On August 29, the U.S. Department of the Treasury (Treasury) and the Internal Revenue Service (IRS), following the U.S. Supreme Court’s decision in United States v. Windsor, jointly announced the issuance of Revenue Ruling 2013-17 (the Ruling), providing guidance on the federal taxation of same-sex couples. Windsor invalidated, on equal protection grounds, the limitation of marriage to opposite-sex couples in the Defense of Marriage Act (DOMA). The Ruling holds that for all federal tax purposes, including income, gift and estate tax, the IRS will recognize same-sex marriages that are legally valid in the jurisdiction where the couple married, regardless of whether the state in which the couple resides would recognize the marriage.
Citing the need for uniformity in federal tax law and the administration of employee plans, the Ruling answers the most fundamental question that employers, individual taxpayers and others had following Windsor: whether the law of the state of a same-sex couple’s domicile or the law of the state in which they entered into their marriage would control their status for federal tax purposes. The Ruling specifically says that same-sex marriages legally entered into in any state that recognizes such marriages, including the District of Columbia, a U.S. territory, or a foreign country1, will be recognized for all federal tax purposes. The Ruling does not, however, extend to same-sex couples in registered domestic partnerships or civil unions.
The Ruling applies prospectively beginning on September 16, 2013, but employers and employees may rely upon the Ruling retroactively for purposes of filing certain credit or refund claims related to the changed law. In related Treasury and IRS releases, the agencies said they intend to issue future guidance with a streamlined process for employers to file refund claims for payroll taxes paid previously on health benefits or other fringe benefits provided to an employee’s same-sex spouse. The IRS also issued two sets of Frequently Asked Questions (FAQs) with the Ruling that separately address questions for same-sex couples and couples in domestic partnerships, including several questions regarding employer refund claims relating to payroll taxes on benefits previously provided to same-sex spouses. The Ruling provides that, for purposes of refund claims by an individual or his or her employer, amounts an employee paid on an after-tax basis for health or other fringe benefits for a same-sex spouse can be treated as pre-tax contributions if the employer had a cafeteria plan and the employee made pre-tax salary reduction contributions for his or her own coverage.
The Ruling specifies that retroactive reliance on it for benefit plan purposes is limited to the exclusions from income for:
- Employer contributions for health plan coverage under Internal Revenue Code (Code) section 106;
- Qualified tuition reductions under Code section 117(d);
- Meals and lodging furnished for the convenience of the employer under Code section 119;
- Dependent care assistance under Code section 129; and
- Certain miscellaneous fringe benefits under Code section 132.
At this time the Ruling may not be relied upon retroactively with respect to matters relating to qualified retirement plans and certain other arrangements. The IRS has promised future guidance on how Windsor and the Ruling will apply to cafeteria plans, qualified retirement plans and other tax-favored arrangements for periods prior to September 16, 2013. Presumably, this will include guidance on how to apply the spousal continuation rule of Code section 72(s)(3) to non-qualified annuities and the minimum required distribution rules of Code section 401(a)(9) to Individual Retirement Accounts and Annuities, 403(b) annuities and qualified plans. The Ruling indicates that future guidance will take into account the impact of retroactivity on all taxpayers involved, including plans, plan sponsors, employers, employees and affected beneficiaries, and will provide sufficient time for qualified plans to be amended and corrected as necessary to preserve existing favorable tax treatment.
The Ruling also makes clear that same-sex couples married in jurisdictions that recognize such marriages are entitled to the federal gift and estate tax marital deduction for interspousal transfers during life and at death on the same basis as opposite-sex married couples. (In fact, Windsor involved a claim for refund of federal estate tax on property passing to a surviving, same-sex spouse.) Although the Ruling has wide-ranging effects on estate planning for same-sex couples, in connection with employee plans and annuity contracts, the Ruling allows plan balances and annuities payable to a surviving same-sex spouse beneficiary to pass free of estate tax at the death of the employee spouse or annuity owner.
State Income Tax Implications
For states that do not recognize same-sex marriage but follow federal adjusted gross income, federal gross income or federal taxable income for state income tax purposes, a key question will be whether same-sex spouses may file a joint state income tax return and whether the value of health insurance coverage for a same-sex spouse will be taxable. Before
Windsor, income was imputed for the value of health insurance coverage and other fringe benefits for federal and state income tax purposes unless the state recognized same-sex marriage or recognized another same-sex relationship and provided that income would not be imputed. Many states have a state constitutional amendment or statute similar to DOMA that remains in effect but the states follow federal adjusted gross income or a similar federal measure for tax purposes. Unless these states change their laws or determine otherwise, it is possible that income will not be imputed on the value of these benefits for a same-sex spouse due to the states following federal income measures. For states that do not recognize same-sex marriages and do not follow a federal income measure, the value of the health insurance coverage and other fringe benefits provided to same sex spouses will, in most cases, continue to be taxable.
The Ruling will have a significant impact on the administration of employee benefit plans, from both the employer and employee perspective, and will also impact non-qualified annuity contracts. The chart below outlines the impact of Windsor and the Ruling on various employee benefit provisions and annuity contracts, taking into account the guidance contained in the related FAQs.
Click here to view tables.