It is hard to believe that nearly five months have passed since the United States Supreme Court issued its landmark decision in United States v. Windsor. As a reminder, the Supreme Court held that the provisions contained in the Defense of Marriage Act (“DOMA”) that exclude same-sex relationships from the definition of marriage and spouse for federal law purposes (i.e., Section 3 of DOMA) are unconstitutional. The broad impact of this holding is clear: for purposes of federal law (e.g., ERISA, the Internal Revenue Code, etc.), same-sex marriages must be treated the same as opposite-sex marriages. But, while the general effect is clear, the Supreme Court’s decision left many questions unanswered.
The various federal agencies have begun churning out guidance to fill these gaps. For example, we now know that both the Internal Revenue Service (the “IRS”) and the Department of Labor (the “DOL”) have adopted a “state of celebration” standard for defining “spouse” and “marriage.” This means that same-sex couples who are married in a domestic or foreign jurisdiction that recognizes same-sex marriages will be treated as legally married for federal tax and employee benefit plan purposes, regardless of whether the couple lives in a state that does not recognize same-sex marriage. We also know the deadline for employers to begin following these rules with respect to the administration of their qualified retirement plans was September 16, 2013.
While this was all welcome guidance for employers and employees, it left everyone wondering whether the Supreme Court’s decision would have any retroactive effect and, if so, how this would impact prior year tax returns. In what should be viewed as good news for both employers and employees, the IRS has responded: both employers and employees can file claims for tax refunds related to same-sex spouse benefits.
This article, which was previously posted in the November newsletter for Whalen & Company, CPAs and Consultants, provides helpful guidance for both employers and employees who are seeking to recover these types of taxes.
Employees: Recovery of Federal Income Tax
Before the Supreme Court’s Windsor ruling, if an employer provided health coverage for an employee’s same-sex spouse, the value of that coverage was included in the employee’s gross income and was subject to federal income tax. Similarly, if the employer sponsored a cafeteria plan that allowed employees to pay premiums for health coverage for their same-sex spouses, those premiums were generally paid on an after-tax basis.
One impact of the Windsor ruling is that the value of employer-provided coverage for same-sex spouses is no longer included in the employee’s gross income (and is not subject to federal income tax), and employees can now make pre-tax contributions to cafeteria plans to pay for the cost of coverage for their same-sex spouses. This much was immediately clear based on the Supreme Court’s ruling. However, recent IRS guidance confirms that employees can also get refunds of federal income tax paid in relation to same-sex spouse benefits.
In a set of recently issued Q&As, the IRS confirmed that employees who file an amended income tax return (i.e., an amended Form 1040) can recover federal income tax paid on both the imputed value of employer-provided health coverage for same-sex spouses and the premiums the employee paid on an after-tax basis. Employees can receive a refund for all open tax years (all years for which the period of limitations for filing a claim for refund is open). The deadline for requesting a refund for a particular year is the later of (a) three years following the date the return was filed or (b) two years from the date the tax was paid.
Employers: Recovery of Employment Taxes
Employers can also obtain refunds of employment taxes paid with respect to benefits provided to same-sex spouses, and the IRS has issued simplified procedures that employers can utilize to request these refunds for open tax years.
Before Windsor, employers were required to withhold and pay employment taxes on the value of employer-provide health coverage for same-sex spouses and on amounts contributed by employees to a cafeteria plan on behalf of same-sex spouses. Because these amounts are no longer taxable following the Windsor ruling, employers are no longer subject to these additional employment taxes.
In Revenue Ruling 2013-17 and a related set of Q&As, the IRS clarified that employers can claim refunds of employment taxes related to these same-sex spouse benefits, provided the period of limitations for filing a claim for refund is open. Generally, employment taxes are reported quarterly on Form 941, and the process for recovering overpayments is relatively complicated. To receive a refund of overpaid employment taxes, an employer generally must (a) obtain statements/consents from employees, (b) repay or reimburse employees in the amount of any overpayments of FICA tax and income tax withholding, (c) file a Form 941-X for each corrected quarter, and (d) file Forms W-2c.
Recognizing the impracticality of this approach, the IRS issued Notice 2013-61, which provides simplified methods for requesting refunds of employment taxes for 2013 and prior years.
- Employment Tax Returns in Third Quarter of 2013. If an employer withholds employment taxes for same-sex spouse benefits in the third quarter of 2013, but repays or reimburses the employee for the amount of these taxes before filing the third quarter Form 941, the employer will not include these amounts when reporting wages and withholding on the third quarter 2013 Form 941. If the employer does not make the repayments/reimbursement before filing the third quarter 2013 Form 941, the employer can use one of the following two alternatives to make adjustments for the third quarter of 2013.
Other 2013 Adjustments. Employers that overpaid on taxes in the first three quarters of 2013 can utilize one of the following alternatives to claim a refund.
- Alternative One: Correct before close of calendar year. Under this first alternative, the employer must repay or reimburse the employee for any overpayments that occurred during the first three quarters no later than December 31, 2013. On the fourth quarter 2013 Form 941, the employer would then reduce (1) fourth quarter wages, tips, and other compensation reported on line 2, (2) taxable social security wages reported on line 5a, and (3) taxable Medicare wages reported on line 5c. The reduction is equal to the amount of the same-sex spouse benefits treated as wages for the first three quarters of 2013.
Employers would also reduce the income tax withheld from wages, tips, and other compensation reported on Line 3 of Form 941. This reduction is equal to the amount of income tax withholding with respect to the same-sex spouse benefits that are repaid or reimbursed to the employees by the end of the calendar year. Finally, if the value of any same-sex spouse benefits was included in taxable wages subject to additional Medicare tax withholding on line 5d in any of the prior 2013 Forms 941, there would be a corresponding reduction in the amount of taxable wages subject to additional Medicare tax withholding that is reported on the fourth quarter 2013 Form 941.
There are some additional rules that apply to employers that utilize this correction method. However, employers that intend to seek repayments for 2013 may want to utilize this method in order to avoid filing additional Forms 941-X and Forms W-2c for the 2013 calendar year (as is required under Alternative Two).
- Alternative Two: Correct after close of 2013 calendar year. This second alternative applies if the employer does not repay or reimburse the employee for any overpayments that occurred during the first three quarters by the December 31, 2013 deadline. Under this method, the employer would file the fourth quarter 2013 Form 941 without taking the adjustments described in Alternative One.
The employer would then file a single Form 941-X for the fourth quarter of 2013 to claim refunds for all of 2013. The employer must follow the usual requirements for filing the Form 941-X, including repaying/reimbursing the employees, obtaining required statements, providing the IRS and employees with a Form W-2c, etc. The employer should write “WINDSOR” in dark, bold letters across the top margin of page 1 of Form 941-X.
This method can only be used to seek a refund of FICA taxes attributable to the same-sex benefits; federal income tax refunds are not permitted because the 2013 calendar year will have closed. Thus, Alternative One may be a better approach where administratively practicable.
- Prior Year Adjustments (Before 2013). As previously noted, employers can also obtain reimbursements for prior years, so long as the period of limitations for filing a claim for refund is open. For each open year, the employer would file a single Form 941-X for the fourth quarter of that year, which would include the adjustments or refunds for all overpayments of employment taxes with respect to same-sex spouse benefits provided during that year. While the employer can file a single Form 941-X for each open year (as opposed to a separate Form 941-X for each quarter), the usual procedures for corrections apply (i.e., repaying/reimbursing the employees, obtaining required statements, providing the IRS and employees with a Form W-2c, etc.). The employer should write “WINDSOR” in dark, bold letters across the top margin of page 1 of each Form 941-X. As with “Alternative 2”, this special administrative procedure for prior years can only be used to seek a refund of FICA taxes attributable to the same-sex benefits.
Many of the questions surrounding the Supreme Court’s Windsor decision are still unanswered. For example, some states have still not provided guidance regarding state taxation of same-sex spouse benefits. However, the IRS’s recent guidance on the federal tax treatment of same-sex spouse health benefits provides much-needed direction to employees and employers who were left wondering, “Where is my money?”
Even though the IRS has provided “simplified procedures” for requesting refunds, there are certain aspects of these rules that can complicate the refund process. Accordingly, employers and employees that plan to take advantage of this refund opportunity should utilize competent legal counsel or professional tax advisers to make sure all of the IRS’s refund requirements are satisfied.