In June of 2013, the Supreme Court ruled in its landmark Windsor decision that section 3 of the Defense of Marriage Act was unconstitutional, clearing the way for same-sex spouses to be respected as married couples for income tax purposes.
In August, the IRS jumped on board by issuing Revenue Ruling 2013-17, which provided that the Service will treat all same-sex couples as married provided the individuals were lawfully married under state law, even if the married couple currently resides in a state that does not recognize the validity of the same-sex marriage.
Since that time, tax advisors have been waiting for guidance from the IRS regarding how the decision will impact certain employee benefits; specifically, what do we do about a benefit that, when paid on behalf of a same-sex spouse of an employee would have been taxable prior to the Windsor decision, but that now should be treated as tax-free fringe benefits in light of the Supreme Court's ruling?
Revenue Ruling 2013-17 touched only briefly on Windsor's impact on employee benefit plans, stating that a taxpayer could rely on the Ruling for purposes of filing an amended return to claim a refund for income or employment taxes related to excludable employer-provided plans.
In September, we got guidance on the employer side, with the IRS issuing Notice 2013-61. In the Notice, the Service provided mechanisms for employers to request refunds of payroll taxes paid on benefits to a same-sex spouse that were taxable prior to Windsor but rendered tax-free in its aftermath.
Putting the three pieces of authority together, tax advisors guessed at their impact on employee benefit plans, with varying degrees of accuracy. Today, much of the guesswork has been rendered unnecessary, as the IRS issued concrete guidance on the Windsor decision's impact on such plans in the form of Notice 2014-1.
While the Notice reveals little that in the way of groundbreaking information – in fact, it largely echoes a Q&A previously posted on the Service's website – at least the guidance is now formalized. While the entire Notice deserves a read, here are the most noteworthy aspects, represented in easy-to-digest Q&A form:
Cafeteria Plans
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.
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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.
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