Module 2

Question 1

To which federal taxes are benefits such as health insurance, sick pay, disability pay, workers’ compensation insurance and retirement savings plans subject?

Answer 1

FIT - Federal Income Taxes
FICA - Federal Insurance Contributions Act
FUTA - Federal Unemployment Tax Act

(Reading A, Taxation of Employee Benefits: Federal, Study Guide Module 2, pg. 29-30)

Question 2

Are employer contributions that are made on an employee’s behalf to a health insurance plan considered wages?

Answer 2

Generally no, not subject to FIT-, FICA- or FUTA as long as through a cafeteria plan.

If there is no cafeteria plan, or if the employee to have employer make premiums or pay higher wages, then it is fully taxable as wages or as employer-paid premiums.

(Reading A, Taxation of Employee Benefits: Federal, Study Guide Module 2, pg. 30)

Question 3

Are health and accident insurance plan payment benefits that are received by an employee taxable?

Answer 3

No, as long as it is for medical care of EE, SP and other dependents.

(Reading A, Taxation of Employee Benefits: Federal, Study Guide Module 2, pg. 30)

Question 4

What requirements must be met for employer contributions to be exempted from FICA and FUTA taxation?

Answer 4

Employer contributions toward health insurance must be made under a plan and apply to employees and their dependents to be free from FICA and FUTA taxation. A plan exists if any one of the following requirements is met:

(a) The plan is in writing and copies of the plan details are made available to employees either in print (e.g., in a booklet, pamphlet or other periodical) or by email.

(b) The plan is referred to in an employment contract.

(c) The employer can document that employees contribute to the plan.

(d) Employer contributions are kept in a separate account from the employer’s salary account.

(e) The employer is required to make the contributions.

(Reading A, Taxation of Employee Benefits: Federal, Study Guide Module 2, pg. 31)

Question 5

2.1 Explain the tax treatment of health benefits offered by employers to employees’ same-sex spouses and their eligible dependents.

Answer 5

Legally married same-sex couples must be treated as spouses, regardless of their state of residence or state of celebration (the state where the marriage was performed).

(Reading A, Taxation of Employee Benefits: Federal, Study Guide Module 2, pg. 31)

Question 6

2.2 Discuss the regulations issued in 2016 by the IRS that codified a nationally uniform rule regarding the tax treatment of benefits provided to individuals in a same-sex marriage.

Answer 6

The 2016 IRS final regulations define the terms spouse, husband and wife in a gender-neutral way, for all federal tax purposes, to mean an individual lawfully married to another individual; the phrase husband and wife means two individuals lawfully married to each other.

According to these regulations, if a couple is married in a state, territory or possession that recognizes same-sex marriage, the marriage is legal for all federal tax purposes regardless of where the couple lives.

Marriages performed in a foreign country are recognized as valid in the United States for all federal tax purposes if at least one state, territory or possession recognizes the marriage as valid. This requirement is easily met because of the 2015 Supreme Court decision mandating that all states have to recognize same-sex marriage.

(Reading A, Taxation of Employee Benefits: Federal, Study Guide Module 2, pg. 32)

Question 7

2.3 List the benefits (12) that an employer may provide to an employee’s same-sex spouse tax-free under federal law.

Answer 7

The following benefits may be provided by an employer to an employee’s same-sex spouse on a tax-free basis under federal law:

(a) Health benefits

(b) Qualified tuition reduction

(c) Meals and lodging provided as a condition of employment

(d) Dependent-care benefits

(e) No-additional-cost services

(f) Qualified employee discounts

(g) Working condition fringe benefits

(h) Qualified transportation fringe benefits

(i) De minimis fringe benefits

(j) Qualified moving expenses

(k) Qualified retirement planning services

(l) Access to on-premises gyms and other athletic facilities.

(Reading A, Taxation of Employee Benefits: Federal, Study Guide Module 2, pg. 32-33)

Question 8

2.4 Under federal law, how is the value of all benefits provided to an employee’s same-sex civil union partner or domestic partner treated?

Answer 8

Not exempt from FIT unless the person is a “dependent” as defined in the IRC.

(FIT are withheld, and they are based on the fair market value (FMV) of the benefits. In taxation terms, FMV is referred to as imputed income.)

(Reading A, Taxation of Employee Benefits: Federal, Study Guide Module 2, pg. 33)

Question 9

The final regulations and the 2013 revenue ruling apply to all federal tax provisions under which marriage is a factor. These include the following 6 items:

Answer 9

(a) Filing status
(b) Caliming personal and dependency exemptions (currently suspended - see pg 32)
(c) Taking the standard deduction
(d) Taxation of employee benefits
(e) Contributing to an Individual Retirement Account
(f) Claiming the earned income tax credit or child tax credit.

Question 10

3.1 Explain the nondiscrimination requirements that the Patient Protection and Affordable Care Act (ACA) enacted for health insurance plans and its current enforcement status.

Answer 10

Prior to ACA, employers could structure health insurance plans offered through a third-party insurance company to favor highly compensated employees (HCEs) without jeopardizing the tax exclusion for employer contributions and reimbursements. ACA changed the rules to require such plans to meet the same nondiscrimination requirements that self-insured plans must meet in order to retain tax-favored status.

(Reading A, Taxation of Employee Benefits: Federal, Study Guide Module 2, pg. 33)

Question 11

3.2 What new requirements did ACA impose on the Form W-2, Wage and Tax Statement reporting? What is included and not included?

Answer 11

All employers that provide group health care coverage that is excludable from employees’ gross income must report the aggregate cost of the coverage to employees on their Forms W-2 in order to inform them of the cost of the coverage. This requirement is strictly for consumer informational purposes only. This includes the portion of the cost paid by the employer and the portion paid by the employee.

Among the coverage types and arrangements that need not be reported on the Form are:

(a) Long-term care coverage

(b) Health Insurance Portability and Accountability Act (HIPAA) “excepted benefits” and dental or vision plan coverage that is not part of a group health plan

(c) Coverage for a specified disease or illness and hospital indemnity or other fixed indemnity insurance, if the premiums are paid for by the employee on an after-tax basis.

(d) Medical savings account (MSA) and health savings account (HSA) contributions (reporting health reimbursement arrangement (HRA) employer contributions is optional)

(e) Cost of employee assistance program (EAP), wellness program and on-site medical clinic, unless the employer charges a Consolidated Omnibus Budget Reconciliation Act (COBRA) premium for continued coverage.

(f) Wellness programs, unless COBRA beneficiaries pay premiums

(g) On-site medical clinics, unless COBRA beneficiaries pay premiums

(h) Excess reimbursement to HCEs that is made under discriminatory insured plans and that is included in the employee’s gross income

(i) Payments or reimbursements of health insurance premiums made for 2% S corporation shareholder employees that are included in the employee’s gross income

(j) Salary reduction election amounts contributed to health flexible spending accounts (FSAs).

(Reading A, Taxation of Employee Benefits: Federal, Study Guide Module 2, pg. 34-35)

Question 12

3.3 Summarize the information that must be reported to employees and to IRS on the ACA-enacted Form 1095-C.

Answer 12

All large, insured employers (i.e., an employer with at least 50 full-time employees, including full-time-equivalent employees) must report whether they offer group health insurance to full-time employees and their non-spouse dependents, and whether that insurance provides minimum value and is affordable. Large self-insured employers must report whether they offer group health insurance to any employees (including part-time employees). This information is reported to employees and to IRS on Form 1095-C.

Small self-insured employers (i.e., an employer with fewer than 50 full-time employees) must complete and file Form 1095-B.

(Reading A, Taxation of Employee Benefits: Federal, Study Guide Module 2, pg. 35)

Question 13

Is an employer paid physical exam taxable to the employee?

Answer 13

No, the employer pays the cost and is not taxable to the employee under fair market value.

Question 14

What is the excise tax or civil penalty a discriminatory plan may face?

Answer 14

$100 per day for each employee it discriminates against and may be required to offer nondisciminatory benefits.

Question 15

4.1 Describe the characteristics of an HRA.

Answer 15

Employers may provide an HRA to reimburse current and former (e.g., retired) employees for medical expenses of the employees and their qualified dependents.

HRAs are fully funded by the employer and cannot be offered to employees through a cafeteria plan or salary reduction.

Employees are reimbursed on a pretax basis up to a set maximum amount for each period of coverage. Any amount not used by an employee by the end of the period is not lost and can be carried over to the next period at the employer’s discretion.

All of the following three conditions must be met for HRA coverage and reimbursements not to be included in an employee’s gross income:
(a) The HRA only reimburses medical care expenses, as defined by IRC;
(b) every request for reimbursement is substantiated;
(c) the HRA does not reimburse medical expenses for a prior tax year, expenses incurred before the HRA plan became effective or expenses incurred before the employee enrolled in the plan.

(Reading A, Taxation of Employee Benefits: Federal, Study Guide Module 2, pg. 39)

Question 16

4.2 What is the criteria that a small employer must meet to qualify for a standalone HRA not linked to a high-deductible health plan (HDHP)?

Answer 16

An eligible small employer (less than 50 full-time employees or equivalent) that does not offer group medical coverage may offer standalone qualified small employer health reimbursement arrangements (QSEHRAs) without running afoul of ACA market reform provisions.

An employer’s contribution into employees’ QSEHRAs, however, is limited to specified amounts for employees depending on their marital status. These amounts are adjusted for inflation. Amounts exceeding those limits, and amounts that an employee does not use to purchase an individual policy that offers minimum essential coverage, are taxable to the employee.

(Reading A, Taxation of Employee Benefits: Federal, Study Guide Module 2, pg. 40)

Question 17

4.3 MSAs were made obsolete (although existing ones were grandfathered) by the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (MMA) with the creation of HSAs. What are some of the unique features of HSAs?

Answer 17

HSAs are tax-exempt accounts used by employees to pay for medical expenses for themselves and eligible dependents.

Offered employees who are enrolled in an HDHP.

All of these statutory amounts are adjusted annually for inflation.

Extra catch-up contributions can be made to an HSA by individuals age 55 and older until they are eligible to enroll in Medicare. No contributions of any kind can be made once an individual enrolls in Medicare.

(Reading A, Taxation of Employee Benefits: Federal, Study Guide Module 2, pg. 42)

Question 18

4.4 How are contributions to HSAs taxed?

Answer 18

Employers and employees can contribute to HSAs up to the annual limits.

Employer contributions are excluded from the employee’s gross income and are not taxable wages for purposes of withholding FIT, FICA taxes and FUTA taxes.

Any employer contributions that exceed the annual limit or that are made for a noneligible individual are included in the employee’s gross income. In addition, the HSA beneficiaries will pay a 6% excise tax on the excess contributions.

HSAs and HDHPs can be offered as part of a cafeteria plan.

(Reading A, Taxation of Employee Benefits: Federal, Study Guide Module 2, pg. 42 )

Question 19

5.1 How is pay for sick days associated with brief minor illnesses treated for tax purposes?

Answer 19

Sick pay is usually provided by employers so that employees do not lose wages when they are absent from work because of brief minor illnesses, such as a cold or the flu. This type of sick pay is subject to FIT, FICA taxes and FUTA taxes when paid.

(Reading A, Taxation of Employee Benefits: Federal, Study Guide Module 2, pg. 43)

Question 20

5.2 How are sick pay benefits for lengthier absences treated for tax purposes?

Answer 20

Employers may provide sick pay under a plan for lengthier absences, either as short-term or long-term disability pay. These benefits are paid either by the employer or a third party such as an insurance company. Benefits that can be attributed to employee contributions made with after-tax dollars are not taxable income to the employee. Benefits that can be attributed to employee pretax contributions or employer contributions are included in the employee’s taxable income and may be taxable for FIT, FICA taxes and FUTA taxes. If both the employer and employee contribute, the benefits are taxable only to the extent of the employer’s contribution.

The manner in which any required taxes are withheld while benefits are being paid out is dependent on several factors: Is the employer self-funding the benefits? Are the benefits administered by a third-party agent? Is the third-party payer an insurer that is not the employer’s agent?

(Reading A, Taxation of Employee Benefits: Federal, Study Guide Module 2, pg. 5.2)

Question 21

5.3 Explain the taxation of permanent disability benefits.

Answer 21

Payments made to employees who are permanently disabled and not returning to work are subject to FIT withholding to the extent that the premiums were paid by the employer or the employee on a pretax basis. Payments made under a plan after the employment relationship ends because of disability, retirement or death are not subject to FICA taxes or to FUTA taxes unless the payments would have been made even if the employment had not ended for one of those reasons.

In addition, special rules apply to permanent disability payments made under a plan to an employee who is receiving Social Security disability insurance benefits.

(Reading A, Taxation of Employee Benefits: Federal, Study Guide Module 2, pg. 45)

Question 22

5.4 Outline the general rules to which workers’ compensation benefits are subject.

Answer 22

When employees suffer a work-related injury or illness, they may receive workers’ compensation benefits. As a general rule, workers’ compensation benefits are not subject to FIT or FICA taxes on amounts that do not exceed the amount of benefits provided under federal, state or local law. However, under an arrangement where the employer pays part or all of an employee’s salary while receiving benefits in return for all of the benefit payments received by the employee, FIT, FICA taxes and FUTA taxes must be withheld on any amounts the employer pays to the employee that exceed the amount of benefits received by the employee. The excess amounts are considered taxable wages.

(Reading A, Taxation of Employee Benefits: Federal, Study Guide Module 2, pg. 46)

Question 23

6.1 Describe a cafeteria plan.

Answer 23

A cafeteria plan is a type of benefit plan permitted by IRS §125 in which the employer offers employees a choice, much like a menu, of benefits that are in the form of either taxable cash compensation or tax-free (qualified) benefits. The plan must include at least one taxable and one qualified benefit. If a plan in which employees are offered this choice does not meet the requirements of §125, IRS-proposed regulations (on which an employer may rely until final regulations are published) provide that all the benefits, even those that would be considered nontaxable benefits, are nonqualified and are taxable income to the employees. The employee will be taxed as though they chose the taxable benefit with the greatest value, even if the employee chooses only nontaxable benefits. The amount is included in the employee’s gross income in the year the employee would have received the taxable benefit.

(Reading A, Taxation of Employee Benefits: Federal, Study Guide Module 2, pg. 46)

Question 24

6.2 What types of plans may be offered under a cafeteria plan?

Answer 24

The following are a few common types of qualified benefits that may be offered under a cafeteria plan:

(a) A §401(k) plan

(b) Health and accident insurance plan coverage

(c) HSA contributions

(d) Long-term and short-term disability coverage

(e) COBRA continuation coverage premiums.

(Reading A, Taxation of Employee Benefits: Federal, Study Guide Module 2, pg. 46)

Question 25

6.3 List benefits (9) that are nonqualified, are taxable income to employees and may not be offered as part of a cafeteria plan.

Answer 25

The following benefits are nonqualified, are taxable income to employees and may not be offered as part of a cafeteria plan:

(a) Scholarships and fellowships

(b) Nontaxable fringe benefits under §132

(c) Educational assistance benefits

(d) Meals and lodging provided for the employer’s benefit

(e) MSA contributions made by the employer

(f) Certain HSAs

(g) Certain long-term care insurance benefits

(h) Certain group-term life insurance benefits

(i) Tax-sheltered annuity plan elective deferrals under §403(b).

(Reading A, Taxation of Employee Benefits: Federal, Study Guide Module 2, pg. 46-47)

Question 26

6.4 A health FSA is an arrangement under which employees may reduce their current cash compensation (i.e., they may make pretax contributions) and instead have that amount contributed to a plan for use in reimbursing them or their dependents for medical expenses.
Describe the following features of a health FSA:
(a) integration into group health plans,
(b) unused amount and
(c) contribution limits.

Answer 26

(a) integration into group health plans,
Under ACA, group plans must meet certain market reforms, including providing preventive services at no cost to an employee and their dependents. The market reforms, however, do not apply to a group health plan that offers excepted benefits. Health FSAs are group plans that must meet the market reform provisions, but they will be considered to provide only excepted benefits if the employer also makes available group coverage that is not limited to excepted benefits, and if the health FSA is structured so that the maximum benefit payable to any participant does not exceed two times the participant’s salary reduction election for the health FSA for the year (or, if greater, cannot exceed $500 plus the amount of the participant’s salary reduction election).

If an employer provides a health FSA that does not qualify as excepted benefits, the health FSA generally is subject to the market reforms, including the preventive services requirements.

(b) unused amount
An employee who has unused funds in their FSA by the end of the year may be eligible to carry over a certain amount (up to an annual maximum that is adjusted annually for inflation) of the unused amount from one plan year to the next. If the plan does not allow rollover, amounts remaining in an FSA at the end of a plan year are forfeited by the employee at the end of the plan year (referred to as the use-it-or-lose-it rule) or 2.5 months after the end of the FSA plan year if the employer has adopted a grace period.

The carryover option provides an alternative to the grace period. A plan may not include both the carryover option and the grace period.

The carryover amount does not count against the max contribution for the next plan year.

(c) contribution limits
There is a maximum amount, annually adjusted for inflation, that employees may contribute to a health FSA. The statutory limit does not apply to employer flex credits. Pretax contributions that erroneously exceed the plan-year maximum must be treated as taxable wages.

(Reading A, Taxation of Employee Benefits: Federal, Study Guide Module 2, pg. 47-48)

Question 27

6.6 What special rules apply to 401(k) plans and group-term life insurance offered under a qualified cafeteria plan?

Answer 27

Special rules apply to 401(k) plans and group-term life insurance. Pretax §401(k) plan employer contributions under a qualified cafeteria plan are subject to FICA and FUTA taxes and must be reported on an employee’s Form W-2 along with amounts withheld. Elective deferrals (contributions made on a pretax basis) are also reported on the Form W-2.

In addition, cafeteria plans may offer employees more than $50,000 of group-term life insurance to an employee as a qualified benefit. (IRC §79 provides an exclusion for the first $50,000 of group-term life insurance coverage provided under a policy carried directly or indirectly by an employer. There are no tax consequences if the total amount of such policies does not exceed $50,000. The imputed cost of coverage in excess of $50,000 must be included in income, using the IRS Premium Table, and are subject to Social Security and Medicare taxes.)

Contributions to a qualified cafeteria plan made with post tax dollars are included in the employee’s income and are FIT-, FICA- and FUTA-taxable, but the benefits purchased are not taxable.

(Reading A, Taxation of Employee Benefits: Federal, Study Guide Module 2, pg. 49-50)

Question 28

6.7 Under a cafeteria plan, if an employee elects to receive cash rather than to purchase benefits, how is the cash treated for tax purposes?

Answer 28

If an employee elects to receive cash rather than to purchase benefits, the cash is wages and is FIT-, FICA- and FUTA-taxable. Also, if a cafeteria plan discriminates in favor of HCEs or key employees, those individuals are FIT-, FICA- and FUTA-taxable on the combined taxable benefits with the highest total value.

(Reading A, Taxation of Employee Benefits: Federal, Study Guide Module 2, pg. 50)

Question 29

6.5 Summarize the taxation requirements of a cafeteria plan.

Answer 29

Employer contributions to a qualified cafeteria plan that relate to tax-free benefits chosen by an employee are not included in the employee’s income and are not taxable for FIT, FICA taxes or FUTA taxes. If the employer contributions relate to taxable benefits, they are included in the employee’s income and are subject to FIT, FICA taxes and FUTA taxes. Employee salary reduction contributions made on a pretax basis, whether made to purchase taxable or qualified benefits, are not included in the employee’s income and are not FIT-, FICA- or FUTA-taxable.

(Reading A, Taxation of Employee Benefits: Federal, Study Guide Module 2, pg. 48)

Question 30

7.1 Upon what factors does the tax treatment of qualified pension and profit-sharing plans depend?

Answer 30

The tax treatment of contributions to qualified pension and profit-sharing plans depends on who makes the contributions. Employee after-tax contributions are included in employee income and are FIT-, FICA- and FUTA-taxable. This applies even if the employees are required to participate in the plan and get a refund of contributions if they leave employment before retirement or death. Voluntary employee contributions are always taxable income. Employee elective deferrals (e.g., contributions made on a pretax basis) are FICA- and FUTA-taxable. Employer contributions to qualified plans are not included in employees’ taxable wages and are not FIT-, FICA- or FUTA-taxable.

Employees are taxed on pension plan payments when they are received to the extent that they are based on employer contributions, pretax deferrals or investment gains. They are only subject to FIT, however, and not to FICA or FUTA taxes. Payment amounts based on employee after-tax contributions are not taxable.

If the plan is a qualified annuity plan, employer contributions are not considered wages and not subject to FIT, FICA taxes or FUTA taxes.

(Reading A, Taxation of Employee Benefits: Federal, Study Guide Module 2, pg. 50)

Question 31

7.2 Are contributions to §401(k) plans considered wages?

Answer 31

Employee elective (i.e., pretax) deferrals to §401(k) plans and employer matching contributions are not considered wages and are not subject to FIT withholding. Only distributions from the plan are taxable. However, employee elective deferrals are subject to FICA and FUTA taxes, even though employer matching contributions are not.

Employee contributions to a §401(k) plan are subject to an annual, inflation-adjusted limitation amount. Employees who will be age 50 or older by the end of the plan year are allowed to make catch-up contributions above the annual contribution limit up to an annual maximum amount. These amounts are adjusted annually for inflation.

In addition, the IRC §415 limits the total amount of all elective deferrals, employer matching contributions and employee after-tax contributions in a year to an annual amount, which is also adjusted annually for inflation.

An annual amount of compensation can also be taken into account when determining the maximum contributions to an employee’s defined contribution plan account for each plan year (indexed annually). Pretax elective deferrals to a §401(k) plan are included in an employee’s compensation when determining the maximum contribution limit for the employee.

(Reading A, Taxation of Employee Benefits: Federal, Study Guide Module 2, pg. 51)

Question 32

7.3 What is the taxability of an IRA?

Answer 32

Employers may offer employees the option to participate in an IRA in addition to a qualified retirement plan. Employer IRA contributions are included in the income of employees but they are not subject to FIT withholding up to the amount the employer reasonably believes employees will be able to deduct on their personal income tax returns. Income earned on contributions is not taxable until distributed to employees. Employer contributions are subject to FICA and FUTA taxes.

(Reading A, Taxation of Employee Benefits: Federal, Study Guide Module 2, pg. 51-52)

Question 33

7.3 What is the taxability of a Roth IRA?

Answer 33

Roth IRAs differ from standard IRAs in that contributions are not deductible from employee income, and distributions are excluded from gross income if certain qualifications are met. Employees can contribute the maximum deductible amount for a standard IRA to a Roth IRA, excluding amounts contributed by the employee to other IRAs in the same year. In addition, the amount that can be contributed to a Roth IRA is phased out once the employee’s adjusted gross income exceeds certain annual limits.

Employees also can transfer amounts from their §401(k), §403(b) or §457(b) retirement accounts to a designated Roth account, provided the retirement plan has a qualified Roth contribution program. The amounts transferred are taxable at the time transferred and are treated as a qualified rollover contribution to the Roth account.

(Reading A, Taxation of Employee Benefits: Federal, Study Guide Module 2, pg. 51-52)

Question 34

7.3 What is the taxability of a SEP plan?

Answer 34

An SEP plan is an option for employers that do not have the financial resources to administer more complicated deferred compensation plans such as §401(k) plans. Employer contributions to a SEP, up to the annual limit, are not FIT-, FICA- or FUTA-taxable, and any contributions over the limit are wages to employees. Employee elective deferral contributions are excluded from wages up to the deferral limit but are FICA- and FUTA-taxable.

(Reading A, Taxation of Employee Benefits: Federal, Study Guide Module 2, pg. 51-52)

Question 35

7.3 What is the taxability of an ESOP?

Answer 35

ESOPs are defined contribution plans that give employees the chance to own shares of the employer’s stock. Employer contributions to a qualified ESOP are not taxable wages and not FIT-, FICA- or FUTA-taxable, provided they do not exceed 100% of the employee’s annual compensation or the annual inflation-adjusted limit, whichever is less.

(Reading A, Taxation of Employee Benefits: Federal, Study Guide Module 2, pg. 51-52)