On June 26, 2013, the Supreme Court of the United States issued its highly anticipated decision in United States v. Windsor, ruling that Section 3 of the federal Defense of Marriage Act (DOMA) is unconstitutional. The Court held that section 3 of DOMA, which excludes a same-sex partner from the definition of “spouse” as that term is used in federal statutes, is unconstitutional as a deprivation of the equal liberty of persons that is protected by the Fifth Amendment of the U.S. Constitution.
This two-part series considers the effects of the Windsor decision on fringe benefits and the taxation of employer-provided health coverage, wage overstatements and refund opportunities. Part one focuses on the significant potential implications of the decision on the administration and taxation of fringe and other employee benefits afforded to same-sex spouses, the full scope and extent of which is not yet known and is expected to be the subject of future Internal Revenue Service (IRS) and U.S. Department of Labor (DOL) guidance.
DOMA and the Supreme Court’s Ruling
DOMA, which Congress enacted in 1996, defines “marriage” under federal law as a legal union between one man and one woman as husband and wife and defines “spouse” as a person of the opposite sex who is a husband or a wife. As such, under DOMA, the legal marriages of same-sex couples were not recognized under any federal law, including the Internal Revenue Code and the Employee Retirement Income Security Act (ERISA), even if they were recognized under state law.
The Supreme Court’s ruling means that, for purposes of federal law, a same sex marriage must be viewed the same as an opposite sex marriage, generally leaving the definition of “spouse” to the states. Note that the Supreme Court’s ruling did not affect Section 2 of DOMA, which continues to allow states to refuse to recognize the validity of same-sex marriages that were legally performed in other states. The Windsor decision did not address which states’ laws control for federal law purposes—the state of marriage or state of domicile—or the numerous employee benefit and tax implications that follow from the decision. Although there are many implications for qualified retirement plans, health and welfare plans, rights under the Consolidated Omnibus Budget Reconciliation Act (COBRA), cafeteria plans, health savings accounts, health reimbursement accounts, and other employee benefits, this article focuses on fringe benefits and the taxation of employer-provided health coverage afforded to same-sex spouses.
Fringe Benefit and Other Tax Implications under DOMA and Going Forward
A number of tax-free employer-provided fringe and health benefits are limited to employees, “spouses,” and dependents. Accordingly, under DOMA, fringe and health benefits that could be provided on a tax-free basis to opposite-sex married couples could not be provided on a tax-free basis to same-sex married couples unless, in certain circumstances, the same-sex spouse was a tax dependent (as defined for federal income tax purposes). The following fringe benefits may either be provided tax-free to employees and their “spouses” or dependents, or the administration thereof may be impacted based on an employee’s “spouse”:
- no additional cost services;
- employee discounts;
- retirement planning services;
- on-premises gym facilities;
- group term life insurance;
- adoption assistance;
- dependent care assistance; and
- tuition benefits provided by a university.
Similarly, the value of medical coverage received under an employer’s health plan is excludable from federal income tax only for benefits provided to the participant and the participant’s “spouse” and dependents.
Because most same-sex spouses do not qualify as a dependent, these fringe and health benefits generally constituted taxable wages under DOMA subject to federal income and Federal Insurance Contribution Act (FICA) taxes, as well as state income taxes in a majority of states, when received for the benefit of an employee’s non-dependent same-sex spouse. In contrast, these benefits could be provided on a tax-free basis to an employee when received for the benefit of the employee’s opposite-sex spouse. Just to be clear, under DOMA, an employer was not prohibited from offering fringe benefits and spousal health benefits to its employees’ same-sex spouses—however, if a same-sex spouse received these benefits, the employee was not entitled to the favorable tax treatment (if any) afforded to employees with opposite-sex spouses.
As a result of the Supreme Court’s ruling in Windsor, in states where same-sex marriages are affected by the ruling, employees with same-sex spouses should receive the same tax treatment that employees with opposite-sex spouses have historically received. The upshot is that employers are no longer required to impute income on the value of such benefit coverage for employees’ non-dependent same-sex spouses (or require the employee to pay for health benefits on an after-tax basis). In addition, employers are no longer required to continue to withhold federal income taxes and pay FICA taxes on the imputed amount, at least with respect to affected employees who reside in states that recognize same-sex marriage.
Note: states that do not permit or recognize same-sex marriages may continue to require employers to impute income for state tax purposes. Future guidance is needed at the federal level to determine whether employers can stop imputing income for federal tax purposes to legally married same-sex couples residing in states that do not permit or recognize same-sex marriages. In addition, employers who were providing tax gross-ups to reimburse employees for taxes on fringe and spousal health benefits provided to same-sex spouses may discontinue that practice to the extent that the benefits are now treated as tax-free.
Employers will have to reprogram payroll systems so that they no longer withhold income tax and FICA tax for these benefits provided to same-sex spouses residing in states where same-sex marriages are recognized. Additionally, depending on future guidance, payroll systems may have to be reprogrammed again so as to not withhold taxes for benefits provided to all same-sex spouses who were married in a jurisdiction that recognizes same-sex marriage, regardless of their state of residence. This leads to the question of whether employers have adequate data to make these changes for affected employees or whether they have to request their present (and past) employees in same-sex marriages to identify themselves (and whether future guidance will require certifications or other proof of marriage from employees with same-sex spouses). Note that the Windsor decision did not address civil unions and domestic partnerships where partners are not considered “spouses,” and therefore the federal protections and benefits afforded by the Windsor decision do not appear to extend to relationships that are not recognized as “marriages” by state law. Accordingly, unless future guidance provides otherwise, fringe benefits provided to an employee’s domestic or civil union partner should remain taxable wages to the employee (unless the individual qualifies as a dependent of the employee).