Pre-Tax Benefit Adjustment from Previous Calendar Year

[Silver70]

I haven't had to deal with this in a while.

 

We just had qualifying event paperwork, for an employee that will be shifting from a PPO Health plan to a HDHP. The effective date is for 12/1/2025. Our insurance plan years are 1/1-12/31 which means after 1/1/26 we have new rates.

 

Wouldn't refunding the employee in the current tax year for pre-tax benefits from the previous tax year also have tax implications?

 

I thought if this happens we need to give them a refund that would include any medi, and local (Ohio) adjustments calculated, and adjust their W-2 information to reflect the change in benefits for the 2025 tax year.

 

I can't find any direct information on this, so i came here.

 

thank you,

 

John

[Brian Gilmore]

The issue here is whether the return of the excess pre-tax contributions is taxable in year one or year two.  There are arguments either way here. 

For example, in the health FSA context the IRS has specifically approved including year one improper payment amounts in year two taxable income under certain circumstances.  Many employers are comfortable with that approach in this type of context, too. 

The employer likely haven't finalized/issued the year one W-2 in this case, so it probably would not be that difficult to address this as year one taxation if they preferred.

IRS Chief Counsel Advice Memorandum 201413006:

https://www.irs.gov/pub/irs-wd/1413006.pdf

In cases in which all other correction procedures have been exhausted by the employer and the employer treats the improper payment as business indebtedness in accordance with Prop. Treasury Reg. §1.125-6(d)(7)(v), the improper payment should be reported by the employer to the employee as wages on a Form W-2 to the extent the employer forgives the indebtedness after requesting payment consistent with collection procedures for other business indebtedness. The amount included in income is subject to withholding for income tax, FICA and FUTA, since the benefits are made available to the employee by the employer for the performance of services. The improper payment is reportable in the taxable year of the employee in which the indebtedness is forgiven.

[Peter Gulia]

Brian Gilmore, so we might learn a little more from your generous teaching:

If an employer has some choices about corrections and tax-information reporting, is there a duty of consistency? Must an employer treat all similarly situated participants the same way?