September 5, 2013

ALERT

Recent IRS Guidance on Same-Sex Marriage Simplifies Benefits Administration

On August 29, 2013, the IRS issued guidance on the treatment of same-sex spouses for federal tax and benefits purposes following the Supreme Court's June 26, 2013 holding in U.S. v. Windsor.

The Supreme Court in Windsor invalidated Section 3 of the 1996 Defense of Marriage Act (DOMA).  Section 3 of DOMA had provided that "the word 'marriage' means only a legal union between one man and one woman as husband and wife, and the word 'spouse' refers only to a person of the opposite-sex who is a husband or a wife."  This provision had the effect of nullifying a state's legalization of same-sex marriage for all federal law purposes.

Based on the holding in Windsor, the IRS ruled in Revenue Ruling 2013-17 that same-sex couples who are legally married in any U.S. state, the District of Columbia, a U.S. territory, or a foreign jurisdiction that has legalized same-sex marriage will be treated as married for federal tax law purposes, including the pre-tax treatment of a same-sex spouse's health insurance coverage.  This rule applies regardless of the couple's current state of residence.

However, this IRS ruling has no direct effect on state income taxes, which still must be assessed on a state-by-state law basis.

Revenue Ruling 2013-17 applies to all federal tax law provisions in which marriage is a factor, including employee benefits, income tax filing status, and claiming personal and dependency exemptions and the earned income tax credit and child tax credit.  However, the ruling does not apply to registered domestic partnerships, civil unions or similar formal same-sex relationships recognized under state law that are not marriages under state law.

Impact on Health Benefits

Those employees who purchase health insurance coverage for their same-sex spouse through their employer may pay the cost of such coverage on a pre-tax basis and exclude the amount of the coverage from income for federal income tax purposes.  Similarly, employers may exclude from income the cost of health insurance coverage for a same-sex spouse that is paid for by the employer.  Same-sex spouses and opposite-sex spouses are now treated the same under these health insurance tax rules, so the burden on plan administrators is significantly reduced.

Employers should remember, however, that states can continue to tax health insurance differently for same-sex versus opposite-sex spouses and that the laws of the particular state will need to be monitored in this regard.

Impact on Qualified Retirement Plans

In supplemental Q&As also issued on August 29, 2013, the IRS reiterated its position that qualified retirement plans must treat a same-sex spouse as a "spouse" under all of the federal tax rules relating to qualified retirement plans.

In this regard, these Q&As require qualified retirement plans to comply with this rule operationally as of September 16, 2013 (the date this ruling will be published in the Federal Register).  The IRS has promised further guidance on when qualified retirement plans will need to be amended to include this rule and to what extent this rule is to be applied retroactively.  Plan sponsors should be prepared to implement additional changes once this guidance is published.

Retroactive Application and Refund Claims

Revenue Ruling 2013-17 establishes a general prospective effective date of September 16, 2013.  With respect to prior years, individuals who were in same-sex marriages at the time may (but are not required) to file amended returns choosing to be treated as married for all federal tax law purposes for tax years still open under the statute of limitations.  Generally, the statute of limitations for filing a refund claim is three years from the date the return was filed or two years from the date the tax was paid, whichever is later.  We anticipate that employers will receive requests from affected employees for corrected Form W-2s relating to health benefit contributions for these prior years so that they may file amended tax returns.

Employers may not file refund claims for overwithheld income tax paid on same-sex spouse health benefits in prior tax years.  Only the individual employees can make these refund claims.  However, employers may make adjustments for overwithheld income taxes that were withheld from an employee in the current year, provided the employer repays or reimburses the employee for the overwithheld income tax before the end of the current calendar year.

Conclusion

The IRS ruling is intended to bring uniformity to a workforce and treat legally married same-sex spouses in the same manner as legally married opposite-sex spouses for tax and benefits purposes.  According to Treasury Secretary Jacob J. Lew, it also "assures legally married same-sex couples that they can move freely throughout the country knowing that their federal filing status will not change."

Orrick's Compensation and Benefits Group will continue to monitor regulatory guidance and legislative developments that affect an employer's tax and benefit obligations to its employees' same-sex spouses.