16, 2013 (i.e., by December 31, 2014, for calendar-year plans). In such a case, that amendment may be effective retroactively to the first day of the plan year including December 16, 2013 (i.e., January 1, 2013, for calendar-year plans), provided the cafeteria plan operates in accordance with the guidance under Notice 2014-1.