By: HUB’s EB Compliance Team
In an information letter to Senator (and Presidential candidate) Amy Klobuchar, the IRS confirmed that a former spouse is not a dependent for purposes of the cafeteria plan rules. (The letter related to one of Sen. Klobuchar’s constituents, not the Senator herself.) As a result, the death of a former spouse does not give an employee the right to change his/her election under the cafeteria plan rules.
The letter is light on the facts, but it appears to be an all-too-common scenario. The employee got divorced and had a court order requiring him/her to provide coverage for the former spouse. Under the tax code and nearly every health plan, a former spouse is not a dependent. As a result, the employee should have notified the employer of the divorce and paid for the former spouse’s COBRA coverage (or some other source of coverage).
Employees often make this mistake. They assume (incorrectly) that the court order allows them to keep covering their former spouse on the plan just like a current spouse or dependent. Alternatively, some savvy employees may go for this approach because they know COBRA is more expensive. However, most often the mistake appears to be more out of ignorance rather than fraud.
Employees may be confused, in part, because qualified medical child support orders (QMCSOs) do allow them to continue to cover their children, even if the children are no longer living with them. However, under ERISA, health plans are required to provide health coverage to children covered by a QMSCO; no similar rule exists for former spouses. Additionally, there are special tax rules that allow the children to be treated as tax dependents even if they are not living with the employee in some cases, so the tax result may be different.
The Truth Comes Out
However, the truth eventually comes to light and that’s where this gets sticky. Down the road, some change happens where the employee wants to change his or her election. Either the employee remarries and tries to add the new spouse, a court order comes in allowing the employee to stop paying for the former spouse, or (as is the case in this IRS information letter) the former spouse passes away. Whatever the reason, the employee now wants to drop the former spouse.
The problem, of course, is that the former spouse should not have been on the plan in the first place. Once the divorce happened, the employee should have notified the employer.
As the IRS information letter notes, the spouse is not a tax dependent. If the employee is paying for coverage on a pre-tax basis through a cafeteria plan, he/she can only change the amount he/she is paying for coverage at open enrollment or due to a permitted change in status. Permitted changes in status are events like a change in employment status of the employee or a dependent, or a change in marital status of the employee or dependent, among other types of events. Note: the change has to relate to the employee or a dependent. A former spouse is not a dependent.
Because covering non-tax dependents creates tax reporting complications, many employers similarly limit coverage to employees and tax dependents (including spouses). In some cases, they may cover domestic partners who are not tax dependents, but they often require evidence of a committed relationship and have the employee pay the premium after-tax. If the premium is paid after-tax, then the restrictions around changes in status do not apply and elections can be changed when the domestic partnership dissolves, even though the domestic partner is not a tax dependent.
What Happens Now?
When employers are faced with a former spouse improperly on the plan, there are a few steps they should take:
- Remove the former spouse from the health plan. Even though the cafeteria plan rules may not allow the employee to change his or her election, eligibility for the health plan is separate from the cafeteria plan rules. To put it another way, the election for coverage under the health plan is about who is covered, while the cafeteria plan election is about how much the employee will pay for that coverage. Therefore, while the two are related, they are not the same. If, as is typical, the former spouse is not eligible for the health plan, the former spouse should be removed from the health plan as soon as possible.
- Notify the carrier (or stop loss carrier, if the plan is self-funded). Be sure to explain that this was an employee error and work with them to provide coverage.
- Consider the impact of COBRA. We delve into that issue more here.
- Check other plans. If the employee failed to notify you of the divorce, other plans (dental, vision, dependent life insurance, etc.) may also need to be changed. Be sure to work through those plans as well.
- Communicate proactively. At the next open enrollment, and potentially throughout the year at various times, be sure to remind employees to notify you of changes in status, including divorce. If this issue has occurred to you before, you may want specific messaging that confirms a former spouse cannot remain on the health plan, even if the employee has a court order requiring him/her to pay for coverage.
What about the cafeteria plan election?
The information letter says that the tax rules do not allow the employee to change his/her election (meaning, the amount the employee is paying for coverage on a pre-tax basis). This means that the employee may be paying for, for example, employee +1 coverage even though the employee is now receiving employee-only coverage. What is an employer to do?
HUB recommends consulting with counsel because the facts may determine the correct approach. For example, if the removal of the spouse doesn’t change the tier of coverage, then no cafeteria plan change may be necessary. In other words, if the employee would still have family coverage, then the cafeteria plan election may stay the same. There may also be other arguments that the election can be changed outside the change in status rules. Note that the IRS does not address or approve any other approaches in this information letter (or any official guidance), so extreme caution is advised in changing the cafeteria plan election outside of those rules.
NOTICE OF DISCLAIMER
The information herein is intended to be educational only and is based on information that is generally available. HUB International makes no representation or warranty as to its accuracy and is not obligated to update the information should it change in the future. The information is not intended to be legal or tax advice. Consult your attorney and/or professional advisor as to your organization’s specific circumstances and legal, tax or other requirements.