The Federal Tax Implications of the Supreme Court's Decision on Same-Sex Marriages
On June 26, 2013, the Supreme Court of the United States ruled in the well-publicized decision United States v. Windsor that Section 3 of the Defense of Marriage Act (“DOMA”) was unconstitutional. Section 3 of DOMA defined “marriage” as exclusively the union between a man and a woman and “spouse” as a person who is married to someone of the opposite sex. Prior to the Windsor decision, these definitions were to be used for all provisions of federal law, including the Employee Retirement Income Security Act (“ERISA”) and the Internal Revenue Code (the “Code”). In light of DOMA, many of the tax benefits available to spouses were not extended to same-sex spouses. Where employers attempted to provide comparable benefits (e.g., health plan benefits) to same-sex spouses, employers were required to impute the value of that coverage to the employee as income. This resulted in additional taxable income to the employee and additional employment taxes for the employer.
In the wake of the Windsor decision, companies were left with very little guidance as to how to interpret and apply the ruling, including whether and to what extent they would be required to adjust their practices retroactively. In light of that uncertainty, most employers adopted a ‘wait and see’ approach to permit the government time to issue additional guidance.
The long-anticipated guidance was issued on August 29, 2013, when the Treasury Department and the Internal Revenue Service (the “Departments”) issued Revenue Ruling 2013-17. In the Ruling, the Departments stated that same-sex couples who are legally married in a jurisdiction that recognizes same-sex marriages will be treated as married couples for federal tax purposes, regardless of where they currently live. This is often referred to as the “state of celebration” rule because the laws of the state that issued the marriage certificate will dictate whether parties are considered married for federal tax purposes, regardless of whether the individuals actually live in the state of marriage. The Department’s Ruling became effective on September 16, 2013 (and for certain purposes, retroactively).
The Revenue Ruling applies for all purposes under federal tax law where marriage is a factor. This includes the following:
- income tax filing status;
- gift and estate taxes;
- claiming personal and dependency exemptions;
taking the standard deduction;
- retirement plans;
- contributing to an IRA; and
- claiming the earned income tax credit or child tax credit.
This Ruling does not apply to registered domestic partnerships; the Ruling is limited to same-sex individuals who are lawfully married under state law.
NOTE: The IRS did not specifically address the impact of this Ruling on state tax laws. However, the Ruling does not necessarily change state tax law. We expect that over the next few months, states will issue guidance specific to the impact of the IRS ruling on state tax laws.
The Ruling provides that legally married, same-sex couples must file their 2013 federal tax return using either the married filing jointly or married filing separately status. These individuals may, but are not required to, file amended returns choosing to be treated as married for prior federal tax years. Similarly, the IRS explained in a series of FAQs that where an employer provided health coverage to an employee’s same-sex spouse and included the value of that coverage in the employee’s gross income, the employee can file an amended Form 1040 reflecting the employee’s status as a married individual to recover federal income tax paid on the value of that coverage. In either circumstance, claims for refunds can be filed for three years from the date the return was filed or two years from the date the tax was paid, whichever is later. Ultimately, this means that same-sex couples may elect to claim refunds for tax years 2010, 2011 and 2012.
The IRS FAQs also indicate that retirement plans are required to comply with various aspects of the ruling. Specifically, a retirement plan must treat a same-sex spouse as a spouse for purposes of satisfying the federal tax laws that govern qualified retirement plans. Qualified retirement plans were required to comply with this guidance by September 16, 2013. New guidance by the IRS is expected to address plan amendment requirements including the timing of any required amendments and any necessary corrections relating to plan operations for periods prior to the issuance of this guidance.
Employment Tax Adjustments
A number of income tax and employment tax provisions provide for exclusions from gross income and wages, respectively, for certain benefits provided to the spouse of an employee. In addition, services performed by an individual in the employ of the individual’s spouse that are not in the course of the employer’s trade or business are excepted from FICA tax. As a result, employers withheld and paid employment taxes with respect to certain benefits provided to the same-sex spouse of an employee because the marriage was not recognized for purposes of the Code, and the benefits were not excludable from gross income or wages.
In follow-up to Revenue Ruling 2013-17, on September 23, 2013, the IRS provided special administrative procedures for employers to correct overpayments of employment taxes for tax year 2013 and prior years. Under this latest guidance, Notice 2013-61, the IRS offers two alternative special administrative procedures to remedy employment tax overpayments. First, employers may use the 2013 fourth quarter Form 941, “Employer’s Quarterly Federal Tax Return,” to correct overpayments of employment taxes with respect to the first three quarters of 2013. Second, employers can use Form 941-X, “Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund” for the fourth quarter of 2013 to correct previous overpayment of FICA for all 2013 quarters.
For FICA tax overpayments in years before 2013, employers can make a claim or adjustment for all quarters of a calendar year on one Form 941-X filed for the fourth quarter of each year if the period of limitations for refund and credit claims is still open.
These special administrative procedures are optional. Employers that prefer to use the regular procedures for correcting employment tax overpayments related to same-sex spouse benefits, instead of the special administrative procedures, may do so.
Department of Labor Guidance
In addition to the guidance issued by the IRS, on September 18, 2013, the Department of Labor (DOL) issued Technical Release 2013-04 to address the implications of Windsor on employee benefit plans. The DOL’s guidance mirrors that issued by the IRS. Specifically, the DOL stated that with respect to ERISA, the term “spouse” will be read to refer to any individuals who are lawfully married under any state law, including individuals married to a person of the same sex who were legally married in a state that recognizes such marriages, but who are domiciled in a state that does not recognize such marriages. Similarly, the term “marriage” will be read to include a same-sex marriage that is legally recognized as a marriage under any state law.
Nebraska State Tax Law
For purposes of Nebraska state tax law, the Nebraska Department of Revenue has clearly stated that because Nebraska does not recognize same-sex marriages, same-sex spouses must file their Nebraska individual tax returns separately. The Department of Revenue’s approach cites to the Nebraska state constitution which provides that marriage is between a man and a woman; therefore, same-sex spouses, legally married in another jurisdiction cannot file Nebraska individual income tax returns using married, filing jointly or married, filing separately status. This will result in different tax treatment on the state and federal tax level for same-sex spouses filing tax returns in Nebraska. The Nebraska Department of Revenue is expected to issue additional guidance on how to file Nebraska individual income tax returns for individuals in same-sex marriages.
What does this all mean?
The bottom line is that Nebraska and Iowa employers will need to treat same-sex spouses the same as opposite-sex spouses for federal tax purposes, so long as the parties can demonstrate that they were legally married under the state law of any state. This outcome does not depend on where the couple is currently living. For instance, a couple legally married in Iowa that now lives and works in Nebraska must be treated as legally married for federal tax purposes by their Nebraska employers. In contrast, for state tax purposes, Nebraska employers should not treat same-sex spouses as legally married for purposes of state taxation. Therefore, Nebraska employers only need to adjust the treatment of same-sex spouses for federal tax purposes.
In light of the latest guidance on DOMA, we recommend the following action items for employers:
- Communicate with Employees. There is little doubt that your affected employees have heard about this new guidance. Take a proactive approach to allaying concerns by distributing information outlining your plan with respect to same-sex spouses and asking affected employees to meet with Human Resources to discuss the impact on their benefits.
- Review Benefit Plan Documents and SPDs. Review plan documents and gather information to determine the impact of this guidance. Specifically, employers should determine whether employees who were previously considered “single” should now be treated as “married” for benefit plan purposes. Employers also should review plan documents to determine how plans define key terms such as “spouse” and “marriage.” Revise summary plan descriptions as needed to reflect plan document changes.
- Imputed Income. Stop imputing income for federal purposes on benefits provided to legally married same-sex spouses and determine the appropriate tax treatment for state-law purposes.
- Domestic Partners. If your plans cover domestic partners and civil unions, evaluate whether this coverage remains appropriate.
- Tax Gross-Ups. Stop providing unnecessary tax gross-ups for health coverage provided to same-sex spouses. Decide how to address historical gross-ups and imputed income for prior tax years.
- Refunds. Decide whether to file a refund claim or adjustment for employment taxes.
- Retirement Plans. Same-sex spouses must be treated as lawful spouses for purposes of maximum benefit limitations, spousal consent rules, rollovers, death benefits, minimum required distributions, availability of in-service hardship withdrawals, and assignment of benefits under qualified domestic relations orders.
- Cafeteria Plans. If an employee made a pre-tax salary-reduction election for health coverage under an Internal Revenue Code section 125 cafeteria plan sponsored by an employer, and also elected to provide health coverage for a same-sex spouse on an after-tax basis, the employer may now treat the after-tax election as a pre-tax election and begin taking pre-tax salary reductions.
- Survivor Annuities. Provide a qualified joint and survivor annuity and/or a qualified optional survivor annuity to all participants in same-sex marriages, if the plan is subject to the QJSA rules.
- Spousal Waiver. Require the consent of a participant’s same-sex spouse to the participant’s election of an optional form of benefit.
- Beneficiaries. Require the consent of a participant’s same-sex spouse to the participant’s designation of a non-spouse beneficiary.
- QDROs. Follow a qualified domestic relations order awarding benefits to a participant’s same-sex former spouse.
In light of the recent flurry of guidance relating to same-sex spouses, we recommend that our clients evaluate their payroll practices and administrative procedures to ensure that proper adjustments are made to comply with the expanded definition of spouse and marriage.