In dealing with the federal tax consequences of employee benefits, employers must apply definitions of spouse and marriage that include same-sex couples who are validly married in a state or foreign jurisdiction that authorizes same-sex marriage. In recent guidance, the U.S. Treasury Department and Internal Revenue Service (IRS) provided that for federal tax purposes, including employee benefits, a same-sex couple will be treated as married if the so-called "state of celebration" or "state of ceremony" rule is met. Civil unions and domestic partnerships will not be recognized as marriage for federal tax purposes. The federal definitions of spouse and marriage for federal tax purposes had been unclear since the U.S. Supreme Court struck down the federal Defense of Marriage Act (DOMA) definitions as unconstitutional in the June 26, 2013, decision for U.S. v. Windsor. The IRS is one of the federal agencies that regulates employee benefits. Other agencies, including the Department of Labor, have not yet issued guidance specifically addressing employee benefits.
Under DOMA, the federal definitions of spouse and marriage were limited to opposite-sex spouses and opposite-sex marriages, respectively. The Supreme Court struck down the statute and recognized marriage equality, reasoning that a federal definition that excluded same-sex spouses recognized as lawfully married under applicable state law violated the U.S. Constitution. Without DOMA's definition, and in the absence of any definitions in the federal tax code, it was unclear which state law would apply to determine marital status for employee benefit purposes – the law of the state where the couple resides or the law of the state in which the marriage was performed.
State of Celebration
The "state of celebration" or "state of ceremony" rule provides that a same-sex couple that is legally married in a state or country that authorizes same-sex marriage is recognized as legally married throughout the United States, regardless of where the couple lives or works. The IRS has ruled that, for purposes of federal tax recognition of marriage, the term "state" includes any foreign country. The significance of this rule is that federal tax law will recognize a same-sex marriage even if the taxpayers reside in states that do not permit or recognize a same-sex marriage. For example, if a same-sex couple is legally married in Albany, New York (which permits same-sex marriage), and moves to Alabama (which does not permit or recognize same-sex marriage), the couple is married for purposes of federal taxes and federally-governed employee benefits. Several other federal agencies have adopted the state of celebration rule for purposes of other federal laws.
For health plans, the guidance clarifies the federal tax treatment of health coverage offered to same-sex spouses. If an employer offers health coverage to same-sex spouses, the employee's share of the cost of that coverage can be paid on a pre-tax basis through a cafeteria plan, and the employer's share can be provided without any increase in the employee's federal taxable wages, known as "imputed income." In addition, eligible expenses incurred by same-sex spouses are eligible for account-based consumer-directed health plans that receive federal tax-favored status, including flexible spending accounts (FSAs), health reimbursement arrangements (HRAs) and health savings accounts (HSAs). Same-sex spouses also have rights under federal law to special enrollment and COBRA health coverage continuation, if the employer offers health coverage to spouses.
For retirement plans, the guidance also clarifies the treatment of retirement plan spousal rights, including spousal consent and survivor benefits. The clear rule is that "a qualified retirement plan must treat a same-sex spouse as a spouse for purposes of satisfying the federal tax laws relating to qualified retirement plans." The IRS noted the importance of uniformity in the administration of benefit plans, including default beneficiaries and required minimum distributions. The state of celebration rule will ease the burden on employers, employees and the IRS in implementing retirement benefits for same-sex spouses.
A few other clarifications of note:
- A civil union, domestic partnership or any other relationship that is not identified with the term "marriage" is NOT considered a marriage for federal tax purposes.
- Employees and employers can request refunds for income tax and employment taxes for imputed income for open tax years.
- The guidance is effective September 16, 2013, but can be relied upon prior to that date.
- Employers can adjust tax withholding for same-sex spouse health coverage for 2013 by December 31, 2013.
The Treasury Department and IRS acknowledge that there are still open issues, including the following:
- How should retirement plans apply the Windsor case retroactively?
- How should cafeteria plans apply the Windsor case retroactively?
- How and when should plans be amended?
- Will there be streamlined processes for tax refunds?
While waiting for additional guidance, employers can take steps to implement the recent Treasury and IRS guidance. Employers should evaluate their current processes and work with employees to identify same-sex spouses based on the state of celebration rule. Additionally, employers should review their plan definitions of spouse, civil union and domestic partner and revise them as needed. Employers that offer health coverage to same-sex spouses should work with payroll to adjust tax withholding for 2013. For past years, employers should identify the amount of imputed income for same-sex spouses and consider whether to claim a refund for employment taxes. Beneficiary designations and benefit distribution applications received after September 16, 2013, should be reviewed to determine whether spousal consent or a spousal form of benefit is required.