In U.S. v. Windsor, the Supreme Court struck down Section 3 of the Defense of Marriage Act as a violation of the 5th Amendment’s guarantee of equal protection under the law. Section 3 defined “marriage” and “spouse” for purposes of Federal law as limited to a legal union between one man and one woman as husband and wife. Elimination of this standard impacts a multitude of Federal laws, and guidance from a number of Federal agencies will be needed before the ruling fully is integrated into the U.S. Code.
Some of the first of that guidance explains Federal tax treatment of same-sex spouses under certain employment benefits plans and arrangements. The guidance was released on August 29, 2013 by the Treasury Department and the Internal Revenue Service, in the form of Revenue Ruling 2013-17 and two sets of Frequently Asked Questions (FAQs.) I addressed this guidance briefly in my prior post. Below I go into more detail on the key compliance points of relevance to employers:
Treatment of Same-Sex Marriage under Federal Tax Law
- Same-sex marriages lawfully performed in any U.S. state, the District of Columbia, or a foreign county are valid as marriages under Federal tax law, regardless of where the couple reside.
- This means that employers with operations in states that do not recognize same-sex marriage, such as Texas, must treat same-sex spouses residing in those states equal to opposite-sex spouses for Federal tax purposes, so long as the couple legally was married in a state or other locale that recognizes same-sex marriage.
- Obviously, equal Federal tax treatment is also required in those states that currently recognize same-sex marriage: California (since June 28, 2013; also some unions prior to November 5, 2008); Connecticut, Delaware (eff. July 1, 2013); Iowa, Maine, Maryland, Massachusetts, Minnesota (eff. Aug. 1, 2013); New Hampshire, New York, Rhode Island (eff. Aug. 1, 2013); Vermont; Washington; District of Columbia.
- For Federal tax purposes, the terms “spouse,” “husband and wife,” “husband” and “wife” and “marriage” include reference to lawful same-sex marriage as defined above.
- Registered domestic partnerships, civil unions, or other relationships formalized under state law as something other than marriage are not treated as marriage for Federal tax purposes, whether between same-sex or opposite sex individuals.
- The Internal Revenue Code (“Code”) permits tax-free treatment of employer-sponsored benefits, including health care, offered to employees, their spouses (now including same-sex spouses) and dependents. Employer-sponsored benefits provided to individuals not meeting these categories constitutes taxable income to the employee; specifically “imputed” income generally equal to the value of the benefits provided.
- These rulings take effect September 16, 2013 and subsequent, but have some retroactive effect as described below.
Compliance Point: As a result of these rulings, employers must identify employees who are in legal same-sex marriages, and, for those employees, adjust income tax withholding, and Social Security and Medicare taxes for 2013, so that the cost of benefits provided to same-sex spouses are treated as excluded from gross income. Employers must continue to impute income to employees for Federal tax purposes, equal to the value of benefits provided to registered domestic partners, partners in a civil union, and other non-marital relationships, whether same-sex or opposite sex.
Tax Refunds and Credits for Prior “Open” Tax Years
Individuals in Lawful Same-Sex Marriages
- Individuals in legal same-sex marriages must file their income tax returns for 2013 and subsequent as either “married filing jointly” or “married filing separately.”
- These individuals may – but are not required to – amend or re-file their income taxes, and claim tax refunds or credits, for all “open” tax years in which they were in a legal same-sex marriage.
- Generally, for refund or credit purposes a tax return remains “open” for three years from the date the return was filed or two years from the date the taxes reported in the return were paid, whichever is later.
- For individuals who timely filed their Form 1040 tax returns and paid related taxes by the April deadline each year, returns for 2010, 2011 and 2012 likely remain open, however readers must confirm with their own accountants or other tax advisors which tax years remain open for them.
- The retroactive tax relief is as follows:
- As mentioned, individuals in lawful same-sex marriages may re-file their federal tax returns as “married filing jointly,” or “married filing separately,” which was not previously an option under Federal law.
- Note: this change in filing status could significantly change the amount of federal taxes owed and readers must consult with their own accountants or other professional tax advisors about the impact to their own bottom line.
- Individuals may request a refund of income taxes they paid on “imputed income” resulting from benefits provided to same-sex spouses. This relief can also take the form of a credit against future income taxes owed.
- Example: Alex legally was married to a same-sex spouse for all of 2012. Alex’s employer offers group health coverage to employees, their spouses and dependents, and pays 50% of the cost of coverage elected by the employee. The value of the employer-funded portion of coverage for Alex’s spouse was $250 per month. Alex may file an amended Form 1040 (Form 1040X) for 2012 that reduces gross income by $3,000 ($250 x 12 months) and be refunded the taxes paid on that amount.
- Employees who paid for their own health coverage with pre-tax dollars under a Code § 125 cafeteria plan have the option of treating after–tax amounts that they paid for same-sex spouse coverage as pre-tax salary reduction amounts.
- Example: Alex’s employer sponsors a group health plan under which employees must pay the full cost of spousal and dependent coverage. However, they may do so with pre-tax dollars under a Section 125 cafeteria plan. During open enrollment in late 2011 Alex enrolled in self-only coverage for 2012, but she entered into a legal same-sex marriage on March 1, 2012. Alex enrolled her spouse in health coverage beginning March 1, 2012. The monthly premiums were $500. Alex may file an amended Form 1040 (Form 1040X) for 2012 that reduces her gross income by $5,000 ($500 x 10 months). This puts her in the position she would have been in, had she been able to increase her salary reductions under the cafeteria plan to cover spousal coverage beginning in March 2012.
- Other benefit plans with regard to which retroactive tax relief is available include qualified scholarships under Code § 117(d), fringe benefits under Code § 132, dependent care benefits under Code § 129, and employer-provided meals or lodging under Code § 119.
- Note: individuals who seek a tax refund or credit related to imputed income credited to them in past, open tax years must adjust their tax returns for those years consistent with the tax status (i.e., married filing jointly or separately) that they are claiming with respect to the refund or credit. In other words, an individual cannot seek a refund of taxes paid for imputed income credited to them in 2012, but retain their status as a single taxpayer for 2012.
Compliance Point: Employers need to be aware that employees in same-sex marriages may be filing amended returns and seeking tax refunds related to these benefits, and take steps to quantify the imputed income or provide other information to employees to assist in retroactive tax relief.
- Retroactive income tax relief is only available to individuals; employers may not seek refunds for overwithheld income taxes in prior years.
- Employers may seek a refund of Social Security and Medicare taxes paid on imputed income resulting from same-sex coverage, or claim a credit against future taxes owed.
- The relief is available for “open” tax years which generally are the same as for individual tax returns (3 years from date of filing return or 2 years from date of paying taxes, whichever is later).
- For purposes of calculating the open period, quarterly Form 941s are treated as if they were all filed on April 15 of a given calendar year.
- The relief generally applies to the employer and employee portions of Social Security and Medicare taxes, however employers are limited to recovery of the employer portion only in two instances:
- In relation to an employee who cannot be located, or
- When the employer notifies an employee that it is seeking a refund but the employee declines, in writing, to participate in same.
- The IRS will establish a “special administrative procedure” for employers to seek refunds or claim credits for Social Security and Medicare taxes related to same-sex spousal benefits, to be defined in future guidance.
Compliance Point: Employers should be alert to future guidance from the IRS on the “special administrative procedures” that will apply to Social Security and Medicare tax refunds, and should take steps to quantify the amounts involved for open tax years.
Retirement Plan Issues
The IRS Frequently Asked Questions for individuals in lawful same-sex marriage begin to address same-sex spouse treatment under qualified retirement plans (QRPs), including 401(k) and profit sharing plans. Much more guidance in this area will be needed both from Treasury and from the Department of Labor. The following guidance applies as of September 16, 2013 and subsequent. Future guidance will address any retroactive application of Revenue Ruling 2013-17 to retirement plans and other tax-qualified benefits, including with regard to plan amendments and plan operation in the interim between September 16, 2013 and the date such future guidance is published.
- QRPs must treat a same-sex spouse as a spouse for all Federal tax purposes relating to QRPs, regardless of where the same-sex spouses reside.
- For instance, a QRP maintained by an employer in Florida, which does not recognize same-sex marriage, must pay a survivor annuity to a surviving same-sex spouse of a plan participant, unless the spouse consented in writing to another beneficiary prior to the participant’s death.
- QRPs are not required to treat registered domestic partners, partners to a civil union, or partners to other formalized but non-marital relationships as spouses, whether the partners are same-sex or opposite sex.
- For instance, a QRP need not pay a surviving spouse annuity to a registered domestic partner upon a participant’s death. However a plan may treat a registered domestic partner as a default beneficiary who will receive a plan benefit if the participant failed to choose another beneficiary. Plans must also treat registered domestic partners as designated beneficiaries when they are named as such by the participant.
Compliance Point: Employers should be on the alert for future guidance on QRP administration related to same-sex spouses. In the interim, check with your company’s accountant or other tax professional if same-sex spouse benefit questions arise.
Affordable Care Act Issues
Not all of the consequences of Federal tax recognition of same-sex marriage are positive. Under the Affordable Care Act, couples in a legal same-sex marriage now must combine their incomes for purposes of determining eligibility for premium tax credits and cost sharing on the healthcare exchanges, beginning in 2014. This may prevent some persons in same-sex marriages from receiving federal financial aid they would have qualified for, as unmarried individuals.
The reason for this is that financial aid towards health coverage on the exchanges is based on “household income” and household income must be between 100% and 400% of federal poverty level for financial aid to apply. Couples whose combined income exceeds 400% of the Federal Poverty Level (currently $62,040 for a 2-person household) will be ineligible for any financial aid toward the cost of coverage even if, individually, the same-sex spouses might have qualified for coverage on their own.
Additionally, “dependent” coverage which must be offered by applicable large employers in 2015 applies to children up to age 26, but not to “spouses,” and hence not to same-sex spouses.
Hopefully, future guidance from the IRS and from Health and Human Services will address in more detail the impact that Federal tax treatment of same-sex marriages has under the Affordable Care Act.
Compliance Point: Employers need to be aware that household income for employees in legal same-sex marriages will include their spouse’s compensation and will likely impact their eligibility for financial aid towards coverage on the health exchanges.