February 20, 2006
2005 Year End IRS Guidance Summary
The IRS and the legislature finished 2005 with a flourish of activity regarding group health plans and retirement plans.
Publications 502 and 503. In late December, the IRS released the 2005 versions of Publications 502 (medical and dental expenses) and 503 (child and dependent care expenses) for use with 2005 tax returns.
For a copy: http://www.irs.gov/pub/irs-pdf/p502.pdf and http://www.irs.ustreas.gov/pub/irs-pdf/p503.pdf.
Highlights of the changes from last year's version of Pub. 502 include the following:
- Dependent. The discussion of the persons whose medical expenses can be deducted has been updated to reflect the modified definition of dependent that applies for this purpose after the Working Families Tax Relief Act of 2004 (WFTRA).
Note: This change in definition also impacts whose medical expenses may be reimbursed on a tax-free basis under medical expense reimbursement plans (health FSAs), health reimbursement arrangements (HRAs), and health savings accounts (HSAs). |
- Transportation. The standard mileage rate for use of an automobile to obtain medical care is 15 cents per mile for January-August 2005 and 22 cents per mile for September-December 2005. (Note: This mileage rate will change to 18 cents per mile for 2006.)
Highlights of the changes from last year’s version of Pub. 503 include the following:
- Qualifying Person. The discussion of who is a qualifying person (i.e., a person whose child or dependent care expenses will qualify for the dependent care tax credit or for reimbursement under a dependent care expense reimbursement plan) has been updated to reflect certain changes that were made by WFTRA and by WFTRA technical corrections legislation. (See comments below regarding the Gulf Opportunity Zone Act of 2005.)
- Requirement to Maintain a Household. The 2005 version of Pub. 503 notes that the requirement that a taxpayer maintain a household no longer applies.
- Student-Spouse Rules. For purposes of determining whether a spouse is a full-time student (and is therefore deemed to be gainfully employed), internet schools have been added to the list of institutions that do not qualify as schools.
- Care of a Qualifying Person. The discussion of which expenses are considered to be for the care of a qualifying person now indicates that expenses for "nursery school, pre-school, or similar programs for children below the level of kindergarten" are for care, while expenses for "kindergarten or a higher grade" are not. Pub. 503 also indicates that the cost of sending a child to day camp "may be a work-related expense, even if the camp specializes in a particular activity, such as computers or soccer."
- Payments to Relatives or Dependents. The revised Pub. 503 states that payments to a spouse or to the parent of the taxpayer's qualifying child for the care of the taxpayer’s qualifying child who is under age 13 will not qualify for tax-favored treatment.
Note: These impact dependent care reimbursement plans. |
Gulf Opportunity Zone Act of 2005. This legislation, signed into law on December 21, 2005, addresses a variety of tax benefits available to the victims of Hurricanes Rita and Wilma. In addition, it also includes various technical corrections to the Working Families Tax Relief Act (WFTRA). WFTRA amended the definition of dependent under Sections 152 and 105 of the Code. The technical corrections affect dependent care expense reimbursement plans (DCAPs) and HSAs.
- Dependent care expense reimbursement plans (DCAPs). Code Section 21(b)(1), which contains the definition of a qualifying individual for DCAP purposes, has been amended to include the modified Code Section 152 definition of dependent that WFTRA created for health plan purposes. The effect of the modification is to broaden the group of individuals whose expenses can qualify for a DCAP reimbursement to include dependents of a Code Section 152 dependent, married dependents filing a joint return, and individuals with gross income that equals or exceeds the applicable limit. In light of this amendment to Code Section 21, cafeteria plan documents will likely need to be amended if an employer wants to expand the definition of qualified individual as now allowed by the statute.
- Health savings accounts (HSAs). Code Section 223(d)(2), which addresses whose qualified medical expenses can be paid from an HSA on a tax-free basis, was also amended to include the modified definition of dependent. This change should not require any plan document changes; but employees with HSAs should be made aware of the change.
Note: The WFTRA technical corrections are effective retroactively to taxable years beginning after December 31, 2004. |
USERRA Regulations. On December 19, 2005, the Department of Labor issued final regulations regarding the Uniformed Services Employment and Reemployment Rights Act (USERRA). Please see our separate client communication regarding these final regulations. If you did not receive a copy of this communication, a copy is available on our website.
The final regulations provide employers the ability to establish reasonable requirements regarding the election of USERRA continuation coverage and the payment of premiums for such coverage. Without such procedures, the plan will likely be unable to deny USERRA continuation coverage to an employee who fails to make an election at the time of leave and will have difficulty terminating coverage for the failure to pay premiums. Accordingly, it is important for plan sponsors to adopt such requirements. The requirements should be incorporated by reference into plan documents and described in some detail in summary plan descriptions or summary descriptions. Plan documentation should be reviewed by counsel and appropriate amendments or restatements prepared. If you need assistance updating your plan documents in light of the final USERRA regulations, please contact us.
Note: There is no small plan exception. |
Publication 15-B. The IRS has released the 2006 version of Publication 15-B, which contains information on the employment tax treatment of various fringe benefits such as accident and health, adoption assistance, and educational assistance benefits. The 2006 version is substantially similar to the 2005 version. The revised publication references the increase in the qualified parking exclusion (to $205 per month) and reflects increases in indexed amounts that are used in the definitions of key employees and certain highly compensated employees. For a copy: http://www.irs.gov/pub/irs-pdf/p15b.pdf.
Form 8889. The IRS has released the 2005 version of Form 8889 (Health Savings Accounts (HSAs)), which HSA account holders (and beneficiaries of deceased account holders) are required to attach to their Form 1040s to report information about HSA contributions and distributions. Spouses who file jointly but who have separate HSAs are required to complete a separate Form 8889 for each spouse. The 2005 Instructions for Form 8889 have also been released.
The Form 8889 and Instructions for 2005 are substantially similar to the 2004 version. Minor changes include updates for the 2005 limits and for new line numbers from the 2005 version of Form 1040. The Instructions have been modified to reflect the broader definition of dependents whose qualified medical expenses can be paid on a tax-free basis by the HSA account holder. The Instructions also contain a worksheet that may be helpful for individuals trying to calculate their HSA contribution limit. This worksheet will be especially helpful for married individuals who are HSA eligible. Such couples must apply a special rule to determine the couple's combined contribution limit.
For a copy of Form 8889: http://www.irs.gov/pub/irs-pdf/f8889.pdf. For a copy of Instructions: http://www.irs.gov/pub/irs-pdf/i8889.pdf.
Withholding and Reporting Requirements for Nonqualified Deferred Compensation. On December 8, 2005, the IRS issued Notice 2005-94. As reflected in the Notice, the IRS has suspended the reporting and income tax withholding requirements for 2005 with respect to deferred compensation amounts that are subject to Code Section 409A. Absent this guidance, employers would have to report such deferrals on Form W-2.
If you have any questions regarding any of the forgoing items, please feel free to contact us.