IRS Issues Guidance on Tax Treatment of Employee Benefits for Same-Sex Spouses
OverviewSince its enactment in 1996, the Defense of Marriage Act ("DOMA"), which forms part of the United States Code, has prohibited the federal government from recognizing same-sex marriages for purposes of federal law, including federal tax laws pertaining to employer-provided benefits. Consequently, the value of health insurance and other benefits provided by an employer on behalf of a same-sex spouse has been required to be included in the employee's wages as imputed income. Similarly, any premiums paid by an employee under an employer-sponsored plan for the coverage of the same-sex spouse was required to be paid on an after-tax basis. Other examples of disparate treatment in regard to employee benefits include the inability of employees to seek reimbursement under a health care FSA for expenses incurred by the same-sex spouse, and a same-sex spouse not being eligible for survivor benefits under a retirement plan.
On June 26, 2013, the United States Supreme Court issued its historic United States v. Windsor decision, which held that the provision of DOMA which excluded a same-sex partner from the definition of "spouse" as applied under federal law was unconstitutional.
On August 29, 2013, the IRS released eagerly awaited guidance on the effect of the Windsor decision on various tax issues, including the coverage of same-sex spouses under employer-sponsored benefit plans. This guidance is discussed below.
Currently, the following 13 states recognize and approve same-sex marriages: California, Connecticut, Delaware, Iowa, Maine, Maryland, Massachusetts, Minnesota, New Hampshire, New York, Rhode Island, Vermont, and Washington.
Washington D.C. does so as well.
New Mexico is a rogue state. Certain of its counties have begun to issue same-sex marriage licenses, even though not formally allowed under the state. The Attorney General for New Mexico has advised that the state will not challenge the validity of the licenses issued in those counties.
1. Key Employee Benefit Implications of IRS Ruling
The more significant employee benefit plan aspects of the IRS ruling are below.
- The value of employer-provided health coverage for employee's same-sex spouse no longer is to be included in the employee's gross income for federal tax purposes.
- Contributions made by an employee for the coverage of a same-sex spouse are no longer required to be paid on an after-tax basis.
- A retirement plan must recognize a same-sex spouse for purposes of qualified joint and survivor annuity and spouse death benefits.
2. State of Celebration Standard
A key question was raised in the aftermath of the Windsor decision was whether the IRS would recognize same-sex marriages performed in a state or jurisdiction that allowed such marriages (the "state of celebration") if the same-sex couple moved and now reside in a state that does not recognize same-sex marriages. For example, if a couple were married in Washington (which recognizes same-sex marriages), but later moved to Oregon (which does not allow for same-sex marriages), will the couple be considered to be married for federal tax purposes?
The question has been answered by the IRS. Its ruling holds that same-sex couples who were legally married in jurisdictions that recognize their marriages will be treated as married for federal tax purposes. This marriage status applies even if the couple lives in a state that does not recognize same-sex marriage. It also applies if the same-sex marriage occurred in a foreign country that recognizes such marriages, such as Canada.
3. Effective Date of Implementation of New Tax Standards
The Windsor ruling does not enact new law; it revokes old law. As such, the implications of the decision are not prospective, but instead generally reach back retroactively for all periods involved. In regard to tax aspects of employee benefits plans, the IRS guidance provides for the following implementation rules.
- An employer is not required to make any adjustments to employee's wages for the imputed value of health and welfare benefits provided in prior years (i.e., before 2013).
- An employer may make adjustments for imputed income for the current year (2013). It is not required to do so.
- An employee is entitled to file a claim for refund with the IRS for the taxes paid on the imputed income for all open tax years (generally 2010, 2011 and 2012).
- An employer may file a claim for refund for the FICA taxes that it paid on the imputed income for all open tax years.
4. Required Compliance Date for Retirement Plans
The IRS ruling assumes that employers will begin complying with the new standards in regard to health and welfare benefits as soon as is administrative practicable.
Retirement plans are subject to a hard-and-fast compliance date. Specifically, the IRS requires that these plans comply with the new rules no later than September 16, 2013. Thus, for example, any annuity under a pension plan to be paid to a participant having a same-sex spouse that commences on or after September 16, 2013 must comply with the qualified joint and survivor annuity rules. Similarly, the payment of the benefits of a deceased participant with a surviving same-sex spouse that will be paid on or after the effective date must comply with the surviving spouse rules.
The IRS guidance does not address compliance with the new standard for periods prior to September 16, 2013. For example, it is unclear whether a pension plan that is currently paying a single life annuity to a participant with the same-sex spouse must now allow the participant to elect a qualified joint and survivor annuity. The IRS has indicated that it will provide future guidance with respect to plan operations for prior periods, and to address other issues.
5. Implications to Health Care FSAs
The IRS guidance does not provide any specific rules in regard to health care FSAs. However, the underlying rationale and spirit of the IRS rulings point to recognizing a same-sex marriage for purposes of health care expense reimbursements occurring in the current plan year. As such, employee should be able to request reimbursements for unreimbursed medical expenses incurred by a same-sex spouse during the current plan year. Presumably, an employer will not be required to provide reimbursements of expenses that occurred in prior years.
6. Change in Status Events
The IRS guidance also does not indicate whether the Windsor decision is a Code Section 125 qualified status event that allows an employee to make a mid year election change under a group health plan or health care FSA. Logically, however, it should be recognized as a qualified status event.
This position has in fact been taken by the federal government, which issued a memorandum allowing civilian employees with legally married same-sex spouses to make immediate changes to their elections under the Federal Employee Health Benefit plan. Employees were provided 60 days in which to make the special election.
The guidance issued by the IRS pertains only to federal tax law. It does not address ERISA rights. This raises the issue as to whether a same-sex spouse can bring a claim for benefits for prior periods. For example, if a health insurance policy in effect in 2012 expressly provides for the coverage of a "legal spouse," must the policy pay the expenses incurred by a same-sex spouse during that year?
Presumably, the Department of Labor will provide its view on this ERISA issue.
The guidance from the IRS obligates employers to begin treating same-sex spouses as legal spouses for employee benefit purposes. The most urgent steps to be taken or considered are below.
- Advise employees of the new tax rules pertaining to same-sex spouses, including the right to file claims for refunds for prior years.
- Seek out and retrieve relevant information regarding same-sex spouses.
- Implement procedures to ensure compliance under retirement plans by September 16, 2013. This should include a review of the language of beneficiary designation form templates to ensure that they are not inconsistent with the new standards.
- Proceed to allow employees to pay for cost of benefits for same-sex spouses on a pre-tax basis, under the same policies that apply to similarly-situated opposite-sex spouses.
- Allow employees to be reimbursed under a health care FSA for qualified medical expenses incurred during the current plan year by a same-sex spouse.
- Invite employees to now enroll same-sex spouses in a health or other benefit plan on a special enrollment basis.
- Consider adjusting the over-withheld taxes for same-sex coverage for the current tax year.
- Consider filing a claim for FICA taxes for same-sex coverage for prior, open tax years.
For further information or questions regarding the actions required of the implications of the IRS guidance, please contact the Schwabe attorney with whom you work or Wally Miller at 541-686-3299 or firstname.lastname@example.org.
IRS rules of practice require us to inform you that any federal tax advice contained in this correspondence is not intended or written to be used, and cannot be used, by the recipient or any taxpayer for the purpose of avoiding tax penalties under the Internal Revenue Code.