Publications
August 2013 - Quarles & Brady LLP

Treasury and IRS Issue Ruling Clarifying Tax Treatment of Employee Benefits for Same-Sex Couples

Employee Benefits Law Alert


John Barlament, Amy Ciepluch, Alyssa Dowse, Marla Anderson

On August 29, 2013, the United States Department of the Treasury (the "Treasury") and the Internal Revenue Service (the "IRS") ruled that it will determine the marital status of a same-sex couple using the so-called "state of celebration" rule. This means that if a same-sex couple is legally married in a jurisdiction that recognizes the marriage, that couple will be treated as married for federal tax purposes, regardless of whether the state in which the couple resides recognizes the marriage. IRS Revenue Ruling 2013-17 (the "Ruling"), and two sets of Answers to Frequently Asked Questions released in conjunction with the Ruling, provide much-needed guidance for employers who have struggled with how to proceed after the recent United States Supreme Court decision striking down Section 3 of the Defense of Marriage Act ("DOMA").

The IRS will begin applying the Ruling on September 16, 2013. Employers should immediately review their retirement plans and gather information about whether employees who were previously considered "single" should now be treated as "married" for retirement plan purposes. Employers also should carefully review their health, welfare, and executive compensation plans to ensure they understand how those plans define key terms such as "spouse" and "marriage."  However, the new IRS guidance does not specifically address many health and welfare plan concerns, such as how this new IRS position applies for COBRA and HIPAA special enrollment purposes. Further IRS guidance is expected.

Background. On June 26, 2013, the Supreme Court issued a decision in United States v. Windsor ("Windsor"), holding that the federal government must recognize valid same-sex marriages in a similar manner as it recognizes opposite-sex marriages. Windsor left many employers questioning how, if at all, they needed to change their health, welfare and retirement plans to comply with the Court's ruling. Our employee benefits law alert regarding Windsor, found here, noted twenty possible effects of Windsor on health, welfare, retirement, and executive compensation plans.

IRS Ruling Provides Some Answers. The Ruling answers some "big picture" questions employers have asked after Windsor. However, employers will need to review their health, welfare, and retirement plans in light of applicable tax laws to determine how the Ruling affects their plans. This alert summarizes the issues addressed in the Ruling and in the accompanying Answers to Frequently Asked Questions.

"Spouse" Includes a Same-Sex Spouse for Purposes of Federal Tax Law. The Ruling clarifies that the terms "spouse," "husband," or "wife" as used in federal tax laws include a individual who is married to a person of the same sex if the individuals were legally married in the United States, the District of Columbia, a U.S. territory, or a foreign country. In addition, the IRS Ruling interprets the gender-specific terms "husband" and "wife" to include a same-sex spouse (regardless of gender).

 Q&B Key: The Ruling does not necessarily change state tax law. State law will continue to govern the state tax treatment of a same-sex couple living in a state that does not recognize same-sex marriage. See below ("State Tax Law Implications") for a further discussion of this issue.

IRS Adopts State of Celebration Rule. The Ruling concludes that, for purposes of federal tax law, the IRS will recognize the marriage of a same-sex couple if the marriage is recognized in the state of celebration, even after moving (or returning home) to a state that does not recognize such marriages (i.e., the "state of celebration" rule).

 Q&B Key: State marriage laws continue govern whether a marriage is legal in a couple's state of celebration. For example, some states require that a couple reside within the state for a period of time before the couple can legally marry within the state. Other states permit "fly-in" marriages without any residency requirement.

The state of celebration rule that the IRS adopted provides employers with a uniform rule of application for federal tax law purposes that applies to all employees in all states in which the employer operates. It also provides individuals with assurance that a move from one state to another won't affect their marital status for federal tax purposes.

 Q&B Key: The Ruling applies only for purposes of federal tax law. Other federal agencies may adopt different rules for federal benefit purposes. For example, the Department of Labor ("DOL") recently announced that an employer must extend Family Medical Leave Act rights to an employee with a same-sex spouses only if the employee resides in a state that recognizes same-sex marriage (i.e., the DOL has adopted a "state of residence" rule instead of the "state of celebration" rule adopted by the IRS). The Department of Health and Human Services also recently came out with its own definition of spouse for Medicare purposes and U.S. Immigration agencies did the same for immigration purposes.

Qualified Retirement Plans. Under the Ruling, an employer must treat an employee's same-sex spouse as a spouse for purposes of satisfying the federal tax laws that relate to qualified retirement plans. For example, a qualified retirement plan will be required to provide spousal consent rights to the spouse of an employee in a legal same-sex marriage even if the couple resides in a state that does not recognize same-sex marriage. See below ("Effective Date of IRS Ruling") for a discussion of the effective date of this change (September 16, 2013). This date provides little time for employers to prepare, as is discussed in the example below.
 
Short Time to Determine Who is "Spouse" or "Beneficiary." Bigco has a 401(k) plan. The 401(k) plan provides that the default beneficiary under the plan is a participant's "spouse", if any. If there is no spouse, the default beneficiary is a participant's next-of-kin (e.g., parents or children). Bigco operates in a state which does not recognize same-sex marriage. Bigco has gathered information from 401(k) plan participants about whether they are "married" but has always treated "marriage" to only include opposite-sex marriages, not same-sex marriages.

Andrew is a Bigco employee and participates in the 401(k) plan. Last year Andrew and his partner, Robert, were married in a state which recognizes same-sex marriages. Andrew has not informed Bigco of this fact because Andrew believes (correctly) that Bigco has not recognized same-sex marriages for 401(k) plan purposes. Andrew dies on September 17, 2013, without designating a beneficiary. Suppose Andrew's parents are alive and, but for Andrew's marriage to Robert, would receive the 401(k) plan benefit. To whom should Bigco pay the benefit?

Because the benefit is payable after the effective date of the IRS Ruling, it seems clear that Robert — and not Andrew's parents — should receive the benefit. However, note that Bigco's records indicate that Andrew was "unmarried" at the time of his death. Thus, Bigco may not even know that Andrew was, in fact, married to Robert. This exposes Bigco to risk that it will, in good faith, pay the 401(k) plan benefit to Andrew's parents, then face a later claim from Robert that he should have received the benefit. To minimize this risk, Bigco should have — starting on September 16, 2013, if not earlier — tried to gather information about whether "unmarried" 401(k) plan participants were, in fact, married.

 Federal Tax Law Implications. The Ruling is clear that, for federal tax purposes, the value of health plan coverage provided to a same-sex spouse is not taxable. This is even true retroactively, at least for certain "open" tax years, as illustrated in the example below.

Health Plan Taxation. Bigco sponsors a group health plan covering same-sex spouses. Andy, a participant in the plan, was married to Roger for all of 2012. Andy and Roger were covered under Bigco's health plan. The value of Roger's coverage was $250 per month in 2012 (i.e., $3,000 for the year).
Bigco reported on Andy's 2012 Form W-2 $3,000 in wages. The Ruling confirms that:
  • Andy can file an amended Form 1040 for the 2012 taxable year and seek to exclude the $3,000 in taxable wages previously reported;
  • Bigco can claim a refund for social security and Medicare taxes paid on the benefits;
  • Bigco cannot claim a refund for overwithheld federal income tax; and
  • Andy can claim a refund for overwithheld federal income tax — for example, if Andy paid for Roger's coverage on an after-tax basis, outside of a cafeteria plan.

State Tax Law Implications. While the federal tax treatment for health plans has been clarified, the state tax treatment remains unclear. The Ruling does not necessarily change state tax laws regarding the treatment of same-sex couples. This could result in difficulty for employers, especially those with operations in multiple states. Consider the following example.

 
Operations in Multiple States. Goodco has operations in States X and Y. Goodco offers health plan coverage to same-sex spouses. The value of this coverage is $500 per month. State X does not recognize same-sex marriages for any purpose, including for income tax purposes. It appears that the $500 value of health plan coverage offered to same-sex spouses is taxable for state income tax purposes for employees working and residing in State X. However, this same $500 is not taxable for federal tax purposes.

In addition, suppose that State Y does recognize same-sex marriages in general, including for income tax purposes. If so, it appears that the $500 value of health plan coverage offered to employees living and working in State Y would not be taxable -- at either the federal or state level. Goodco may consider this situation unfair and may want to "gross up" employees in State X who — unlike their co-workers in State Y — are taxed on the value of same-sex coverage. 

Unfortunately, resolving this situation likely requires a state-by-state analysis. For example, some states do not have state income tax (these include Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming). This tax issue should be less significant for employers and employees in those states. Other states do not incorporate the federal tax code, while some start with the federal tax code but then make changes. One non-profit organization recently noted that 24 states should provide further tax guidance to employers and employees after the IRS Ruling on same-sex spouses.[1]  

Non-Tax Health Plan Issues. The Ruling is limited to tax-related issues. So, the Ruling does not address how same-sex spouses could potentially be treated for other purposes, such as COBRA (e.g., whether a same-sex spouse is required to be offered COBRA) or HIPAA special enrollment (e.g., whether a newly-married same-sex couple is entitled to HIPAA special enrollment rights). We anticipate future guidance in this area and other areas (such as cafeteria plans and dependent care plans).

Implications of Ruling for Church Plans. The Ruling applies to all qualified retirement plans and does not specifically address or provide an exception for church plans. However, the tax qualification requirements applicable to church plans use the term "spouse" in only certain circumstances, such as the required minimum distribution rules. Religious employers should carefully review their church plans to verify how the plans define "spouse," and consider whether they need to make any changes to that definition based on the Ruling. Such employers may have creative options for restructuring their retirement plans in light of church governing policies and objectives, and will want to consider the tax qualification, discrimination, and plan administration complications of their current plan definitions and these options as soon as possible.

"Domestic Partners" are Not "Married." The Ruling clarifies that the term "marriage" for federal tax law purposes does not include a registered domestic partnership, civil union, or other similar relationship under state law.

Effective Date of IRS Ruling. The IRS will begin prospectively applying the Ruling on September 16, 2013. The IRS plans to issue additional guidance for employers regarding cafeteria plans, and how qualified retirement plans and other tax-favored arrangements should treat same-sex spouses for periods before the effective date of the Ruling.

However, employers and individuals can rely on the terms of the Ruling for periods earlier than September 16, 2013 for purposes of filing tax returns (original, amended, or adjusted) and filing claims for credit or refund of any prior tax overpayments resulting from the Ruling, provided the statute of limitations has not expired.

 Q&B Key: As noted above, employers need to take immediate action to determine how the Ruling affects their benefit plans. Some examples of actions steps employers may need to take include:
  • Stop imputing, for federal income tax purposes, income for the value of health plan coverage for employees' same-sex spouses;
  • Gather information about which employees who are currently considered "unmarried" are, in fact, married;
  • Possibly reverse of reporting of taxable amounts from earlier in the year;
  • Determine state tax treatment of same-sex spouse benefits;
  • Work with payroll vendors and plan vendors to make systems adjustment;
  • Amend health and retirement plan documents and update summary plan descriptions and other communication materials; and
  • Determine whether to extend same-sex spouse health benefits, if not already doing so.
Links to Guidance: IRS Revenue Ruling 2013-17 can be found here. The IRS document "Answers to Frequently Asked Questions for Individuals of the Same Sex Who Are Married Under State Law" can be found here. FAQs for couples in registered domestic partnerships, civil unions or other similar relationships can be found here. The August 29, 2013 press release from the Treasury and IRS can be found here.

[1] Tax Foundation, "IRS Issues 'State of Celebration' Guidance for Same-Sex Couples -- Further Guidance by 24 States May Be Required" (August 29, 2013) (available here).