Category Archives: Payroll Issues

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

IRS Details Benefit Parity for Same-Sex Spouses

In U.S. v. Windsor, the Supreme Court struck down Section 3 of the Defense of Marriage Act as a violation of the 5th Amendment’s guarantee of equal protection under the law.  Section 3 defined “marriage” and “spouse” for purposes of Federal law as limited to a legal union between one man and one woman as husband and wife.  Elimination of this standard impacts a multitude of Federal laws, and guidance from a number of Federal agencies will be needed before the ruling fully is integrated into the U.S. Code.

Some of the first of that guidance explains Federal tax treatment of same-sex spouses under certain employment benefits plans and arrangements.  The guidance was released on August 29, 2013 by the Treasury Department and the Internal Revenue Service, in the form of Revenue Ruling 2013-17 and two sets of Frequently Asked Questions (FAQs.)  I addressed this guidance briefly in my prior post.  Below I go into more detail on the key compliance points of relevance to employers:

Treatment of Same-Sex Marriage under Federal Tax Law

  • Same-sex marriages lawfully performed in any U.S. state, the District of Columbia, or a foreign county are valid as marriages under Federal tax law, regardless of where the couple reside.
    • This means that employers with operations in states that do not recognize same-sex marriage, such as Texas, must treat same-sex spouses residing in those states equal to opposite-sex spouses for Federal tax purposes, so long as the couple legally was married in a state or other locale that recognizes same-sex marriage.
    • Obviously, equal Federal tax treatment is also required in those states that currently recognize same-sex marriage: California (since June 28, 2013; also some unions prior to November 5, 2008); Connecticut, Delaware (eff. July 1, 2013); Iowa, Maine, Maryland, Massachusetts, Minnesota (eff. Aug. 1, 2013); New Hampshire, New York, Rhode Island (eff. Aug. 1, 2013); Vermont; Washington; District of Columbia.
    • For Federal tax purposes, the terms “spouse,” “husband and wife,” “husband” and “wife” and “marriage” include reference to lawful same-sex marriage as defined above.
    • Registered domestic partnerships, civil unions, or other relationships formalized under state law as something other than marriage are not treated as marriage for Federal tax purposes, whether between same-sex or opposite sex individuals.
      • The Internal Revenue Code (“Code”) permits tax-free treatment of employer-sponsored benefits, including health care, offered to employees, their spouses (now including same-sex spouses) and dependents.  Employer-sponsored benefits provided to individuals not meeting these categories constitutes taxable income to the employee; specifically “imputed” income generally equal to the value of the benefits provided.
      • These rulings take effect September 16, 2013 and subsequent, but have some retroactive effect as described below.

Compliance Point:  As a result of these rulings, employers must identify employees who are in legal same-sex marriages, and, for those employees, adjust income tax withholding, and Social Security and Medicare taxes for 2013, so that the cost of benefits provided to same-sex spouses are treated as excluded from gross income.  Employers must continue to impute income to employees for Federal tax purposes, equal to the value of benefits provided to registered domestic partners, partners in a civil union, and other non-marital relationships, whether same-sex or opposite sex.

Tax Refunds and Credits for Prior “Open” Tax Years

Individuals in Lawful Same-Sex Marriages

  • Individuals in legal same-sex marriages must file their income tax returns for 2013 and subsequent as either “married filing jointly” or “married filing separately.”
  • These individuals may – but are not required to – amend or re-file their income taxes, and claim tax refunds or credits, for all “open” tax years in which they were in a legal same-sex marriage.
    • Generally, for refund or credit purposes a tax return remains “open” for three years from the date the return was filed or two years from the date the taxes reported in the return were paid, whichever is later.
      • For individuals who timely filed their Form 1040 tax returns and paid related taxes by the April deadline each year, returns for 2010, 2011 and 2012 likely remain open, however readers must confirm with their own accountants or other tax advisors which tax years remain open for them.
      • The retroactive tax relief is as follows:
        • As mentioned, individuals in lawful same-sex marriages may re-file their federal tax returns as “married filing jointly,” or “married filing separately,” which was not previously an option under Federal law.
          • Note:  this change in filing status could significantly change the amount of  federal taxes owed and readers must consult with their own accountants or other professional tax advisors about the impact to their own bottom line.
  • Individuals may request a refund of income taxes they paid on “imputed income” resulting from benefits provided to same-sex spouses.  This relief can also take the form of a credit against future income taxes owed.
    • Example:  Alex legally was married to a same-sex spouse for all of 2012.  Alex’s employer offers group health coverage to employees, their spouses and dependents, and pays 50% of the cost of coverage elected by the employee.  The value of the employer-funded portion of coverage for Alex’s spouse was $250 per month.  Alex may file an amended Form 1040 (Form 1040X) for 2012 that reduces gross income by $3,000 ($250 x 12 months) and be refunded the taxes paid on that amount.
    • Employees who paid for their own health coverage with pre-tax dollars under a Code § 125 cafeteria plan have the option of treating after–tax amounts that they paid for same-sex spouse coverage as pre-tax salary reduction amounts.
      • Example:  Alex’s employer sponsors a group health plan under which employees must pay the full cost of spousal and dependent coverage.  However, they may do so with pre-tax dollars under a Section 125 cafeteria plan.  During open enrollment in late 2011 Alex enrolled in self-only coverage for 2012, but she entered into a legal same-sex marriage on March 1, 2012.  Alex enrolled her spouse in health coverage beginning March 1, 2012.  The monthly premiums were $500.  Alex may file an amended Form 1040 (Form 1040X) for 2012 that reduces her gross income by $5,000 ($500 x 10 months).  This puts her in the position she would have been in, had she been able to increase her salary reductions under the cafeteria plan to cover spousal coverage beginning in March 2012.
    • Other benefit plans with regard to which retroactive tax relief is available include qualified scholarships under Code § 117(d), fringe benefits under Code § 132, dependent care benefits under Code § 129, and employer-provided meals or lodging under Code § 119.
    • Note:  individuals who seek a tax refund or credit related to imputed income credited to them in past, open tax years must adjust their tax returns for those years consistent with the tax status (i.e., married filing jointly or separately) that they are claiming with respect to the refund or credit.  In other words, an individual cannot seek a refund of taxes paid for imputed income credited to them in 2012, but retain their status as a single taxpayer for 2012.

Compliance Point:  Employers need to be aware that employees in same-sex marriages may be filing amended returns and seeking tax refunds related to these benefits, and take steps to quantify the imputed income or provide other information to employees to assist in retroactive tax relief.


  • Retroactive income tax relief is only available to individuals; employers may not seek refunds for overwithheld income taxes in prior years.
  • Employers may seek a refund of Social Security and Medicare taxes paid on imputed income resulting from same-sex coverage, or claim a credit against future taxes owed.
  • The relief is available for “open” tax years which generally are the same as for individual tax returns (3 years from date of filing return or 2 years from date of paying taxes, whichever is later).
    • For purposes of calculating the open period, quarterly Form 941s are treated as if they were all filed on April 15 of a given calendar year.
    • The relief generally applies to the employer and employee portions of Social Security and Medicare taxes, however employers are limited to recovery of the employer portion only in two instances:
      • In relation to an employee who cannot be located, or
      • When the employer notifies an employee that it is seeking a refund but the employee declines, in writing, to participate in same.
    • The IRS will establish a “special administrative procedure” for employers to seek refunds or claim credits for Social Security and Medicare taxes related to same-sex spousal benefits, to be defined in future guidance.

Compliance PointEmployers should be alert to future guidance from the IRS on  the “special administrative procedures” that will apply to Social Security and Medicare tax refunds, and should take steps to quantify the amounts involved for open tax years.

Retirement Plan Issues

The IRS Frequently Asked Questions for individuals in lawful same-sex marriage begin to address same-sex spouse treatment under qualified retirement plans (QRPs), including 401(k) and profit sharing plans.  Much more guidance in this area will be needed both from Treasury and from the Department of Labor.  The following guidance applies as of September 16, 2013 and subsequent.  Future guidance will address any retroactive application of Revenue Ruling 2013-17 to retirement plans and other tax-qualified benefits, including with regard to plan amendments and plan operation in the interim between September 16, 2013 and the date such future guidance is published.

  • QRPs must treat a same-sex spouse as a spouse for all Federal tax purposes relating to QRPs, regardless of where the same-sex spouses reside.
    • For instance, a QRP maintained by an employer in Florida, which does not recognize same-sex marriage, must pay a survivor annuity to a surviving same-sex spouse of a plan participant, unless the spouse consented in writing to another beneficiary prior to the participant’s death.
    • QRPs are not required to treat registered domestic partners, partners to a civil union, or partners to other formalized but non-marital relationships as spouses, whether the partners are same-sex or opposite sex.
      • For instance, a QRP need not pay a surviving spouse annuity to a registered domestic partner upon a participant’s death.  However a plan may treat a registered domestic partner as a default beneficiary who will receive a plan benefit if the participant failed to choose another beneficiary.  Plans must also treat registered domestic partners as designated beneficiaries when they are named as such by the participant.

Compliance PointEmployers should be on the alert for future guidance on QRP administration related to same-sex spouses.  In the interim, check with your company’s accountant or other tax professional if same-sex spouse benefit questions arise.

Affordable Care Act Issues

Not all of the consequences of Federal tax recognition of same-sex marriage are positive.  Under the Affordable Care Act, couples in a legal same-sex marriage now must combine their incomes for purposes of determining eligibility for premium tax credits and cost sharing on the healthcare exchanges, beginning in 2014.  This may prevent some persons in same-sex marriages from receiving federal financial aid they would have qualified for, as unmarried individuals.

The reason for this is that financial aid towards health coverage on the exchanges is based on “household income” and household income must be between 100% and 400% of federal poverty level for financial aid to apply.  Couples whose combined income exceeds 400% of the Federal Poverty Level (currently $62,040 for a 2-person household) will be ineligible for any financial aid toward the cost of coverage even if, individually, the same-sex spouses might have qualified for coverage on their own.

Additionally, “dependent” coverage which must be offered by applicable large employers in 2015 applies to children up to age 26, but not to “spouses,” and hence not to same-sex spouses.

Hopefully, future guidance from the IRS and from Health and Human Services will address in more detail the impact that Federal tax treatment of same-sex marriages has under the Affordable Care Act.

Compliance Point:  Employers need to be aware that household income for employees in legal same-sex marriages will include their spouse’s compensation and will likely impact their eligibility for financial aid towards coverage on the health exchanges.


Filed under 401(k) Plans, Affordable Care Act, Benefit Plan Design, Cafeteria Plans, Defense of Marriage Act, Employer Shared Responsibility, ERISA, Fringe Benefits, Health Care Reform, Health Insurance Marketplace, Payroll Issues, PPACA, Profit Sharing Plan, Registered Domestic Partner Benefits

Update on Fiscal Year Health FSAs and the $2,500 Limit

On January 10, 2011 I posted about how employers with health FSAs that follow a fiscal year might comply with the $2,500 deferral dollar limit going into effect on January 1, 2013. This post updates and corrects the earlier post as follows:
Notice 2012-9, which provides updated guidance on Form W-2 reporting of the value of group health care, exempts most health FSAs from the reporting requirement. The specific exemption applies to health FSAs that are exempt from HIPAA because they are funded entirely by employee salary deferrals, or because any employer contribution is $500 or less. (W-2 reporting of health care is waived entirely for employers filing fewer than 250 Forms in 2013, based on 2012 employment figures.)
• As a consequence, the IRS will not be able to monitor, through tax returns, any instances in which employee salary deferrals in 2013 exceed the $2,500 limit.
• One of the proposed approaches described in my January 10 post – namely, stopping deferrals at the $2,500 mark – would violate the requirement, set forth in the 2007 Proposed Regulations, that employee salary deferrals be taken in intervals that are uniform for all participants, which in turn potentially could disqualify the plan. (Proposed Treas. Reg. § 125-5(g)(2)). It is possible the IRS will address this method in future guidance but until such time it is not recommended.
• Another proposed method – “front-loading” the 2012-2013 deferral amount so that only $2,500 is deferred in the 2013 portion of the fiscal year – would not expressly violate Section 125 regulations because they do not require deferrals be made in uniform amounts, only uniform intervals. However this method could be viewed as inconsistent with the spirit, if not the letter, of the uniform coverage rule, which prohibits timing deferral payments based on the rate or amount of covered claims incurred. Front-loading is also arguably inconsistent with the uniform deferral rate requirement. An employer could also pro-rate the higher 2012 deferral amount and the lower 2013 deferral amount across the 12 month fiscal year but this would require that the employer reduce deferrals in the first half of the 2013-3014 fiscal year to equal $2,500, when combined with the pro-rated deferrals during the latter half of the 2012-2013 fiscal year. Clearly, timing of the fiscal year start (whether early in 2013, or late in the year) may make the front-loading or pro-rated options unaffordable for some participants.
• Even if unequal deferral amounts are permitted, the actual functioning of the pro-rated or front-loaded method could result in violation of Section 125’s nondiscrimination rules, specifically the rule that key employees receive no more than 25% of aggregate tax qualified benefits under a plan in any given year. This easily could occur if, for instance, shareholders and executives of a business typically were the only participants who deferred in excess of $2,500 per year, and continued to defer $5,000 per year under the pro-rated/front-loading method.
• The third method mentioned in my earlier post – imposing the $2,500 deferral cap at the start of the 2012-2013 fiscal year, is the most conservative approach to take but also the approach that will be most unpopular with participants who are accustomed to deferring significant amounts of money in prior plan years.
• At this point, any further guidance from the IRS would only be useful for employers whose fiscal years begin March 1 or later, as February 1 start date plans are almost through open enrollment. It may well be that the Service recognized that sponsors of fiscal year health FSAs would face administrative and legal obstacles to implementing the $2,500 limit and decided that the less the said about the matter, the better.

I want to thank my client and good friend Mike Igoe of Igoe Administrative Services in San Diego, California, for providing the ideas and impetus behind this post. There are very few true experts in this area, but Mike is one of them. Thanks, Mike.

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Filed under Cafeteria Plans, Flex Plans, Health FSA, Payroll Issues

IRS Updates Guidance on W-2 Reporting of Health Care Costs

In Notice 2012-9, published January 3, 2012, the IRS has updated guidance on employer reporting of group health care costs via Form W-2. The Notice replaces earlier guidance issued in March 2011 (Notice 2011-28). Reporting in January 2013 is mandatory for employers filing 250 or more Forms W-2 with respect to 2012 compensation.

The new guidance clarifies several points covered in the earlier Notice and adds new guidance on a number of issues. It does not provide permanent reporting relief to employers filing fewer than 250 Forms W-2 for the preceding year, but simply confirms that reporting duties are suspended for this group until further notice.

A brief summary of the clarified and new guidance follows:

• The cost of coverage provided under a health FSA does not need to be reported so long as the amount of the employee’s salary reduction under the cafeteria plan (for all tax-qualified benefits) exceeds the amount set aside for the health FSA for the plan year (including salary deferrals plus employer flex credits the employee allocates to the health FSA, or an employer match based on the employee deferral.) A new example provided under Q&A 19 illustrates that use of an employer flex credit will not trigger reporting duties so long as employee deferrals exceed the health FSA amount. This is contrasted with an earlier illustration showing how an employer matching contribution to the health FSA can trigger reporting.
• The cost of dental or vision coverage need not be reported on Form W-2 if the dental or vision coverage constitutes limited scope “excepted benefits” for purposes of HIPAA. (Note: The Notice refers to excepted benefits under Section 54.9831-1(b)(3) of the HIPAA Regulations, but I believe the accurate citation is to Sec. 54.9831-1(c)(3)).)
• For purposes of the small employer exemption, the “fewer than 250” Form W-2 threshold is determined without regard to use of a reporting agent under Internal Revenue Code Section 3504. (Unlike traditional payroll companies such as ADP, agents under Code Section 3504 assume liability with regard to reporting functions).
• The reportable cost of coverage need not include coverage that is included in the gross income of a “highly compensated individual” as a result of failing nondiscrimination requirements under Code Section 105(h) (applicable to self-funded plans) or payments or reimbursements of health insurance premiums for a 2% shareholder-employee of an S-corporation.
• Employers using a composite rate for active employees but not for COBRA recipients may either use the composite rate to determine the aggregate cost of coverage for reporting purposes (consistent with methods described in Notice 2011-28 and repeated in Notice 2012-9, Q&A 25 through 27), or may use the applicable COBRA premium, provided that the methods used are consistent among active employees, on the one hand, and COBRA recipients, on the other.
• Related employers that share employees but do not use a common paymaster may report the aggregate cost of health care for a shared employee either by allocating the cost among the related employers (using any reasonable method of allocation), or by reporting the entire cost on a single Form W-2 issued by one of the employers.
• The exemption from health care cost reporting applicable to Federally recognized Indian tribal governments extends to wholly owned, tribally chartered corporations.

New Guidance
• So long as no COBRA premium is charged for participation in wellness programs, employee assistance programs (EAPs) or for use of on-site medical clinics (which generally is the case), the value of access to such programs need not be calculated and reported on Form W-2.
• Employers voluntarily may report the aggregate cost of coverage that is not required to be reported, such as the cost of coverage under a Health Reimbursement Account (HRA), a multi-employer plan, EAP, wellness program, or on-site medical clinic, provided that the cost of coverage is calculated according to existing guidance and provided that the coverage constitutes “applicable employer sponsored coverage” as defined in Q&A 12.
• Employers that offer group health coverage under a program that includes coverage that need not be reported (such as long-term care insurance) may calculate the reportable cost using any reasonable allocation method. Reporting relief is available with regard to “incidental” amounts of reportable or non-reportable coverage under certain circumstances.
• Employers may report the aggregate cost of coverage on Form W-2 for a calendar year based on information available to them as of December 31 of that year. No corrections need be made on the basis of information gained in the new year which would affect the cost of coverage in the prior year (such as an employee’s divorce in the prior year). Further, once an employer issues a Form W-2 in the new year it need not issue a corrected Form W-2c on the basis of new information received before the Form W-2 reporting deadline.
• The cost of coverage for periods that include December 31 but continue into the subsequent calendar year may be reported in one of three ways: (a) as relating all to the calendar year ending December 31; (b) as relating all to the subsequent calendar year; or (c) allocated between the two years based on any reasonable allocation methods. The employer must apply the chosen method consistently to all employees.
• The cost of coverage under hospital indemnity or other fixed indemnity insurance, or for coverage for a specified disease or illness, must be reported if purchased with pre-tax dollars including through a cafeteria plan. Reporting is not required if the same types of coverage are purchased by the employee with after-tax dollars.
• The aggregate cost of health care coverage need not be reported on Forms W-2 prepared by third-party sick pay providers.

The Notice provides that any future expansion of the W-2 reporting requirements would be prospective only and would not apply earlier than January 1 of the calendar year beginning at least six months after the issuance of the guidance. Further, it clarifies that the existing transition relief for 2012 Forms W-2 (issued early in 2013), including the relief for small employers, is “locked in” and no longer subject to modification.

For a summary of earlier guidance on Form W-2 reporting of health care costs, click here.


Filed under Affordable Care Act, Payroll Issues, PPACA, Wellness Programs

Rollback of Expanded Form 1099 Reporting under PPACA – and how Congress Paid for Repeal

On April 14, 2011, President Obama signed H.R. 4, the “Comprehensive 1099 Taxpayer Protection and Repayment of Exchange Subsidy Overpayments Act of 2011.” Half of that catchy title is self-evident: the Act repeals Section 9006 of PPACA which, starting in 2012, would have expanded Form 1099 reporting to include payments of $600 or more to corporations providing services or goods. (Form 1099 currently is limited (generally) to reporting services worth $600 or more received from individuals or non-corporate entities.) Repeal of expanded Form 1099 reporting duties was almost inevitable after President Obama singled out the expanded reporting measure in his January State of the Union address as an expendable provision of PPACA. And although expanded reporting was unpopular with both political parties, they disagreed on how to pay for repeal of the measure, which was expected to generate approximately $22 billion over 10 years, largely by capturing formerly unreported cash transactions.

The second, less intelligible part of the Act’s title (“Repayment of Exchange Subsidy Overpayments Act”) explains how Congress decided to pay for the repeal. Under PPACA, individuals earning between 133% and 400% of the federal poverty level will in 2014 become eligible for “premium assistance credits” they can use towards purchase of coverage on a state exchange. The credits are designed to limit this group’s health insurance premium costs to an amount that is between 2% and 9.5% of total household income. The government will fund the credits in advance, through direct payments to insurance carriers, which permits eligible individuals to pay reduced premiums right away. Similarly, an individual’s current-year income is used to “pre-determine” the size of his or her subsidy in the subsequent calendar year. If the advance payments exceed the premium credit the individual qualifies for based on income earned in that subsequent year, the excess must be repaid in the form of additional tax on the person’s Form 1040.

PPACA limited the amount that could be recaptured from modest earners to a fairly small amount. Specifically, under newly-created Internal Revenue Code Section 36B(f)(2)(B)(i), no more than $400 could be recaptured from individuals with family income up to 400% of the federal poverty line ($250 for single taxpayers). H.R. 4 amends Section 36B to significantly increase the recapture amounts from the $400/$250 levels. The new levels are as follows:

• $600 for persons with household income less than 200% of the federal poverty line ($300 for single taxpayers),
• $1,500 for persons with household income from 200% to less than 300% of the federal poverty line ($750 for single taxpayers), or
• $2,500 for persons with household income from 300% to less than 400% of the federal poverty line ($1,250 for single taxpayers).

Thus, a family of four earning up to 400% of the federal poverty level ($89,400) potentially could owe $2,500 instead of $400 with their taxes in order to repay the government for the subsidy it received based on a prior year’s, lower income level. Also under H.R. 4, individuals whose household income exceeds 400% of the federal poverty level must repay all premium assistance credits received; previously the repayment amount was capped at $3,500 and only applied to individuals with household income of 450% to 500% of FPL.

This significant expansion of repayment obligations (in the form of increased income taxes) in order to replace revenue lost upon repeal of the expanded Form 1099 reporting duties passed without much controversy, I expect, because explaining it is so complicated.

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AB 36 Becomes Law; California Employers Face Corrective Reporting for 2010

Governor Jerry Brown signed AB 36 into law on April 7, 2011. This law brings California income and certain employment tax laws into parity with federal tax law, retroactive to March 30, 2010, regarding group health coverage extended to employees’ children up to age 26. That is the date that federal law first permitted treatment of “overage” dependents to be excluded from employees’ income, for tax purposes, through the year in which their child turns age 26, and irrespective of the child’s student or marital status. Prior to passage of AB 36, California employers were required to track overage dependent coverage, assign it a value, and add that value to employees’ taxable wages as “imputed income.”

Now California employers who offered overage dependent coverage in 2010 and properly tracked imputed state income have to amend 2010 state payroll tax returns retroactive to the date the employer first permitted overage dependent coverage. Employers will have to identify how much imputed state income each employee received in 2010, and prepare amended W-2s (Forms W-2C) for employees excluding this amount from Box 16.

Preparation of amended employer returns is made more complicated in 2011 as the California Employment Development Department (EDD), which collects employment taxes, has just changed its payroll withholding returns and forms effective this year. Fortunately, the EDD has already posted online guidance for employers here. It directs employers to use EDD Form DE 678 to report corrections of income reported on DE 6 quarterly withholding reports for 2010. Employers have until the end of this month to file quarterly withholding reports for the first quarter of this year, and the EDD guidance states that employers may exclude imputed income from their DE 9 returns (quarterly withholding reports that replace DE 6) and file returns that are accurate with the new retroactive law. Employers that have already submitted their DE 9 are directed to report corrections for first quarter of 2011 using the new version of DE 678, Form DE ADJ.

All employers will still have deposited payroll taxes in excess of the corrected amount reported. Detailed instructions for correcting excess deposits are found on pages 77-78 of the California Employer’s Tax Guide for 2011; note that the instructions differ depending on whether taxes were deposited using Form 88, or electronically, and that correction of over-withheld personal income tax differs from correction of over-withheld employment taxes (state disability insurance, unemployment insurance, etc.).

The Franchise Tax Board, governing personal and business income tax, also has updated its website with guidance for employees who included overage dependents in their coverage last year. They are directed to file amended state income tax returns (FTB Form 540X), once they receive their Forms W-2C omitting the imputed state income. They are also told to use FTB Form 3525 as a substitute for federal Form W-2C if unable to obtain a Form W-2C from their employer.

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Notice 2011-28: Transition Relief and More on W-2 Reporting of Health Care Costs

On March 29, 2011 the IRS released Notice 2011-28 which contains guidance, in question-and-answer format, on W-2 reporting of the cost of health care coverage, a requirement of PPACA. This reporting requirement – often mistaken for a tax on health care costs – was originally required for Form W-2s for 2011 issued to employees and SSA in early 2012. In an earlier Notice the IRS postponed the reporting requirement until 2012 W-2s issued in early 2013. Now, Notice 2011-28 postpones the reporting duty yet another year – and until further guidance issues – for employers that in 2011 issue fewer than 250 Forms W-2 (this is also the threshold for mandatory electronic reporting).

Again – if your company issues fewer than 250 Forms W-2 for 2011 – i.e., the forms that you send to employees and SSA in early 2012 – then in 2012 your company is relieved from tracking and reporting the value of group health care coverage on Forms W-2.

For employers that will have to report the value of health coverage for 2012 Forms W-2 the Notice contains helpful information on a number of points:

1) With regard to reporting the cost of health coverage in a year in which an employee terminates employment, the employer can either report the cost of COBRA coverage for the balance of the months of the year, or report only on months in which the employee actively was employed. The employer must use one or the other reporting method for all terminating employees.

2) If terminated employee requests a copy of his or her Form W-2 before the end of the year, the employer is not required to report any amount in box 12, designated for the cost of coverage.

3) When an employee transitions employment in the course of a year, either the predecessor or successor employer may each report the cost of coverage for the period the employee worked for them, or the successor employer can report the cost for the whole year pursuant to a procedure set forth in Revenue Procedure 2004-53. Employers that undergo a change in control transaction should flag this issue for negotiation along with COBRA duties and related payroll issues.

4) The amount that must be tracked and reported is the “aggregate cost of applicable employer-sponsored coverage.” “Applicable employer-sponsored coverage” means coverage under any group health plan that is excludible from an employee’s gross income under IRC Section 106, with the exception of: (a) coverage for long-term care; (b) coverage for on-site medical clinics; (c) coverage under separate dental or vision insurance (unbundled from group health); or (c) individual hospital indemnity or disease-specific coverage.

5) The aggregate cost of coverage includes the employer and the employee portion, whether or not the employee paid for the coverage on pre-tax basis under a cafeteria plan. The aggregate cost also includes the cost of coverage provided to over-age dependents (older than age 26 – some states mandate coverage past this age) – even when the cost of this coverage is added to employees’ taxable wages.

6) Amounts excluded from the aggregate cost of coverage include (a) contributions to an Archer MSA, (b) contributions to HSAs, and (c) salary reduction elections under a health flexible spending arrangement (“FSA”). When a health FSA is offered under a Section 125 cafeteria plan, the amount the employer must include in the aggregate reportable cost of coverage on Form W-2 is the amount of the employee’s salary reduction for all qualified benefits – not just the health FSA, plus the amount of any employer flex credits or contributions that the employee elects to apply to the health FSA. If the employee’s total salary reduction for all flex benefits equals or exceeds that amount of the health FSA for a given year, the employer does not include the amount of the health FSA for that employee for that year. Examples in the Notice under Q&A 19 spell this out in more detail.

7) An employer may choose from among several methods of calculating the reportable cost under a plan: (a) using the COBRA premium cost to the employee; (b) using the premiums charged for the employee’s coverage; (c) using a modified COBRA premium (where the employer subsidizes COBRA premiums or bases them on premiums calculated in a prior year. In addition, employers using one or more composite rates can use those rates to calculate the cost of coverage for reporting purposes.

8 ) Employers must track changes to the cost of coverage occuring during the year, for reporting purposes. This will occur when an insured health plan is on a fiscal year renewal cycle or when a self-funded plan uses the COBRA premium method and the 12-month period used to determine the COBRA applicable premium is not the calendar year.

9) Employers must track changes to the cost of coverage occuring when an employee commences, changes, or terminates coverage, for instance when an employee who switches from individual to individual plus spouse coverage in the middle of the year.

10) The reportable cost of coverage must always be determined on a calendar year basis; this will be an issue for employers whose health plans use a fiscal year.

The IRS requests public comments on a number of points including on challenges employers may face in implementing reporting of coverage costs on the 2012 Forms W-2, as well as issues raised by applying the reporting requirement to employers filing fewer than 250 Forms W-2 in a year. This may suggest that the IRS is evaluating a permanent reporting waiver for this group; hopefully this will be addressed in future guidance.

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