DOMA-Related Guidance Addresses Tax Treatment of Employee Benefit Arrangements. (Parker Tax Publishing January 2014)

The IRS has issued additional guidance, in question-and-answer format, on the application of the Supreme Court's Windsor decision to certain rules governing the federal tax treatment of various types of employee benefit arrangements. Notice 2014-1

Until the recent decision of the Supreme Court in U.S. v. Windsor, 2013 PTC 167 (2013), 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. As a result, employers could not permit employees to elect coverage of same-sex spouses on a pre-tax basis under a cafeteria plan unless the spouse otherwise qualified as a tax dependent of the employee. Following the Windsor decision, the IRS issued Rev. Rul. 2013-17, in which it ruled that, for federal tax purposes, if a same-sex couple is married in a state where it is legal to perform same-sex marriages, the marriage is recognized for federal tax purposes.

On December 16, the IRS issued Notice 2014-1, in which it clarified that a cafeteria plan may treat a participant who was lawfully 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. Thus, 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. Any election made with respect to a same-sex spouse (and/or the spouse's dependents) must satisfy the requirements of the regulations concerning election changes generally.

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 December 16, 2013, the cafeteria plan will not be treated as having failed to meet the requirements of Code Sec. 125 or Reg. Sec. 1.125-4 to the extent coverage under the cafeteria plan becomes effective no later than the later of:

(1) the date that coverage under the cafeteria plan would be added under the cafeteria plan's usual procedures for change in status elections; or

(2) a reasonable period of time after December 16, 2013.

Example: ABC Corporation sponsors a cafeteria plan with a calendar year plan year. Amy, an ABC employee, married Bonnie in October 2012, in a state that recognized same-sex marriages. During open enrollment for the 2013 plan year, Amy elected to pay for the employee portion of the cost of self-only health coverage through salary reduction under the cafeteria plan. ABC permits same-sex spouses to participate in its health plan. On October 5, 2013, Amy elected to add health coverage for Bonnie under ABC's health plan, and made a new salary reduction election under the cafeteria plan to pay for the employee portion of the cost of Bonnie's health coverage. ABC was not certain whether such an election change was permissible, and accordingly declined to implement the election change until the publication of Notice 2014-1. After publication of Notice 2014-1, ABC determines that Amy's revised election is permissible as a change-in-status election. ABC enrolls Bonnie in the health plan as of December 20, 2013, and begins making appropriate salary reductions from Amy's compensation for Bonnie's coverage beginning with the pay period starting December 20, 2013. The cafeteria plan is administered in accordance Notice 2014-1.

Notice 2014-1 also addresses the situation in which a cafeteria plan participant has 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 is also paying the employee cost of health coverage for a same-sex spouse under a health plan of the employer on an after-tax basis. Specifically, the notice addresses when, and under what circumstances, the employer must begin to treat the amount that the employee pays for spousal coverage as a pre-tax salary reduction. Notice 2014-1 provides that an employer that, before the end of the cafeteria plan year including December 16, 2013, receives notice that such a participant is married to the individual receiving health coverage must begin treating the amount that the employee pays for the spousal coverage as a pre-tax salary reduction under the plan no later than the later of:

(1) the date that a change in legal marital status would be required to be reflected for income tax withholding purposes under Code Sec. 3402; or

(2) a reasonable period of time after December 16, 2013.

For this purpose, a participant may provide notice of the participant's marriage to the individual receiving health coverage by making an election under the employer's cafeteria plan to pay for the employee cost of spousal coverage through salary reduction or by filing a revised Form W-4 representing that the participant is married.

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. Thus, 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 limitations period under Code Sec. 6511 has not expired.

In general, a cafeteria plan participant may choose to pay for the employee cost of same-sex spouse coverage on a pre-tax 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 to continue paying for these benefits on an after-tax 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 after-tax and may exclude these amounts from gross income when filing an income tax return for the year.

Example: Assume the same facts as the previous example, except that starting January 1, 2013, Amy paid for the employee portion of health coverage for Bonnie under ABC's group health plan on an after-tax basis. The value of Bonnie's health coverage was $500 per month, and this amount was included as taxable income and wages to Amy for payroll purposes with respect to all pay periods starting January 1, 2013. On October 5, 2013, Amy made a change-in-status election under the cafeteria plan electing to pay for the employee cost of Bonnie's health coverage on a pre-tax basis through salary reduction. ABC implemented the change in status election on November 1, 2013, and excluded the cost of Bonnie's coverage from Amy's gross income and wages with respect to all remaining pay periods in 2013 starting November 1, 2013. Amy and Bonnie file a joint federal income tax return for 2013. The value of Bonnie's health coverage for the full 2013 tax year (including the $5,000 of coverage ($500 per month for 10 months) that ABC initially reported as includible in gross income with respect to all pay periods from January through October) may be excluded from gross income on the couple's joint return for 2013. Amy may also request a refund of any federal employment taxes paid on account of such coverage.

For a discussion of changing and revoking elections under a cafeteria plan, see Parker Tax ¶122,540. (Staff Editor Parker Tax Publishing)

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