Same-Sex Spousal Benefits: Is Your Business in Compliance with the Recent Federal Ruling?

John E. Rich, Jr.
Director & Chair, Tax Department
Published: New Hampshire Business Review
September 27, 2013

Q. I own a business that employs two employees who are in same-sex marriages. I have yet to make any changes to my benefit plans. What changes do I need to make to be in compliance with the law?

A.  On June 26, 2013, the Supreme Court, in U.S. v. Windsor, a case involving a refund of federal estate tax, ruled that Section 3 of the federal Defense of Marriage Act (“DOMA”) which had precluded recognition of a same-sex spouse for purposes of federal law, was unconstitutional. DOMA’s definitions of “marriage” and “spouse” impact more than 200 Tax Code Provisions and Treasury Regulations. Because DOMA limited the definition of “marriage” and “spouse” under the Tax Code and the Employee Retirement Income Security Act of 1974 (“ERISA”) which regulates employer sponsored benefit plans to only opposite‐sex couples, same‐sex couples that were legally married under the laws of their state were subject to different legal protections and tax treatment of certain benefits.

The Court’s decision raised numerous transition issues, retroactivity issues and recognition issues for employers and employees for which guidance was required. On August 29, 2013, the Internal Revenue Service issued Revenue Ruling 2013-17 and a set of questions and answers will assist employers to implement the Court’s ruling. Although limited guidance has been issued, employers should begin to implement the decision.

IRS adopts “State of Celebration” Rule

Revenue Ruling 2013-17 stated that for federal tax purposes, as of September 16, 2013, marriage includes a marriage between individuals of the same sex. More importantly, the IRS stated that it will recognize a same-sex marriage validly entered into in a state or foreign country whose laws authorize same-sex marriage even if the couple moves to one of the 38 states that do not recognize the validity of same-sex marriages. This means that New Hampshire employers with offices and employees in states that do not recognize same-sex marriages, must treat those employees as married for federal tax purposes. This ruling will significantly simplify benefit administration for employers with employees in states with different marriage recognition rules.

Implications for Health and Welfare Plans

Under DOMA, employers that allowed employees to cover same-sex spouses on their health plans were required to impute income to the employee for federal tax purposes equal to the fair market value of the coverage provided to the same-sex spouse. After Windsor, employers will no longer be required to impute income and should stop doing so. In its guidance, the IRS stated that employers may make adjustments for 2013 income tax withholdings, provided the employer has repaid and reimbursed the employee for the over withheld income tax before the end of 2013. Employers may also retroactively claim a refund of, or make an adjustment for, any excess Social Security and Medicare taxes paid attributable to imputed income due to DOMA for 2013 and prior tax years open under the 3 year statute of limitations. For any open years, employees may amend their previously filed federal income tax returns to change their filing status and recalculate their federal income taxes.

Although the IRS has clarified income tax treatment, it has not yet addressed whether Windsor requires or permits employers to allow employees in same-sex marriages to make mid-year election changes to Section 125 cafeteria plans, flexible spending and dependent care account plans. Guidance is also necessary to address whether a health plan mid-year open enrollment must or can occur for same-sex spouses as a result of Windsor and numerous other welfare benefit issues.

Tax Qualified Retirement Plans

The Revenue Ruling confirms that as of September 16, 2013, same-sex spouses must be treated as a spouse for all federal tax laws impacting tax qualified retirement plans. Thus, same-sex spouses are entitled to survivor annuity protection in pension plans, automatic account balance death benefits in 401(k) and 403(b) plans and have direct rollover treatment on a spouse’s death. Same-sex former spouses are also now entitled to receive a portion of a retirement plan account at divorce on a tax-free basis through a qualified domestic relations order. There are numerous other unanswered questions starting with whether Windsor must be applied retroactively with respect to retirement plans, an issue that could have a significant financial impact on employers. The IRS stated that future guidance will consider the consequences of retroactive application to all impacted parties – the plan sponsor, the plan, the employer, and employees and beneficiaries. Future guidance will also provide sufficient time for plan amendments, and “any necessary corrections” so that the plan and benefits will retain favorable tax treatment.

What the Decision and the IRS Revenue Ruling Do Not Change

Revenue Ruling 2013-17 confirmed that the Windsor decision does not apply to registered domestic partnerships, civil unions, or other similar arrangement not denominated as “marriage,” under state law whether between individuals of the same or opposite sex. In addition, any benefit plan that does not currently offer spousal coverage or spousal benefits, will not be required to offer spousal benefits as a result of the Windsor decision.

You should also keep in mind that employees in same-sex marriages are entitled to the same treatment as other married employees under all other workplace policies. In addition to the action items outlined above, even prior to the issuance of additional guidance by the IRS and other federal agencies, you should start to implement Windsor by treating all same-sex spouses as “spouses” for plan purposes regardless of plan terms. Review your plan documents, summary plan descriptions, election and distribution forms, and review administrative procedures to ensure compliance immediately. You may also want to consider sending an employee communication to notify them of the change.