In a recent landmark ruling by the Obama Administration, the federal government will recognize same-sex married couples. That means for one, married same-sex couples will no longer have to file two separate single tax returns for the IRS (however, if they currently reside in a state that does not recognize same-sex marriages, they may still have to file two separate state returns). But the IRS has not released any guidance about how employee benefits will be handled for gay couples…until now.
Tony Nitti (@nittigrittytax), a contributor for Forbes magazine, recently clarified some of the most pressing questions concerning employee benefits as it relates to married same-sex couples:
Q: How does Windsor 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: Let’s start with a key definition, shall we?
A “cafeteria plan” is defined by Section 125(d)(1) as one under which an employee may choose among two or more benefits consisting of cash and qualified benefits. A “qualified benefit” is then defined as an employee benefit that is excludable from taxable income by virtue of a statutory provision.
Now that we’ve got that out of the way, let’s look at what Notice 2014-1 has to say. An employee who participates in a cafeteria plan may elect to pay for the cost of health coverage for the employee, spouse, and dependents on a pre-tax basis through the cafeteria plan’s salary reduction option. Prior to Windsor, however, if the employee elected to also cover a same-sex spouse, it was required to be treated as wages to the employee, because same-sex spouses were not eligible family members.
After Windsor, provided the same-sex couple is respected as married under Rev. Rul. 2013-17, any amounts the employee paid for coverage on his same-sex spouse will be treated as having been made on a pre-tax basis as part of the employee’s salary reduction election. This is the case even if the employer reports the coverage for the same-sex spouse as taxable wages to the employee. As a result, the amount the employee pays for the same-sex spouse will be excluded from the employee’s income, regardless of how the employer treats it. This rule applies for the plan year that includes December 16, 2013, and any years that remain open under the statute of limitations, which is typically three years.
Example: 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.
In addition, starting January 1, 2013, Employee A paid for the employee portion of health coverage for Spouse B on an after-tax basis. The value of Spouse B’s coverage was $500 per month, and this amount was included as wages to Employee A through November 2013.
On November 1, 2013 – after the decision in Windsor — Employee A made a change in status election to treat Spouse B as a recognized spouse, and elected to pay for the employee cost of Spouse B’s health coverage on a pre-tax basis through salary reductions for the remainder of the year.
Also as of November 1, 2013, the employer began excluding the cost of Spouse B’s coverage from Employee A’s wages.
Employee A and Spouse B file a joint return for 2013. Even though the employer included $5,000 of coverage ($500 for 10 months) related to Spouse B in Employee A’s wages, the couple may exclude this amount from gross income on their tax return. Employee A may also request a refund of any employment taxes paid on the $5,000.
Q: How does Windsor impact an employee’s Flexible Spending Arrangement (FSA), if the employee attempts to have the FSA reimburse expenses incurred by the employee’s same-sex spouse during a period that is prior to the date of the Windsor decision?
A: Again with a definition. Prop. Treas. Reg. § 1.125-5 defines a FSA as a plan that provides employees with coverage that reimburses specified incurred expenses. The regulations provide that the benefits that may be offered through FSAs include dependent care assistance programs under Section 129 and medical reimbursement arrangements under Section 105.
Now, back to our question. The crux of it is, if an employee tried to get an expense reimbursed related to a same-sex spouse that was incurred prior to the decision in Windsor, may the FSA reimburse the expense?
Notice 2014-1 provides that yes, the FSA may reimburse an employee’s expenses related to a same-sex spouse, provided the expenses were incurred during a period beginning on a date that is no earlier than:
1. the beginning of the cafeteria plan year including the June 2013 date of theWindsor decision, or
2. the date of marriage, if later.
Example: Employer sponsors a cafeteria plan with a calendar year plan year that includes a health FSA. For the plan year beginning January 1, 2013, Employee A elected $2,500 in coverage under the health FSA.
On October 5, 2013, Employee A elected to add health coverage for Spouse B under the group health plan. On October 15, 2013, Employee A submitted a reimbursement request under the health FSA for an expense incurred by Spouse B on July 15, 2013.
Even though the expense was incurred by Spouse B before the effective date of the Windsor decision, the employer may reimburse the expense because it was incurred after January 1, 2013, the earlier of the first day of the plan year (January 1, 2013) or the date of marriage (but only if the date of marriage is later, which it’s not).
Contribution Limits for HSAs
Q: Is a same-sex married couple subject to the joint deduction limit for contributions to an HSA?
A: You guessed it…it’s definition time! Section 223(d) defines a Health Savings Account (HSA) as a trust set up exclusively for the purpose of paying the qualified medical expenses of the account beneficiary. The term “qualified medical expenses” includes amounts paid by a beneficiary for medical care for that individual and the spouse of that individual. Section 223(a) allows a deduction for contributions to an HSA; in 2013 the maximum deduction is limited to $6,450 in the case of an eligible individual who has family coverage. In the case of married individuals either one of whom has family coverage, the HSA deduction limitation is divided equally among the spouses unless they agree on a different division.
Notice 2014-1 provides that the maximum annual deduction limit of $6,450 applies to same-sex couples who are treated as married for 2013. If each of the spouses elected to make contributions to separate HSAs that, when combined, exceed the $6,450 limit, the excess contribution must be corrected. This can be done by either reducing the remaining contributions until the end of the year to avoid exceeding the limit, or if it’s too late for that, the excess contributions must be distributed from the HSAs to one or both spouses by the due date of the tax return.
Any excess contributions that aren’t returned are subject to excise tax Section 4973. In addition, any income earned on the excess contributions must be included in the individual’s taxable income.
Example: Same-sex spouses C and D were married in a state recognizing same-sex marriages in December 2012. For the period beginning January 1, 2013, Spouse C elected family coverage and elected to make $6,000 in contributions to a HSA. For the same period, Spouse D separately elected family coverage and elected to make $4,000 in contributions to a HSA.
As a result of the Windsor decision and Rev. Rul. 2013-17, Spouses C and D became recognized as legal spouses for federal tax purposes. The spouses remained married for the remainder of the 2013 taxable year.
Under Section 223(b), the maximum deductible contribution to a HSA for 2013 for a married couple either of whom elects family coverage is $6,450. The combined HSA contributions made by Spouses C and D for the 2013 taxable year totaled $10,000, which exceeded the allowable deduction limit by $3,550.
On February 15, 2014, Spouse C receives a HSA distribution of $3,550, plus an additional $150 in income attributable to the $3,550 excess contribution. The $150 in income on the excess contributions is includable in Spouse C’s gross income for 2014, as provided in section 223(f)(3)(A). Because the distribution was made prior to the due date for Spouse C’s federal tax return, the $3,550 in excess contributions is not subject to excise taxes under section 4973.