IRS/Treasury Release August 2013
Recognition of Same-sex Marriage for Federal Tax Purposes
The U.S. Supreme Court decision in the Windsor case held that the Defense of Marriage Act (DOMA) was unconstitutional as it violated the principles of equal protection of the laws by not allowing recognition of a same-sex marriage created validly under a state law.
- Unanswered Questions The Windsor decision, however, because of its reference to state laws for determining whether a same-sex marriage was valid, left unanswered whether a same-sex couple who married in a state that provided for same-sex marriage, but lived in a state that did not recognize same-sex marriage would be treated as married for all federal law purposes. This uncertainty left employers in the dark regarding proper tax treatment for employer-provided same-sex benefits.
- Would characterizing the benefits as taxable or non-taxable be dependent on where the couple lived?
- Could the employer simply treat the employee as married if the couple had gotten married in a state that allowed the creation of same-sex marriages?
The IRS faced the same issue regarding Federal tax administration: should the tax outcome be dependent on where the same-sex couple lived or would the couple be treated as married if they married in a state that allowed the creation of same-sex marriages?
Federal Tax Law Changes
Revenue Ruling 2013-17 resolves the unanswered questions above:
- For federal income tax purposes the same-sex couple will be treated as married if legitimately married in any domestic or foreign jurisdiction whose laws authorize the marriage of a same-sex couple.
- The tax treatment will not be dependent on the state of residence. For Federal tax purposes, the term "marriage" does not include registered domestic partnerships, civil unions, or other similar formal relationships recognized under state law that are not denominated as a marriage under that state's law.
By creating one uniform rule, the ruling provides certainty and clear, coherent tax filing guidance for all legally married same-sex couples nationwide. As stated in the new revenue ruling: "Although states have different rules of marriage recognition, uniform nationwide rules are essential for efficient and fair tax administration. A rule under which a couple's marital status could change simply by moving from one state to another state would be prohibitively difficult and costly for the Service to administer, and for many taxpayers to apply."
Retroactive Tax Benefits
This ruling has retroactive tax benefits for open tax years:
1. Any medical benefits provided to a same-sex couple by an employer and reported as taxable for tax years before Windsor and this ruling (i.e. reported as taxable on the employee's W-2 and, consequently, on the employee's tax form 1040) can now be treated retroactively as not taxable.
2. If the employer sponsors a pre-tax election 125 plan, employees who purchased same-sex spouse health insurance coverage from their employers on an after-tax basis may treat the amounts paid for that coverage as pre-tax and excludable from income.
Both the employee and the employer will be able to file amended tax returns claiming a refund for the related taxes for any open tax year. Generally, there is a three year open period. Only the employee may file for an income tax refund. During 2013, the employer may make adjustment for the "over-withheld" 2013 income taxes by repaying or reimbursing to the employee that over-withheld amount.
In contrast to the income taxes, the FICA taxes affect both the employer and the employee. This FICA refund possibility can be a little quirky; however, the employer can get back both the employee's as well as the employer's FICA taxes for past years, but that requires adherence to some special refund/credit rules for the employer's refund filing; the employer must pay to the employee the withheld taxes and obtain a certification from the employee that the employee won't also file for a refund of the same taxes. See instructions to IRS Form 941-X. In the FAQs released by the IRS with Revenue Ruling 2013-17, the IRS indicated it would soon release a special administrative procedure for employers to file these refund claims.
Qualified Retirement Plan Treatment
Revenue Ruling 2013-17 also addresses the federal tax law treatment of same-sex partners for qualified retirement plan purposes. On and after September 16, 2013, a qualified retirement plan must recognize a same-sex marriage that was validly entered into in a jurisdiction whose laws authorize the marriage and consequently treat a same-sex spouse as a spouse. This rule applies even if the married couple lives in a domestic or foreign jurisdiction that does not recognize the validity of same-sex marriages (e.g. Ohio). This means that the same-sex spouse must receive the qualified plan's death benefit unless a validly appointed non-spouse beneficiary has been appointed, which can only occur if the appointment by the participant of a non-spouse beneficiary has been approved by the same-sex spouse.
Unresolved Employee Benefit Administration and Income Tax Issues
Revenue Ruling 2013-17 is good news for employers, but this ruling does not resolve all issues regarding the impact of Windsor on employee benefit administration and income taxes.
- The IRS specifically stated that with respect to qualified plans, it has not yet provided rules regarding the application of Windsor and this revenue ruling for periods before September 16, 2013. Does an employer have retroactive exposure for paying the death benefit of a qualified plan to someone other than the participant's same-sex "spouse" during the pre-Windsor period?
- Retroactive application of the Windsor decision is not limited to federal tax law matters. Still unresolved is the exposure that an employer could have, for example, due to denying spousal medical benefits to the same-sex partner/spouse of an employee who clearly has eligibility for the medical benefits plan.
- The ruling and the related FAQs do not directly address whether the requirement that a qualified plan treat a same-sex spouse as a spouse applies to a state government unit, including a state university, in a state, such as Ohio, which does not recognize same-sex marriage. State government, including its cities and counties and/or educational institutions, is not subject to ERISA and further is exempt from various IRC qualified plan provisions, including joint and survivor annuity rules and appointment of nonspousal beneficiaries. Hence, may the state continue to define who it will recognize as married for its benefit programs, including qualified retirement plans?
- Most states that have an income tax connect its taxable income definition to the federal income tax definition, but that definition of "income" is distinguishable from a state's income tax definition of who is considered married and hence eligible to file a joint income tax return under state law. In Ohio, there appears to be no official announcement as of this briefing whether the federal definition of "spouse" will be followed, but given the Ohio Constitution provision not recognizing same-sex marriages, it would seem likely that Ohio will not recognize same-sex partners as eligible to file a joint Ohio return.
- In contrast to the tax law guidance which creates a uniform rule, the DOL's position is that lawfully married same-sex couples who live in a state that recognizes same-sex marriage may be eligible for FMLA leave to care for a seriously ill spouse or for activities related to a spouse's military deployment. However, employers would not be required to make FMLA leave available to a same-sex spouse who resides in a state that doesn't recognize same-sex marriage. Hence, the DOL position is the determination of spouse status for the mandatory application of FMLA will be dependent on the state law of residency. There is nothing that precludes the employer from electing to treat the employee who has a same-sex spouse as eligible for "FMLA-like" time off despite the law of the state of residence of that employee. But if the employer does elect to treat that employee with a same-sex "spouse" as eligible for FMLA-like benefits, the employer for administration of FMLA will still have to make a determination of marital status dependent on the law of the state of residence, because if the employee asserts a right to a valid FMLA leave the time off for the "FMLA-like" time off cannot count against the FMLA time off.
In the near term, there still will be differences in benefits provided by employers to employees with opposite sex spouses in contrast to those with same-sex spouses due to the differences in state law, and the consequence is likely to be more and continuing litigation based on the U.S. and state constitutions and various existing employment laws prohibiting discrimination. Ultimate resolution of this issue will require a combination of federal and state legislation which is unlikely to occur any time soon. Until that clear resolution happens, employers will be stuck in the middle trying to resolve the employer's benefit/compensation philosophy and to manage its risk exposure to employee lawsuits based on disparate treatment.
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