IRS Windsor Guidance Addresses Cafeteria Plans, FSAs and HSAs | Practical Law

IRS Windsor Guidance Addresses Cafeteria Plans, FSAs and HSAs | Practical Law

The Internal Revenue Service (IRS) has issued Notice 2014-1, which addresses the implications of the Supreme Court's decision in U.S. v. Windsor for cafeteria plans, flexible spending arrangements (FSAs) and health savings accounts (HSAs). Among other things, Notice 2014-1 permits certain mid-year cafeteria plan election changes for employees who purchased health coverage for same-sex spouses.

IRS Windsor Guidance Addresses Cafeteria Plans, FSAs and HSAs

Practical Law Legal Update 8-552-3127 (Approx. 6 pages)

IRS Windsor Guidance Addresses Cafeteria Plans, FSAs and HSAs

by Practical Law Employee Benefits & Executive Compensation
Published on 17 Dec 2013 • USA (National/Federal)
The Internal Revenue Service (IRS) has issued Notice 2014-1, which addresses the implications of the Supreme Court's decision in U.S. v. Windsor for cafeteria plans, flexible spending arrangements (FSAs) and health savings accounts (HSAs). Among other things, Notice 2014-1 permits certain mid-year cafeteria plan election changes for employees who purchased health coverage for same-sex spouses.
On December 16, 2013, the IRS issued Notice 2014-1 (Notice), which provides question-and-answer guidance regarding the impact of the Supreme Court's Windsor decision (June 26, 2013) striking down Section 3 of the Defense of Marriage Act (DOMA) (IRS Notice 2014-1, (Dec. 17, 2013) and see Legal Update, Supreme Court: DOMA Section 3 is Unconstitutional and Proposition 8 Proponents Lack Standing). The Notice:

Mid-year Election Changes

Under the Notice, cafeteria plans may permit a participant in a legal same-sex spouse to make a mid-year election change, on the ground that the participant experienced a change in marital status under the cafeteria plan regulations. This mid-year election change is allowed if:
  • The participant was legally married to a same-sex spouse on June 26, 2013.
  • The election satisfies the general requirements for cafeteria plan election changes, including the consistency requirement (see Practice Note, Cafeteria Plans: Consistency Rule).
As a result, the participant can:
  • Revoke an existing election.
  • Make a new election that is consistent with the change in legal marital status.
The plan can accept an election change due to Windsor if it is filed any time during the cafeteria plan year that includes June 26, 2013, or the plan year that includes December 16, 2013.
Plans may also permit a participant who marries a same-sex spouse after June 26, 2013 to make a mid-year election change due to change in legal marital status.
According to the IRS, however, the Windsor decision does not generally permit a mid-year election change under the rule permitting election changes due to a significant change in the cost of coverage. The Notice includes an exception for plans that allowed same-sex spouses to make a mid-year election change:
  • Between June 26 and December 31, 2013.
  • Based on a plan administrator's decision that the Windsor-related change in tax treatment of spousal health coverage resulted in a significant change in the cost of health coverage.
The Notice also includes rules addressing when Windsor-related elections become effective.

Transition to Pre-tax Treatment for Same-sex Coverage

The Notice addresses (and potentially affects) cafeteria plan participants who both:
  • Elected to pay for the participant's cost of health coverage on a pre-tax basis through salary reduction.
  • Paid the employee cost of health coverage for a same-sex spouse under the employer's health plan on an after-tax basis.
If an employer receives notice, before the end of the cafeteria plan year that includes December 16, 2013, that the participant is legally married to the individual receiving health coverage, it must treat the amount the employee pays for the spousal coverage as a pre-tax salary reduction. The employer must do so by the later of:
  • The date a change in legal marital status must be reflected for income tax withholding purposes (under 26 U.S.C. § 3402).
  • A reasonable period of time after December 16, 2013.
To provide the employer with notice of the participant's same-sex marriage, the participant can either:
  • Elect under the employer's cafeteria plan to pay for the employee cost of spousal coverage through salary reduction.
  • File a revised Form W-4 indicating that the participant is married.

Taxation of Same-sex Coverage Paid After-tax

The Notice also addresses the tax implications if a cafeteria plan participant:
  • Elected to pay for the employee cost of the participant's health coverage pre-tax through salary reduction.
  • Paid for the employee cost of health coverage for a same-sex spouse under the employer's health plan on an after-tax basis.
In this situation, the participant's salary reduction election 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. The amount that the employee pays for spousal coverage is:
  • Excluded from the participant's gross income.
  • Not subject to federal income or employment taxes.
This rule applies for:
  • The cafeteria plan year that includes December 16, 2013.
  • Any prior years for which the limitations period (under 26 U.S.C. § 6511) has not expired. (Under Section 6511, taxpayers generally must file claims for overpayments within three years from when the return was filed.)
As a result, a cafeteria plan participant can either:
  • Pay for the employee cost of same-sex spouse coverage pre-tax through the remaining pay periods in the plan year by providing the employer notice of the participant's marital status.
  • Continue paying for these benefits on an after-tax basis.
Either way, the participant can:
  • Request a refund of federal income or employment taxes paid on any amounts representing the employee cost of spousal health coverage that were treated as after-tax.
  • Exclude these amounts from gross income when filing an income tax return for the year.

FSA Reimbursements

Under the Notice, FSAs (including health, dependent care or adoption assistance FSAs) offered under a cafeteria plan can reimburse the covered expenses of a participant's same-sex spouse (or the same-sex spouse's dependent) incurred for a period beginning on:
  • The start of the cafeteria plan year that includes June 26, 2013.
  • If later, the date of the marriage.
Under a calendar-year plan, for example, an FSA could reimburse covered expenses of a participant's same-sex spouse incurred during a period beginning either:
  • On or after January 1, 2013.
  • If later, the participant's date of marriage.
Also, a same-sex spouse can be treated as covered by the FSA for this period, even if the participant initially elected coverage under a self-only FSA.

HSA and Dependent Care FSA Contribution Limits

For HSAs, the maximum annual deductible contribution to one or more HSAs for a married couple electing family coverage under a high-deductible health plan (HDHP) is $6,450 for 2013 (see Practice Note, Defined Contribution Health Plans). The limit applies to same-sex married couples treated as married for federal tax purposes for a tax year, including 2013 (that is, couples who are married as of the last day of the tax year).

HSA Excess Contributions

The Notice includes rules addressing how excess contributions can be corrected if each spouse in a same-sex marriage elected contributions to separate HSAs that cumulatively exceed the limit for married couples. These rules provide that:
  • Contributions for one or both of the spouses can be reduced for the remainder of the year to avoid exceeding the limit.
  • If the couple's combined HSA contributions are more than the limit, any excess contributions can be distributed from the HSAs of one or both spouses before the spouses' tax return due date.
  • Excess contributions that are not distributed by the due date of the spouses' tax return are subject to excise taxes.

Dependent Care FSAs

Same-sex married couples are also subject to the exclusion limit for contributions to dependent care FSAs ($5,000), and the Notice includes rules addressing excess contributions to dependent care FSAs (which are taxable if they exceed the limit).

Plan Amendments

According to the IRS, if a cafeteria plan allows an election change because of a change in legal marital status, it generally does not need to be amended to permit change-in-status elections regarding same-sex spouses in connection with Windsor.
If the employer chooses to allow election changes that were not previously allowed, the cafeteria plan amendment permitting such election changes:
  • Must be adopted by the last day of the first plan year beginning on or after December 16, 2013.
  • Can be effective retroactively to the first day of the plan year that includes December 16, 2013, if the cafeteria plan is operated consistent with the Notice.