Category Archives: Cafeteria Plans

COVID-19 and Changing Dependent Care Assistance Plan Elections

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Many employers are instructing employees to work from home in order to help in containing the spread of COVID-19.  Other persons are simply experiencing reduced work schedules, for instance in the travel industry.  Many school districts are announcing closures, and private childcare settings such as daycare, onsite child care and after-school activities are also closing in order to minimize the spread of transmission.

Needless to say, these developments are disrupting childcare arrangements that were expected to be in place when employees made salary deferral elections under their employers’ dependent care assistance plans (DCAPs) during open enrollment periods.  As a general rule, elections made under a DCAP are required to remain in place for a full plan year, absent a change in status, in which case a participant may change their election on a prospective basis in a manner that is on account of, and consistent with, the change of status.  Treas. Reg. Sec. 1.125-4(c)(1).

When can parents affected by these scheduling gyrations make mid-year elections under their dependent care flexible spending account, to change amounts set aside pre-tax for child care?  The answer depends, of course, on the factual circumstances.

School closure itself does not squarely fit within the existing regulatory categories of changes in status.  The closest analogy might be a change from one child care provider to another which results in a cost change.  It is possible that subsequent guidance from the IRS will clarify that school closure that results in the need for childcare expenses, is a permissible grounds for a mid-year election change.   By contrast, a reduction in child care costs due to closure of a daycare center or onsite childcare facility is a recognized basis for a participant to reduce or eliminate future deferrals.

With regard to parent working schedule changes, the guidance is is also clear in many, but not all, instances.  Take the airline worker whose schedule has been reduced from full-time to part-time, so they are home several hours per week and can care for their child who would otherwise be in daycare.  This is a permitted basis to change their salary deferral to reduce the amount set aside for dependent care.   

What about the hospital worker whose schedule has gone from part-time to full-time as a result of the health crisis and needs more childcare as a result?  That person could prospectively increase their DCAP elections on the same basis.  

What about the engineer who is working full time, but from home, at the recommendation of their employer, and wants to take their child out of daycare?  Technically if they are still expected to work eight hours per day, they have not had a schedule reduction and arguably don’t have grounds to make an election change.  However if the engineer’s spouse was laid off as a result of the health crisis and was available to care for their children at home for free, that might be an independent reason for a reduction in salary deferrals.

Due to the national state of emergency that has been declared, it is possible that everyone will be confined to their homes in the near future and that childcare workers simply will not be available.   In such a case, DCAP election changes will be the least of our worries.

The above information is provided for general informational purposes only and does not create an attorney-client relationship between the author and the reader.  Readers should not apply the information to any specific factual situation other than on the advice of an attorney engaged specifically for that or a related purpose.  © 2020 Christine P. Roberts, all rights reserved.

Photo Credit:  Dan Burton (Unsplash)

 

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Filed under Cafeteria Plans, COVID-19 Benefit Issues, DCAP, Dependent Care, Flex Plans

Top 10 Questions re: Management Carve Outs in Group Health Plans

            Employers value flexibility in designing their group health benefits so as best to attract and retain qualified personnel. One issue that remains perpetually murky, in this regard, is the legality of management carve-outs, whereby an employer offers certain group health insurance options or classes of coverage only to management or other highly paid groups.   The following true or false discusses some of the rules that come into play.

  1. The ACA contains a rule that restricts employers’ ability to offer different insured group health benefits to highly compensated employees, than to other employees.

             TRUE:  Under Section 2716 of the Public Health Service Act, which was incorporated into the Affordable Care Act (ACA), non-grandfathered, insured group health plans generally must satisfy nondiscrimination rules similar to those that apply to self-insured group health plans under Section 105(h) of the Internal Revenue Code (“Code”). These rules generally require some measure of parity between higher-paid employees, and non-highly paid employees.  Limited scope dental or vision plans provided under policies separate from group medical coverage are excepted.

  1. However, the IRS is not currently enforcing the ACA nondiscrimination rules for insured group health plans.

             TRUE:  In 2011 the IRS postponed enforcement of these rules, pending publication of regulations that will guide employers as to how to comply. As we approach the ACA’s eighth anniversary in March 2018, regulations have yet to issue.  When regulations do issue they will apply on a prospective (going forward) basis.

  1. Therefore employers have free reign to offer different benefits to management employees or other highly-compensated groups of employees.

             FALSE:   Although there are some circumstances in which employers may offer different and/or better group health insurance to management or other highly-paid employee groupings, the Section 125 cafeteria plan rules do impose some design restrictions.  These rules will apply to employers that have any type of Section 125 cafeteria plan arrangement, including premium-only plans (e.g., employees’ share of premiums are paid on a pre-tax basis, with no other cafeteria plan features) and to employers with other cafeteria plan features such as a health flexible spending account or dependent care flexible spending account.  The rules are explained in the questions that follow.

  1. All management employees are “highly-compensated employees” for cafeteria plan testing purposes.

             FALSE: First, the technical term is “highly-compensated individuals,” and it includes the following groups, which will not necessarily overlap 100% with an employer’s management group population:

  • Officers during the prior plan year
  • Greater than 5% shareholders (in either the preceding or current plan year)
  • Highly compensated employees (those earning more than $120,000 in 2017 are highly compensated employees in 2018)
  • Spouses or dependents of any of the above.
  1. If I maintain just a premium-only plan and all employees can participate and elect the same salary reductions for the same benefits, the premium only plan is nondiscriminatory.

             TRUE.  Proposed cafeteria plan regulations that issued in 2007 provide this safe harbor rule. Employers may rely on the proposed rules.

  1. If I maintain just a premium-only plan and don’t meet the requirements of the safe harbor, the POP is automatically discriminatory.

            FALSE.  Under these circumstances your premium-only plan will not satisfy the safe harbor mentioned above, but it could still pass other applicable nondiscrimination tests.  There is some uncertainty, under the 2007 proposed regulations, as to whether the only applicable test applies to eligibility, or whether there is a benefits component of the test.  It may be best to consult a seasoned third party administrator, or benefits attorney, if you have questions.

  1. If my cafeteria plan fails all types of nondiscrimination testing, all is lost.

             FALSE. The 2007 proposed regulations permit “disaggregation” – breaking up one plan into separate component plans – one benefitting participants who have completed up to three years of employment, and another benefitting those with three or more years of employment.  Each component plan must separately pass cafeteria nondiscrimination rules applicable to eligibility, and contributions and benefits.  Plans that fail nondiscrimination testing as a whole may pass testing after permissive disaggregation.  The proposed regulations did not discuss whether plans may be disaggregated based on factors other than length of employment, and further guidance on this point would be welcome.

  1. The IRS does not audit cafeteria plans so it doesn’t matter anyway.

FALSE. Although audits specific to a cafeteria plan are seldom seen, the IRS could expand a payroll audit or other business or benefit plan audit to encompass operation of a cafeteria plan, even a premium-only plan.  Therefore it is important to comply with the cafeteria plan nondiscrimination rules.

  1. Our company pays 100% of health premiums for highly compensated individuals directly to the carrier (or the employees pay themselves on an after-tax basis), so there is no cafeteria plan nondiscrimination issue.

             TRUE.  However, any insured group health plan design that provides better treatment for higher paid employees may fall afoul of the ACA nondiscrimination regulations mentioned in questions 1 and 2, when they issue; although the regulations will apply prospectively, neither employers nor their highly compensation staff should assume that preferential health plan designs are more than temporary.

  1. A “Simple” Cafeteria Plan is exempt from Section 125 nondiscrimination rules.

             TRUE.  A nondiscrimination safe harbor applies to “simple” cafeteria plans under Code Section 125(j), however those plans are subject to other design restrictions that may prove unworkable for many employers, including mandated employer matching or non-elective contributions. They are also limited to employers with 100 or fewer employees on business days during either of the two preceding years.

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Filed under Affordable Care Act, Benefit Plan Design, Cafeteria Plans, Health Care Reform, Nondiscrimination Rules for Insured Health Plans, PPACA, Premium Only Plans

You Just Formed a New Business Entity. What Could Possibly Go Wrong?

What if a somewhat arcane area of tax law had potentially serious ramifications for attorneys and other tax advisors across a broad range of practices, but was not consistently identified and planned for in actual practice? That is an accurate description of the rules surrounding “controlled group” status between two or more businesses, which I have seen arise in business formation/transactions, estate planning, employment and family law settings.  The purpose of this overview is to briefly survey controlled group rules for non-ERISA practitioners, so that they can become aware of the potential complications that controlled group rules can create.

  1. Why Do Controlled Groups Matter?

The main reason they matter is because the IRS treats separate businesses within a controlled group as a single employer for almost all retirement and health benefit plan purposes. In fact, annual reporting for retirement plans (and for health and welfare plans with 100 or more participants) requires a statement under penalty of perjury as to whether the employer is part of a controlled group.  Therefore controlled groups are most frequently a concern where business entities have employees and particularly when they sponsor benefit plans, whether retirement/401(k), or health and welfare plans.  Note, however, that creation of a business entity that has no employees can still create a controlled group issue when it acts as a conduit to link ownership of two or more other entities that do have employees.

Being part of a controlled group does not always mean that all employees of the member companies have to participate in the same benefit plan (although it can sometimes mean that). However it generally means that separately maintained retirement plans have to perform nondiscrimination testing as if they were combined, which not infrequently means that one or more of the plans will fail nondiscrimination testing.  This is an event that usually requires the employer sponsoring the plan to add more money to the plan on behalf of some of the additional counted employees, or to pay penalty taxes in relation to same.  Similar complications can arise in Section 125 cafeteria or “flexible benefit plans,” and for self-insured group health plans, which are subject to nondiscrimination requirements under Code § 105(h).  Nondiscrimination rules are meant to apply to insured group health plans under the Affordable Care Act (“ACA”), so additional complications could arise in that context when and if the rules are enforced by the IRS, following publication of regulatory guidance.

Controlled group status can also mean that several small employers together comprise an “applicable large employer” subject to the ACA “pay or play rules,” and related annual IRS reporting duties. Small employer exceptions under other laws, including COBRA and the Medicare Secondary Payer Act, reference controlled group status when determining eligibility for the exception.

  1. How Do I Identify a Controlled Group?

 Determining controlled group status requires synthesizing regulations and other guidance across multiple Internal Revenue Code (“Code”) provisions and therefore is a task for a specialized ERISA or tax practitioner.  What follows are very simplified definitions aimed at helping advisors outside that specialized area flag potential controlled group issues for further analysis.

Strictly speaking, the term “controlled group” refers to shared ownership of two or more corporations, but this article uses the term generically as it is the more familiar term.  “Ownership” in this context means possession of the voting power or value of corporate stock (or a combination thereof).  Shared ownership among other types of business entities is described as “a group of trades or businesses under ‘common control.’”  Ownership in this context refers to ownership of a capital or profits interest in a partnership or LLC taxed as a partnership.   Controlled groups can also arise in relation to tax-exempt entities, for instance if they own 80% or more of a for-profit entity, or even between two tax-exempt entities where there is substantial overlap of board membership or board control.

Complex interest exclusion rules mean that not all ownership interests are counted towards common control; exclusion may turn on the nature of the interest held (e.g., treasury or non-voting preferred stock) or on the party holding the ownership interest (e.g, the trust of a tax-qualified retirement plan).

The two main sub-types of controlled group are: parent-subsidiary, and “brother-sister,” although a combination of the two may also exist.  A parent-subsidiary controlled group exists when one business owns 80% or more of another business, or where there is a chain of such ownership relationships. As that is a fairly straightforward test, I will focus on the lesser known, but more prevalent, brother-sister type of controlled group.

A brother-sister controlled group exists when the same five or fewer individuals, trusts, or estates (the “brother-sister” group) have a “controlling interest” in, and “effective control” of, two or more businesses.

  • A controlling interest exists when the brother-sister group members own, or are deemed to own under rules of attribution, at least 80% of each of the businesses in question.
  • Effective control exists when the brother-sister group owns or is deemed to own greater than 50% of the businesses in question, looking only at each member’s “lowest common denominator” ownership interest. (So, a group member that owed 20% of one business and 40% of another business would be credited only with 20% in the effective control test.)
  • In order to pass the 80% test, you must use the interests of the same five or fewer persons (or trusts or estates) used for purposes of the greater than 50% test.  See US v. Vogel Fertilizer, 455 US 16 (1982). Put otherwise, the two tests consider only owners with a greater-than-zero interest in each of the businesses under consideration. If, under this rule, you disregard shares adding up to more than 20% of a business, the 80% test won’t be met and that business generally won’t form part of the controlled group. (Although the remaining businesses may do so.)

The controlled group attribution rules are quite complex and can only be touched on here. Very generally speaking, an ownership interest may be attributed from a business entity to the entity’s owner, from trusts to trust beneficiaries (and to grantors of “grantor” trusts as defined under Code § 671-678), and among family members. Stock options can also create attributed ownership under some circumstances.  The attribution rules can have surprising consequences. For instance, a couple, each with his or her wholly-owned corporation, will be a controlled group if they have a child under age 21 together, regardless of their marital status, because the minor child is attributed with 100% of each parent’s interests under Code §1563(e)(6)(A).  Community property rights may also give rise to controlled group status. Careful pre-marital planning may be necessary to prevent unintended controlled group status among businesses owned separately by the partners to the marriage.

This is the first part of a two-part discussion that was first published as an article in the Santa Barbara Lawyer Magazine for October 2017.  The second half will address a variation of these rules that are specific to businesses formed by doctors, dentists, accountants, and other service providers.

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Filed under 401(k) Plans, ADP and ACP Testing, Affordable Care Act, Benefit Plan Design, Cafeteria Plans, COBRA, Common Control Issues, Employer Shared Responsibility, ERISA, Health Care Reform, Nondiscrimination Rules for Insured Health Plans, Nondiscrimination Testing for Qualified Retirement Plans, Plan Reporting and Disclosure Duties

Offer Opt-Out Payments? Don’t Get Snared in Overtime Liability

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If you are an employer within the jurisdiction of the Ninth Circuit Court of Appeals and offer cash payments to employees who opt out of group health coverage (“opt-out payments”), what you don’t know about the court’s 2016 opinion in Flores v. City of San Gabriel may hurt you.

Specifically, the Ninth Circuit court held that opt-out payments had to be included in the regular rate of pay used to calculate overtime payments under the federal Fair Labor Standards Act (FLSA). In May 2017 the U.S. Supreme Court declined to review the opinion, making it controlling law within the Ninth Circuit, and hence in the states of Alaska, Arizona, California, Hawaii, Idaho, Montana, Nevada, Oregon, Washington.

The Flores case arose when a group of active and former police officers in the City of San Gabriel sought overtime compensation based on opt-out payments they received between 2009 and 2012 under a flexible benefits plan maintained by the City.  The plan required eligible employees to purchase dental and vision benefits with pre-tax dollars; they could also use the plan to purchase group health insurance.  Employees could elect to forgo medical benefits upon proof of alternative coverage; in exchange they received the unused portion of their benefits allotment as a cash payment added to their regular paycheck.  The opt-out payments were not insubstantial, ranging from $12,441 annually in 2009 to $15,659.40 in 2012.  The City’s total expenditure on opt-out payments exceeded $1.1 million dollars in 2009 and averaged about 45% of total contributions to the flexible benefits plan over the three years at issue.

The court held that the City had not properly excluded the opt-out payments from the regular rate of pay for overtime purposes under the FLSA, as they were items of compensation even though not tied directly to specific hours of work, and further that the “bona fide” benefit plan exception did not apply, because, inter alia, the cash opt-out payments received under the flex plan comprised far more than an “incidental” portion of the benefits received.

Despite the significant potential impact of getting this classification wrong, the City appears not to have sought a legal opinion on whether it could permissibly exclude the opt-out payments under the FLSA. Instead, a City employee testified that it followed its normal process of classifying the item of pay through joint decision by the payroll and human resources departments, without any further review of the classification or other due-diligence.  For this oversight, the court awarded liquidated damages against the City for failure to demonstrate that it acted in good faith and on the basis of “reasonable grounds” to believe it had correctly classified the opt-out payments under the FLSA.  Further, the court approved a three-year statute of limitations for a “willful” violation of the FLSA, rather than the normal two year period, on the grounds that the City was on notice of its FLSA requirements, yet took “’no affirmative action to ensure compliance with them.’”

Although Flores involved a benefit plan maintained by a public entity, there is nothing in the Ninth Circuit’s opinion that limits its scope to public entity employers.

Therefore employers within the Ninth Circuit who offer opt-out payments should review their payroll treatment of these amounts and seek legal counsel in the event there if potential overtime liability under the FLSA. They should also confirm that cash opt-out payments remain an “incidental” percentage of total flex benefits, which the Department of Labor has defined in a 2003 opinion letter as no more than 20% of total plan benefits.  In Flores the Ninth Circuit found the 20% threshold to be arbitrary, but suggested that it was likely lower than 40% of total benefits.  Finally, employers offering opt-out payments should also revisit the other legal compliance hurdles that these payments present under the ACA, which after its recent reprieve from repeal/replace legislation, remains, for now, the law of the land.

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Filed under Benefit Plan Design, Cafeteria Plans, FLSA, Fringe Benefits, Health Care Reform, Overtime, Post-Election ACA, PPACA, Uncategorized

Untangling ACA Opt-Out Payment Rules

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As group health coverage premiums soar ever higher, it has become increasingly popular for employers to offer employees cash in exchange for their opting out of group coverage. When the cash opt-out payments are provided outside of a Section 125 cafeteria plan, they may have the unintended consequence of reducing the affordability of employer group health coverage, because the IRS views the cash opt-out payment as compensation that the employee effectively forfeits by enrolling in coverage.[1]  Unaffordable coverage may entitle the employee to premium tax credits under IRC § 36, and may also exempt the employee from individual mandate duties under IRC § 5000A.  This post focuses on the impact of opt-out payments on “applicable large employers” subject to employer shared responsibility duties under the ACA.  For such employers, reduced affordability of coverage will impact how offers of coverage are reported under ACA reporting rules (IRC § 6056) and could trigger excise tax payments under IRC § 4980H(b).

By way of background, the IRS addressed opt-out payments last year in the form of Notice 2015-87, concluding that a “conditional” opt-out payment – one that requires that the employee meet a criterion in addition to declining employer group coverage, such as showing proof of other group coverage – would not affect affordability. The Notice also offered transition relief for unconditional offers (paid simply for declining employer coverage) that were in place as of December 16, 2015, the date the Notice was published.  Unconditional opt-out arrangements adopted after December 16, 2015 do impact affordability.

Subsequently, in July 2016, the IRS addressed the affordability issue in proposed regulations under IRC § 36, governing individuals’ eligibility for premium tax credits. The proposed regulations refer to “eligible” opt-out arrangements rather than conditional ones.  An eligible opt-out payment  is one under which an employee’s right to receive payment is conditioned on the employee providing reasonable evidence that the employee and all his or her dependents (the employee’s “expected tax family”) have or will have minimum essential coverage other than individual coverage (whether purchased on or off the health exchange/Marketplace).  Reasonable evidence may include the employee’s attestation to the fact of other coverage, or provision of proof of coverage, but in any event the opt-out payment cannot be made if employer knows or has reason to know that the employee/dependents does not have or will not have alternative coverage.  Evidence of the alternative coverage must be provided no less frequently than every plan year, and no earlier than the open enrollment period for the plan year involved.

The proposed regulations are expected to be finalized this year and thus the “eligible opt-out arrangement” rules likely will apply to plan years beginning on or after January 1, 2017.   In the meantime, the following provides guidance to applicable large employers on conditional and unconditional opt-out payments for purposes of 2016 ACA compliance, and ACA reporting due to be furnished to employees and filed with the IRS early in 2017:

Unconditional opt-out arrangement: opt-out payments increase employee contributions for purposes of the “affordability” safe harbor, and should be added to line 15 of Form 1095-C, unless the arrangement was already in effect on December 16, 2015.  “In effect” for these purposes means that (i) the employer offered the arrangement (or a substantially similar arrangement) for a plan year that includes December 16, 2015; (ii) the employer’s board of directors or authorized officer specifically adopted the arrangement before December 16, 2015; or (iii) the employer communicated to employees in writing, on or before December 16, 2015, that it would offer the arrangement to employees at some time in the future.

Conditional opt-out arrangement: opt-out payments do not increase employee contributions whether or not the condition is met.  Do not include the opt-out payment in line 15 of Form 1095-C.

Opt-out arrangement under a collective bargaining agreement (CBA): if the CBA was in effect before December 16, 2015, treat as a conditional opt-out arrangement, as above, and do not include in line 15 of Form 1095-C.

Medicare Secondary Payer Act/TRICARE Implications: An applicable large employer for ACA purposes will also be subject to provisions of the Medicare Secondary Payer Act (MSPA) that prohibit offering financial incentives to Medicare-eligible employees (and persons married to Medicare-eligible employees) in exchange for dropping or declining private group health coverage[2]. In the official Medicare Secondary Payer (MSP) Manual, the Centers for Medicare and Medicaid Services (CMS) takes the position that a financial incentive is prohibited even if it is offered to all individuals who are eligible for coverage under a private group health plan, not just those who are Medicare-eligible. Traditionally the CMS has not actively enforced this rule, and has focused on incentives directed at Medicare-eligible populations. However, there are reports that the CMS may be retreating from its unofficial non-enforcement position with respect to opt-out payments. At stake is a potential civil monetary penalty of up to $5,000 for each violation. As a consequence, MSPA-covered employers with Medicare-eligible employees, or employees who are married to Medicare-eligible persons, should not put an opt-out arrangement in place, or continue an existing one, without first checking with their benefits attorney. Finally, please note that there are similar prohibitions on financial incentives to drop military coverage under TRICARE. TRICARE is administered by the Department of Defense, but along the same principles as apply to MSPA.

Note:   This post was published on October 6, 2016 by Employee Benefit Adviser.

[1] Note: employer flex contributions to a cafeteria plan reduce affordability unless they are “health flex contributions,” meaning that (i) the employee cannot elect to receive the contribution in cash; and (ii) the employee may use the amount only to pay for health-related expenses, whether premiums for minimum essential coverage or for medical expense reimbursements permitted under Code § 213, and not for dependent care expenses or other non-health cafeteria plan options. See IRS Notice 2015-87, Q&A 8.

 

[2] An employer is covered by the MSPA if it employs 20 or more employees for each working day in at least 20 weeks in either the current or the preceding calendar year.

 

 

 

 

 

 

 

 

 

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Filed under Affordable Care Act, Applicable Large Employer Reporting, Benefit Plan Design, Cafeteria Plans, Employer Shared Responsibility, Flex Plans, Health Care Reform, PPACA

Final Rules on Wellness Program Design: A Chart and FAQs

Recent months have seen a flurry of new guidance related to wellness programs:

  • On May 17, 2016 the EEOC published final regulations and interpretive guidance on wellness programs that include disability-related questions (such as a Health Risk Assessment or HRA) and/or medical examinations (such as biometric testing). The new rules and guidance fall under Title I of the Americans with Disabilities Act (ADA), which permits collection of medical information under an employer’s “voluntary” wellness program. They replace proposed rules and guidance which were published in April 2015. We addressed the proposed rules in an earlier post.
  • In addition, EEOC published in the same issue of the Federal Register final regulations on wellness program participation by employees’ spouses, under Title II of the Genetic Information Nondisclosure Act (GINA). For GINA purposes, health status or health history about a family member, including a spouse, constitutes genetic of the employee. The rule replaces proposed regulations issued in October 2015.
  • In connection with the final rules the EEOC also published a model confidentiality notice to be provided to wellness program participants.
  • Finally, the Internal Revenue Service issued guidance regarding taxation of cash rewards to participate in wellness programs, and reimbursement of premiums paid through cafeteria plan deductions.

Overview. The new ADA and GINA regulations supplement, and in some instances contradict, existing wellness regulations under HIPAA, as modified by the ACA. Most notably, the HIPAA/ACA rules do not impose any incentive limitation on wellness programs that are “participation only,” whereas the ADA and GINA rules do impose a maximum incentive limit if the “participation only” program includes an HRA or biometric testing. The ADA and GINA regulations apply to employers with 15 or more employees, and to wellness programs that are “self-standing” as well as those offered in connection with a group health plan. HIPAA/ACA rules apply only to wellness programs that themselves comprise a group health plan, or that are offered with group health plans.

Effective Dates. The ADA and GINA incentive limits and ADA notice requirement discussed below go into effect for plan years beginning on or after January 1, 2017 (in most cases this will be the year of the health plan to which the wellness program relates). Employers may choose to voluntarily comply with these rules prior to that time. The balance of the new guidance goes into effect immediately, as the EEOC has characterized it as clarification of existing law.

Compliance Chart. Below is a chart summarizing permissible dollar or in-kind incentives for wellness program participation, along with some other requirements under the new ADA and GINA regulations, followed by some frequently asked questions on the new wellness program guidance.

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* If multiple health plans are offered, the 30% limit applies to the lowest cost major medical plan. If no plans are offered, the reference point is the premium paid for a 40 year old non-smoker enrolled in the second-lowest silver plan on the health exchange in the employer’s region.

Q.1:     What are reasonable design criteria for wellness programs under ADA regulations? 

A.1:      A wellness program is “reasonably designed to promote health or prevent disease” if it is (a) not highly suspect in the method chosen to promote health or prevent disease; (b) does not require an overly burdensome period of time to participate, involve unreasonably intrusive procedures or significant costs; (c) is not a subterfuge for violating the ADA or other legal requirements or a means to simply shift costs from employer to employees; and, (d) if medical information is collected, the program provides feedback or advice to participants about risk factors or uses aggregate medical data to design programs or treat specific conditions.

Q.2: How do these requirements differ from the requirements for wellness programs under HIPAA/ACA?

A.2: In addition to the differences in incentive limits noted in the chart above, the HIPAA/ACA test applies a reasonable design criteria only to health-contingent wellness programs, while the ADA rules apply to participation-only wellness programs that include HRAs and/or biometric testing.  In addition, the HIPAA/ACA rules require that participants have a chance to qualify for the full incentive at least annually, and must offer to waive incentive criteria, or offer a reasonable alternative standard, to permit equal participation by all similarly situated participants.  This is somewhat similar, but not identical, to the ADA reasonable accommodation requirement.  HIPAA/ACA also requires that notice of the waiver/reasonable alternative standard be provided.

Q.3: Do GINA wellness program regulations add any requirements?

A.3: Yes, if a spouse is requested to complete an HRA or undergo biometric testing, a separate incentive limit equal to 30% of the total cost of self-only coverage applies, and the spouse must sign a written, knowing and voluntary authorization to take part in the HRA or biometric testing.  The authorization must describe the genetic information being obtained (e.g. health history information in an HRA), how it will be used, and any restrictions on its disclosure.  Additionally, employers may not deny access to coverage or otherwise retaliate in the event a spouse refuses to provide HRA/biometric testing.

Q.4: What are the criteria of a “voluntary” wellness program under ADA regulations?

A.4: A wellness program is voluntary for ADA purposes if employees are not required to participate in the program, are not punished for not participating (e.g., not granted access to all health benefits or plan options), and are not subjected to adverse employment action, retaliation, coercion or other prohibited conduct in order to get them to participate, or to reach certain health goals. In addition, incentives are capped at the percentages shown in the chart, and participants are provided with a written notice re: collection and use of medical information.  The EEOC has provided a form of model notice.

Q.5: What does the model EEOC notice state, and is it mandatory or can we use our own version?

A.5: The notice, which should be provided prior to participation in an HRA or biometric exam, may be modified but must be written in language that recipients can understand, and must describe what medical information is collected, what measures will be used to protect its privacy and security, and must state that the information will not be sold, exchanged, transferred, or otherwise disclosed except as necessary and permitted under law in order to implement the wellness program.  Some of the provisions may repeat provisions of an existing HIPAA privacy notice.

Q.6: Can we email the ADA wellness program notice or must we distribute by hand?

A.6: You can email it so long as you are certain the email will reach the intended employees, e.g. through use of a current work email address, and so long as proper attention is brought to the nature of the notice (for instance, do not attach it to an email already containing a number of other, unrelated human resource forms or disclosures). You may also distribute in hard copy.  Your distribution method should take into account employee disabilities such as visual impairment, or learning disabilities.

Q.6: What confidentiality requirements apply under ADA regulations?

A.6: The employer must receive wellness data in aggregate form only, and may not require an employee to agree to the sale, exchange, sharing, transfer or other disclosure of medical information, or to waive ADA confidentiality protections, as a condition for participation.  Note that ADA confidentiality rules would apply to a wellness program not linked to a group health plan, and for a wellness program that is a health plan or is linked to one, HIPAA/ACA privacy, security and breach notification measures must also be followed.  These rules independently would prohibit the employer from viewing individualized health data.

Q.7: What is the impact of “de minimis” wellness incentives such as tee-shirts and water bottles?

A.7: The ADA regulations do not recognize a “de minimis” rule, thus the approximate dollar value of all “in-kind” incentives should be counted towards the 30% incentive limit.  By contrast, for federal income tax purposes, the IRS allows small items such as tee-shirts and water bottles to be excluded from participants’ taxable income as de minimis fringe benefits under Internal Revenue Code (“Code”) Section 132(e).  See IRS Memo 2016-22031, discussed below.

Q.8: How does the IRS treat cash incentives to participate in a wellness program treated under the Internal Revenue Code?

A.8: In IRS Memo 2016-22031 the IRS concluded that cash incentives to take part in a wellness program, or amounts paid or reimbursed for more than de minimis items that do not qualify as Code Section 213(d) medical expenses (such as gym memberships) are included in employees’ taxable income.  The same is true when an employer uses a wellness program to reimburse employees for premium or other coverage amounts withheld from their salary under a Section 125 cafeteria plan.

Q.9: What is the ADA’s  “insurance safe harbor” or “bona fide benefit plan” safe harbor, and can employers use it to justify a wellness program that does not meet the new ADA wellness program criteria?

A.9: The insurance safe harbor or “bona fide benefit plan” safe harbor permits the gathering of health data from employees so long as it is for underwriting or risk classification purposes, e.g., in order to determine insurability or establish premiums and other costs of coverage.   The safe harbor typically would apply to an insurance carrier but also could apply to a self-insured health plan.  In the past several years, a few employers have successfully used the safe harbor to prevail over EEOC federal court challenges to wellness programs that conditioned very high financial incentives on completion of an HRA or biometric testing; see, e.g., Seff v. Broward County, 691 F.3d 1221 (11th Cir. 2012); EEOC v. Flambeau, Inc., 131 F. Supp. 3d 849 (W.D.Wis. 2015).  The ADA regulations expressly make the insurance safe harbor unavailable to employers sponsoring wellness programs, but this does not resolve how the issue will be determined in federal courts.

Q.10: Are there other GINA regulations that impact wellness programs?

A.10: Yes, Title I of GINA applies to health insurance issuers and group health plans (including self-insured health plans), and prohibits requiring an individual to provide genetic information (including through answering a family history question on an HRA) prior to or in connection with plan enrollment, or at any time in connection with “underwriting purposes,” which broadly refers to any provision of a reward or incentive.  As a result of GINA Title I, a plan may use an HRA that requests family medical history only if it is requested to be completed after plan enrollment and is unrelated to enrollment, and if there is no premium reduction or any other reward offered.

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Filed under Affordable Care Act, Americans with Disabilities Act, Benefit Plan Design, Cafeteria Plans, Flex Plans, Fringe Benefits, GINA/Genetic Privacy, Health Care Reform, HIPAA and HITECH, PPACA, Wellness Programs

Summary Chart of Disallowed Pay or Play Tactics

With the January 1, 2015 employer shared responsibility deadline fast approaching, the three government agencies charged with ACA compliance (IRS, DOL and HHS) have provided recent guidance on several strategies or tactics that have been marketed to applicable large employers as legitimate ways to reduce their coverage costs and exposure to shared responsibility penalty taxes (assessable payments).   Employer reimbursement of individual health insurance premiums is a common but not universal feature of these arrangements.  The Internal Revenue Service ruled out pre-tax reimbursement of individual health premiums in Notice 2013-54, but more recent guidance in ACA FAQ XXII and in IRS Notice 2014-69 expands the prohibition to include after-tax individual premium reimbursements, as well as other shared responsibility cost reduction strategies.  The chart attached below summarizes:

  • the disallowed strategies;
  • the reasons why they were disallowed;
  • the penalties that may apply to applicable large employers that persist in pursuing these strategies; and
  • other relevant facts and concerns.

Disallowed Tactic Chart

As with all content provided on this blog, the chart is meant to serve as a general summary of legal developments and the information it contains should not be applied to any particular factual situation without first consulting experienced tax or benefits counsel.

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Filed under Affordable Care Act, Benefit Plan Design, Cafeteria Plans, Employer Shared Responsibility, ERISA, Flex Plans, Health Care Reform, HIPAA and HITECH, PPACA

New Cafeteria Plan Guidance Eases Transitions to Exchange Coverage

IRS Notice 2014-55, issued September 18, 2014, permits two new types of mid-year changes in cafeteria plan elections (other than health flexible spending account elections) that will enable employees to drop employer group coverage in favor of individual coverage offered on state and federally-facilitated health exchanges (collectively, “the Exchange.”)  Making that transition primarily will appeal to employees with household incomes in ranges that qualify them for financial assistance on the Exchange, in the form of premium tax credits and cost sharing.  Those ranges are between 100% and 400% of federal poverty level in states that have not expanded Medicaid, and between 138% and 400% of federal poverty level in states that have expanded Medicare.

Recap of Existing Change in Status Rules

Under existing cafeteria plan regulations, a participant may make a mid-year change in their plan elections only in the event of a “change in status,” and only to the extent that the election change is both “on account of” and “corresponds with” the change in status.  This latter requirement is referred to as the “consistency rule.”  An example of a change in election that satisfies the consistency rule is removing a spouse from coverage as a result of a change in status that is a legal separation or divorce.  By contrast, the participant dropping his or her own coverage in that situation would not satisfy the consistency rule.

Existing regulations set forth a finite list of changes in status that trigger the right to a mid-year cafeteria plan election.  The list does not currently include a change in employment status – such as a transition from full-time to part-time status – that is not accompanied by a loss of group health plan eligibility. In addition, under special enrollment rights that were introduced with HIPAA, employees may enroll in their employer’s plan in the event they lose other coverage (for instance, through exhausting COBRA coverage), may add to their coverage a dependent newly acquired through birth, marriage, or adoption, and may make mid-year cafeteria plan changes that are consistent with these events.  HIPAA’s special enrollment rights do not contain provisions that relate to availability of individual coverage on the Exchange.

Please note that references below to “changing cafeteria plan elections” may more accurately be described as revoking an election to make pre-tax salary deferral elections towards the purchase of group health premiums.

Notice 2014-55

Effective immediately, although at the option of employers, Notice 2014-55 permits mid-year cafeteria plan election changes in two different situations that are related to Exchange coverage.

The first situation applies when an employee who has been classified as full-time for ACA coverage purposes (averaging 30 or more hours of service per week) has a change in status which is reasonably expected to result in the employee averaging below full-time hours, without resulting in a loss of their group health coverage.  Under the look-back measurement method, as set forth in final employer shared responsibility regulations, an employee who averages full-time hours during an initial (following hire) or standard (ongoing) look-back measurement period generally will be offered coverage for the entire related initial or standard stability period (and associated administrative period) without regard to the actual hours worked during the stability period, such that a schedule reduction would not impact coverage.

Now, under Notice 2014-55, full-time employees whose average weekly hours are “reasonably expected” to remain below 30 – and whose reduced earnings may now qualify them for premium assistance on an Exchange, or increased assistance –  may revoke group coverage for themselves and covered dependents, provided it is for the purpose of enrolling in Exchange coverage or other “minimum essential coverage” that will take effect no later than the first day of the second month following the revocation.   (Minimum essential coverage is not limited to exchange coverage and may, for instance, include group health coverage offered by a spouse’s employer.)  Employers may rely on employee’ representations regarding the purpose of the election change.  Changes to health FSA elections are not permitted in this situation.

The second situation has two variations.  The first applies when an employee has special Exchange enrollment rights, including as a result of marriage, birth or adoption.  Similar to HIPAA special enrollment rights, these permit purchase of Exchange coverage outside of Exchange open enrollment. The second applies under a non-calendar year cafeteria plan when an employee wants to enroll in Exchange coverage during the Exchange open enrollment period, effective as of the first of the following calendar year.

In either instance an employee may prospectively revoke group health coverage for him or herself and family members, provided it is for the purpose of enrolling in Exchange coverage that will take effect no later than the day immediately following the last day of the original coverage that is revoked.  Employers may rely on employee’ representations regarding the purpose of the election change.  Changes to health FSA elections are not permitted in this situation.

Plan Amendments and Effective Dates

The IRS intends to amend cafeteria plan regulations to reflect the guidance in Notice 2014-55.  Employers may rely on the terms of the Notice until new regulations issue.

Employers who want to incorporate the new election changes into their cafeteria plans must amend their plan documents in order to do so.   Employers who put the changes into effect between now and the end of 2014 may amend their plan documents any time on or before the last day of their 2015 plan year (December 31, 2015 for a calendar year plan).  The amendment may be retroactive to the date the change went into effect, provided that participants are informed of the amendment and provided that, in the interim, the employer operates its plan in accordance with Notice 2014-55, or with subsequent issued guidance.

Employer Shared Responsibility Considerations

As mentioned, the first permitted change primarily relates to applicable large employers who use the look-back measurement period to identify full-time employees.  To minimize “pay or play” liability, these employers should continue to monitor, over subsequent measurement periods, the average hours worked by employees who migrate to Exchange coverage, and offer affordable, minimum value coverage over corresponding stability periods to those whose hours average 30 or more per week, or 130 or more per month.

Interestingly, this portion of Notice 2014-55 refers to individuals who were “reasonably expected” to average 30 or more hours of service prior to the change, but who are “reasonably expected” to average below that after the change.  This “reasonably expected” language  – which implies a measure of employer discretion – appears in the final shared responsibility regulations only in connection with assessment of an employee’s likely status (full-time, part-time, seasonable or variable hour) upon initial hire.   After an employee has remained employed throughout an entire standard stability period (which generally corresponds to the plan or policy year), he or she is an “ongoing employee” and his or her status as full-time or not full-time is determined solely based on average hours worked over the preceding look-back measurement method, or, under the “monthly” measurement period, over the preceding calendar month.  In other words, employer discretion is removed from the ongoing measurement process.  Now, it is reintroduced by Notice 2014-55 in the limited context of a schedule reduction during a stability period.

If the second permitted change is adopted by an applicable large employer, presumably that employer will continue to monitor employees who have migrated to the Exchange using the measurement method under which the employee previously qualified for an offer of group health coverage.

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Filed under Affordable Care Act, Benefit Plan Design, Cafeteria Plans, Covered California, Employer Shared Responsibility, Federally Facilitated Exchange, Health Care Reform, Health FSA, Health Insurance Marketplace, PPACA, State Exchange

Implementing the Health FSA Carryover: Tips and Traps

The IRS recently issued guidance modifying the “use it or lose it” rule, which has long been the most unpopular feature of health flexible spending accounts (health FSAs) commonly offered under a Section 125 cafeteria plan.

As a result of the change, set forth in Notice 2013-71,  individuals who participate in health FSAs, and who have not used their full budget of deferrals by the end of a given plan year may carry over up to $500 in unused funds to the next plan year.  (This discussion assumes a Sec. 125 cafeteria plan with the same plan year as the health FSA.)

Even if an employee carries over the full $500 amount, he or she may elect to defer the maximum amount currently permitted, $2,500, such that a health FSA may reimburse up to $3,000 in qualifying medical expenses in a given plan year (that, by necessity, follows a plan year in which no more than $2,000 in expenses were reimbursed).

Employers are eager to make use of this new feature, as the possibility of forfeiting even a small amount of hard-earned wages has kept significant number of employees away from health FSAs for years.  However there are some tips and traps that employers should consider before implementing the new plan feature.

  • Make a Choice.  First, an employer whose health FSA currently includes a grace period cannot implement the carryover feature alongside a grace period.  It is an “either or” choice.
    • A grace period is a period of up to 2 ½ months following the end of a plan year, during which prior year amounts may be used to reimburse expenses incurred during the grace period portion of the new plan year.
    • The main advantage of the grace period is that the full health FSA budget may be used within the grace period, whereas the carryover is limited to $500 (and employers may set a lower level if desired).   On the other hand, the grace period does not eliminate the hurried spend-down that occurs at the end of a cafeteria plan year, it just postpones it slightly.
    • By contrast, the carryover amount (up to $500) can be used at any time in the following cafeteria plan year and even in subsequent plan years, if no medical expenses require it be used in the interim.  Example 4 in Notice 2013-71 describes an instance in which $600 in unused funds from the 2014 calendar plan year, after reduction by $100 to meet the maximum carryover rule, is used to reimburse medical expenses in 2016.  Thus the carryover eliminates the spend-down scramble, but only for amounts up to $500.
    • Note that you do not need to eliminate a claim run-out period, if your plan includes one.  A claim run-out period is period following the end of a plan year, during which expenses incurred in the preceding plan year may be reimbursed using prior year amounts.  Teaming the claim run-out period with a carryover (or a grace period) requires some reimbursement ordering rules, which are discussed below under “Sequence Your Reimbursement Buckets.”
  • Timing is Everything.  For calendar year cafeteria plans, it is probably too late in the year to replace a grace period with a carryover, because employees may have scheduled procedures for after the first of the year that exceed $500 in out-of-pocket costs for the participant.
    • Because employees may have acted (or failed to act) in reliance on the grace period remaining in place, legal principles of “equity” and contract law would prevent employers from removing the feature at such a late date.  (The IRS Notice specifically references “non-Code legal constraints” that would apply; a similar concept is the “anti-cutback” rule applicable in the retirement plan sphere.)
    • Employer flexibility in this area may exist, including under non-calendar year plans, and even for calendar year plans depending on the number of participants in the health FSA and on participants’ forfeiture history.  If forfeitures consistently have been below $500 (which typically is the case), then dropping the grace period in favor of the carryover would allow employees additional time to spend the funds on medical expenses.
    • Employers must also be mindful of deadlines set forth in Notice 2013-71 for amending their cafeteria plans in relation to the carryover rule.  Amendments simply to add a carryover feature generally must be made before the last day of the plan year from which amounts are carried over.  However, only for amendments to add a carryover feature effective for the 2013 plan year (without eliminating a grace period), the amendment may be made by the last day of the 2014 plan year.  Amendments to remove a 2013 grace period (occurring early in 2014) must also be made by the last day of the plan year from which amounts may be carried over, retroactive to the first day of the plan year, but no transition relief is offered.  Therefore, an amendment to remove a grace period from the 2013 plan year, separately or in exchange for a new carryover feature, must be made by the end of the 2013 plan year, subject to the timing concerns raised above.
  • Communicate and Document.  A health FSA is an employee welfare benefit plan subject to ERISA documentation and disclosure duties.  The Notice requires plan sponsors that wish to add the carryover feature, either on its own, or in place of a grace period, to amend their cafeteria plan documents accordingly.  Plan amendments that make a material change to the contents of a cafeteria plan document must in turn be communicated to participants in the form of a written summary.  (Note:  generally this rule applies in the context of Summary Plan Descriptions (SPDs), and Summaries of Material Modifications (SMMs) to same.  However it is not uncommon for cafeteria plan documents, including health FSA components to be set forth in a single plan document without any abbreviated SPD.)
    • For a plan amendment simply adding a carryover feature, the written summary of the change must be furnished within 210 days after the end of the plan year in which the change was adopted.
    • For a plan amendment replacing a grace period with a carryover, a much shorter deadline applies:  the change must be communicated to participants in writing within 60 days after the date the employer adopts the change.

In either event, however, employers should try to provide the written summary of the change to employees as promptly as is possible, because the change likely will impact their health FSA spending before the mandatory notice periods have expired.

  • Sequence Your Reimbursement Buckets.  For your cafeteria plan to run smoothly you need to adopt “ordering rules” for reimbursing medical expenses.  It may be helpful to think of unused health FSA deferrals from the prior year as one “bucket” from which medical expenses may be reimbursed, and the new/current plan deferral amount as another “bucket.”  Important Note:  if your plan includes a claim run-out period, you will not know how much is in your “carryover” bucket until the claim run-out period has expired.  The carryover bucket can never hold more than $500.
  • One Possible Ordering Sequence:
    1. Apply prior year’s unused health FSA balance first to reimburse prior year expenses submitted during the claim-run out period.
    2. At the end of the claim run-out period, funds remaining in the prior year’s unused health FSA “bucket” are treated as follows:
      • Up to $500 remains in the bucket, which is now a carryover bucket.
      • Amounts exceeding $500 are forfeited.
  • Alternative Sequence.  The Notice also permits use of this alternative sequence:
    1. Apply current year unused health FSA balance first to claims incurred in the current plan year.  (Remember that under the uniform coverage rule, the maximum health FSA reimbursement budget elected by an employee is available to reimburse expenses as of the first day of a plan year, without regard to actual employee salary deferrals under the health FSA.)
    2. Apply prior year’s unused health FSA balance only after exhaustion of current year amounts.  Prior year unused amounts used to reimburse a current year expense (a) reduce the amounts available to pay prior plan year expenses during a claim run-out period, while applicable; (b) must be counted against the permitted carryover of up to $500, and (c) cannot exceed that maximum amount.

In either instance, current year health FSA funds may only be used to reimburse claims incurred in the current plan year, (except to the extent they remain unused at the end of a claim run-out period and are carried over to a subsequent plan year).

  • Beware of HSA Complications.  Tax-advantaged contributions to a Health Savings Account (HSA) may not be made by or on behalf of an individual who has coverage (as a participant or dependent) under a group health plan other than a high-deductible health plan (HDHP) (“disqualifying coverage”).  Eligibility under a health FSA that permits reimbursement of all expenses for medical care as defined in Code Section 213(d) is disqualifying coverage.  Coverage under a health FSA whose reimbursements are limited to dental and vision expenses, and or to other medical expenses incurred after the HDHP deductible amount is met, is not disqualifying coverage.  Notice 2013-71 does not address how the carryover feature impacts HSA eligibility.  Two possible approaches that representatives of the Groom Law Group informally have discussed with the IRS include restricting carryovers to a limited purpose health FSA, or permitting participants in general purpose health FSAs to opt out of participation in the health FSAs for years in which they want to preserve eligibility under an HSA arrangement.  Until further guidance is issued employers should assume that a participant who has a carryover balance under a general purpose health FSA, and his/her eligible spouse and dependents, will not be able to contribute to a health FSA while the carryover balance is available.

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Filed under Benefit Plan Design, Cafeteria Plans, ERISA, Flex Plans, Health FSA, Health Savings Accounts, Plan Reporting and Disclosure Duties

Roundup of DOMA Guidance re: Benefit Plans

The Internal Revenue Service and Department of Labor have in recent months issued initial guidance to employers on the benefit plan consequences of the U.S. Supreme Court’s June 2013 decision in U.S. v. Windsor, 133 S.Ct. 2675 (2013), which ruled Section 3 of the federal Defense of Marriage Act (“DOMA”) to be unconstitutional on equal protection grounds.  That now defunct DOMA provision limited the federal law definitions of “marriage” and “spouse” to refer only to unions between members of the opposite sex.

The recent guidance, which I summarize below (and have separately addressed in earlier posts), represents early stages in the process of fully implementing the US v. Windsor holding within ERISA’s extensive compliance regime.  Please note that this post focuses on the federal tax consequences of same-sex benefits; state taxation of such benefits, and those provided to domestic partners, depends upon the revenue and taxation laws of each state.

IRS and DOL Adopt “State of Celebration” Rule

In U.S. v. Windsor the Supreme Court held that federal law will recognize all “lawful marriages” between members of the same sex, but left open the question of which state’s law will determine whether a same-sex marriage is lawful:  the state of domicile (where the married couple lives), or the state of “celebration” (where the marriage took place).

This is an important question because the Supreme Court decision left intact Section 2 of DOMA, under which a state, territory or Indian tribe need not give effect to another state’s laws regarding same-sex marriage.  The “state of domicile” rule, if it determined whether or not a same-sex couple was legally married, could cause benefits chaos.  For instance, an employer with operations in multiple states would be required to track where each employee in a same-sex relationship lived, and possibly modify their benefit offerings if they moved from a state that recognizes same-sex marriage, to a “non-recognition” state.

Note:  As of the date of this post, the District of Columbia and 14 states recognize same-sex marriage: California (since June 28, 2013, also prior to November 5, 2008); Connecticut; Delaware (eff. 7/1/2013); Iowa; Maine; Maryland; Massachusetts; Minnesota (eff. Aug. 1, 2013); New Hampshire; New Jersey (eff. October 21, 2013); New York; Rhode Island (eff. Aug. 1, 2013); Vermont; and Washington.  (Follow updates to this list here.)

The U.S. v. Windsor ruling also gave rise to some confusion over the status, under federal law, of domestic partnerships, civil unions, and other formalized same-sex relationships that fall short of marriage.

Fortunately, both the IRS and the DOL have resolved these issues in separate guidance released in September 2013.

Specifically, in Revenue Ruling 2013-17, the IRS announced that:

  • The IRS will recognize, as a legal marriage for all federal tax purposes, a marriage of same-sex individuals that was validly entered into in a domestic or foreign jurisdiction that recognizes same sex marriage, regardless of where the couple lives.
  • Under federal tax law, the terms “husband,” “wife,” “husband and wife,” “marriage” and “spouse” includes lawful same-sex marriages and individuals in such marriages.
  • “Marriage” for federal tax purposes does NOT include domestic partnerships, civil unions, or other formal relationships falling short of marriage.

To reach these conclusions the IRS invoked a prior Revenue Ruling from 1958 (Rev. Rul. 58-66) that held that individuals who became common-law spouses under state law were entitled to be treated as legally married spouses for federal income tax purposes regardless of where they later resided.

The DOL also adopted the “state of celebration” rule for purposes of defining same-sex marriage under ERISA benefit plans, including retirement plans, in Technical Release 2013-14.  In this guidance, published September 18, 2013, the DOL also specifies that the terms “spouse” and “marriage,” for ERISA purposes, do not include domestic partnerships or civil unions, whether between members of the same sex or opposite sex, regardless of the standing such relationships have under state law.

The IRS ruling takes effect September 16, 2013 on a prospective basis.  The DOL Technical Release should be treated as effective immediately on a prospective basis.  The DOL will issue further guidance explaining any retroactive application of the U.S. v. Windsor ruling under ERISA, for instance with regard to previously executed beneficiary designations, plan distribution elections, plan loans and hardship distributions.

Other Tax Guidance from Revenue Ruling 2013-17 and FAQs

Revenue Ruling 2013-17 also contains guidance on prospective and retroactive tax filing aissues resulting from the U.S. v. Windsor decision, including refund/credit opportunities.  More specific guidance for taxpayers is set forth in separate IRS FAQs for same-sex married couples, and for couples in registered domestic partnerships.

In order to understand  the tax refund/credit procedures it is helpful first to review the federal tax consequences of providing employment benefits to same-sex spouses while Section 3 of DOMA remained in effect.

Through Internal Revenue Code (“Code”) Section 105(b), Federal law has long allowed employers to provide health and other benefits on a tax-free basis to employees, their opposite-sex spouses and dependents.  However, under DOMA § 3, the same benefits provided to same-sex spouses and other partners generally resulted in “imputed incometo the employee for federal tax purposes, in an amount generally equal to the value of the benefits provided.  Similarly, employees could not use Sec. 125 cafeteria plans to pay premiums for same-sex spouses/partners on a pre-tax basis.  Only in rare instances where the same-sex spouse was a dependent of the employee spouse as a result of disability, did same-sex spousal coverage not result in an additional federal tax burden to the employee spouse.

Note that benefits provided to domestic partners and partner in civil unions are still treated this way for Federal tax purposes.  For benefits provided to employees who are lawfully married to same-sex spouses, however, the new rules effective September 16, 2013 and prospectively are as follows:

  • Individuals in lawful same-sex marriages must file their federal income tax returns for 2013 and subsequent years as either married filing jointly, or married filing separately.
  • Employer-provided benefits provided to an employee’s lawfully-married same-sex spouse are excludable from the employee’s income for federal tax purposes.
  • As a consequence, employers must stop imputing income to employees, for federal tax purposes, based on same-sex spousal benefits, and must adjust affected employees’ Form W-2 income for 2013 to remove imputed income amounts.
  • The tax-qualified benefit plans that are affected are:
    • health, dental and vision coverage;
    • qualified tuition reduction plans maintained by educational organizations;
    • meals and lodging provided to employees on business premises (other specific conditions apply);
    • fringe benefit including qualified transportation fringe benefits, moving expenses, employee discounts, and work-related expenses; and
    • pre-tax participation in Section 125 cafeteria/flex plans, including health flexible spending accounts and dependent care flexible spending accounts.
  • Employees in lawful same-sex marriages can file amended personal income tax returns for “open” tax years (generally 2010, 2011, 2012) to recoup over-withheld federal income taxes resulting from imputed income and after-tax cafeteria plan participation.
  • However, if they re-file, they must re-file as married for all tax purposes, not just to obtain the refund or credit.  In many cases, the income tax adjustment will not warrant the loss of other deductions.  Employees must consult their individual CPAs and other tax advisors for answers; employers must refrain from offering any specific advice or guidance in this regard.

Corrective Payroll/Withholding Steps for 2013 and Prior “Open” Tax Years

IRS Notice 2013-61, published September 23, 2013, sets forth optional, streamlined ways for employers to claim refunds of over-withheld “employment taxes” (FICA and federal income taxes) applied to imputed income/same sex spouse benefits in 2013, and prior “open” tax years.

The “normal” over-withholding correction process – which remains available to employers in this instance – varies slightly depending on whether or not the employer is seeking an adjustment of withholding taxes, or a refund of withholding taxes, but generally includes the following steps:

  • identify the amount of over-withholding;
  • repay the employee’s portion to the employee in cash (or “reimburse” them by applying the overpayment to FICA taxes for current year);
  • obtain written statements from affected employees that they will not also claim a refund of over-withheld FICA taxes, and if an employer is seeking a refund of over-withheld taxes, obtain affected employees’ written consent to the refund; and
  • file IRS Form 941-X for each quarter affected, to recoup the employer portion of the tax.

Notice 2013-61 sets forth two streamlined correction methods permitting use of one single Form 941 or Form 941-X for all of 2013.  Under the first method, the employer takes the following steps before the end of the current year:

  • identify and repay/reimburse employees’ share of excess income tax, FICA tax withholdings resulting from same-sex spousal benefits on or before December 31, 2013; and
  • make corresponding reductions in affected employees’ wage and income-tax withholding amounts on the 4th quarter 2013 Form 941.

The second method is available if the employer does not identify and repay/reimburse employees’ share of excess income tax, FICA tax withholdings until after December 31, 2013.  In that case the employer:

  • Files one single Form 941-X in 2014 seeking reimbursement of employer’s share of tax with regard to imputed income for same-sex spouse benefits reported in all quarters of 2013.
  • In addition to the regular Form 941-X filing requirements, including obtaining written statements and/or consents from employees, employers must write “WINDSOR” at the top of the Form 941-X and must file amended Form W-2s (IRS Form W-2c) for affected employees, reporting the reduced amount of wages subject to FICA withholding.

Note:  This second correction method can apply only to FICA taxes.  Employers cannot make adjustments for overpayments of income tax withholding for a prior tax year unless an administrative error (e.g., wrong entry on Form 941) has occurred.

Employers may also recoup their share of FICA taxes for earlier open tax years (generally, 2010, 2011 and 2012) using one Form 941-X for all four calendar quarters that is filed for the fourth quarter of each affected year.  In addition to marking the Form “WINDSOR” the employer must also file amended Form W-2s for affected employees, reporting the reduced amount of wages subject to FICA withholding.

Employers making use of the correction methods set forth in IRS Notice 2013-61 for 2013 or earlier open years must take account of the Social Security Wage Base in effect for applicable years.  For employees whose 2013 compensation exceeds the taxable wage base ($113,700) even after imputed income is eliminated, no corrections for the Social Security component of FICA taxes can be made.  If retroactive corrections are made, you must observe the SS wage base limitations in effect in prior years:  $106,800 for 2010 & 2011, and $110,100 for 2012.

One final note:  many employers that provide benefits to employees’ domestic partners and/or same sex spouses have followed a practice of grossing up the employees’ taxable compensation to account for the additional federal taxes they must pay on imputed income.  The IRS guidance on recouping over-withheld taxes apply only to imputed income amounts, not to the gross-up amounts.  “Normal” over-withholding correction procedures using Forms 941 and 941-X should apply to 2013 gross-up amounts but employers should consult their payroll and tax advisors for specific advice.  Note also that California recently adopted a law that will exclude gross-up amounts from employees’ taxable compensation for state personal income tax purposes.  AB 362 takes immediate effect and is slated to expire January 1, 2019.  You can find a fuller discussion of the measure here.

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Filed under Cafeteria Plans, Defense of Marriage Act, ERISA, Fringe Benefits, Payroll Issues, Registered Domestic Partner Benefits, Same-Sex Marriage, U.S. v. Windsor