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”) is unconstitutional. Section 3 of DOMA provided that only persons of the opposite sex could be recognized as “spouses” and “married” for purposes of federal law. According to the Supreme Court’s opinion, DOMA’s definitions of “marriage” and “spouse” impact more than 1,000 federal laws, including the Internal Revenue Code and the Employee Retirement Income Security Act of 1974 (“ERISA”), which regulates employer sponsored retirement and health and welfare benefit plans. Because DOMA limited the definition of “marriage” and “spouse” under the Tax Code and ERISA 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.
Although the Court’s decision means that the complexities associated with the different treatment of opposite sex and same‐sex couples under the Tax Code, ERISA, and other federal laws such as COBRA, and HIPAA will end in states like New Hampshire that allow and recognize same‐sex marriages, the decision raises numerous transition issues, retroactivity issues and recognition issues.
Health and Welfare Plans
Under DOMA, employers that allowed employees to cover same-sex spouses on their health insurance plan were required to impute income to the employee for federal tax purposes equal to the fair market value of the health insurance provided to the same-sex spouse. Employers will no longer be required to impute income to employees so that previously taxable benefits will no longer be taxable. Self-insured plans in New Hampshire that previously were not required to provide continuation coverage under COBRA to same-sex qualified beneficiaries will now be required to do so.
The Internal Revenue Service has indicated that it will issue guidance on DOMA issues. Since employers have already imputed income for 2013 benefits, hopefully, the IRS will provide guidance on the retroactive treatment of imputed income for 2013 and possibly prior years. It is hoped that the IRS will also promptly issue guidance on the ability of employees to utilize pre-tax dollars in flexible spending accounts, health savings accounts and dependent care accounts for same-sex spouses and dependents along with health reimbursement accounts.
There will also be significant changes for retirement plans. Same-sex spouses will be entitled to survivor annuity protection in pension plans, automatic 100% of account balance death benefits in 401(k) and 403(b) plans and will have direct rollover treatment on a spouse’s death. Same-sex ex-spouses will now be entitled to receive a portion of a retirement plan account at divorce on a tax-free basis through a qualified domestic relations order (QDRO).
Is the Decision Retroactive?
The Supreme Court did not state whether the decision was retroactive and whether employers that had complied with DOMA in the past will now be required to make corrections on a retroactive basis. For certain issues, the Tax Code provides limits on the amount of time for which a refund may be sought that limits the potential retroactive impact. There are plan and common law limits under ERISA for how long participants can make claims for ERISA benefits. As these time limits are normally at least 3 years, it is important for the IRS and Department of Labor to clarify if employers have any retroactive liability for administering their retirement and other plans in conformity with DOMA. Any such retroactive treatment could prove potentially costly to employers who have paid out benefits based on applicable law at the time benefits were due and payable.
How to Treat Employees living in States that do not Recognize Same Sex Marriage
For employers that have same-sex married employees that currently reside in states that do not recognize same-sex marriage, the decision raises the question of which state’s marriage law will control: a couple’s state of residency or the state in which the same-sex marriage was performed. Although the Internal Revenue Service generally recognizes the law of the state of residency for tax purposes, the IRS could adopt a “state of celebration” rule to ensure consistent implementation nationwide regardless of the state in which the employer is located or the state in which the employee currently resides. That would not be unexpected given that the current Administration did not actively defend DOMA in Windsor. It has also been speculated that the President could issue an executive order requiring employers to recognize same-sex marriages irrespective of whether or not the employee and spouse reside in a state that has legalized same- sex marriage. Until guidance is issued, it would be reasonable for employers to continue to treat employees in states that do not recognize same-sex marriage as not entitled to the favorable tax and benefits treatment described above. As guidance is issued, employers will need to review the definitions contained in all employee benefit plans and their administration to verify compliance.
What the Decision does not Change
It is important to briefly mention what the ruling in Windsor did not do. The Supreme Court did not address states that allow civil unions or domestic partnerships in lieu of marriage. Additional guidance will be necessary as some states afford same-sex couples in civil unions the same rights as married couples. 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.