Global Tax Alert | 2 September 2013

IRS and Treasury issue guidance on federal tax treatment of legally married, same-sex couples

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In Revenue Ruling 2013-17 (August 29, 2013), the Treasury Department and the IRS ruled that same-sex couples who are legally married in state and foreign jurisdictions recognizing same-sex marriages will be treated as married for US federal tax purposes.

This ruling applies a "place-of-celebration" standard, which means that couples who were married in a jurisdiction recognizing same-sex marriages are treated as married even if they reside in a jurisdiction that does not recognize same-sex marriage. The ruling does not apply to registered domestic partnerships, civil unions or "similar formal relationships recognized under state law."

At the same time that the Revenue Ruling 2013-17 was issued, the IRS posted "Answers to Frequently Asked Questions for Individuals of the Same Sex Who Are Married Under State Law" and "Answers to Frequently Asked Questions for Registered Domestic Partners and Individuals in Civil Unions." These FAQs provide additional guidance on the federal tax implications of the rulings in Revenue Ruling 2013-17.

Revenue Ruling 2013-17 resolves a number of federal income and gift and estate tax issues for individual taxpayers and for employers maintaining benefit plans for their employees. This Alert summarizes the ruling and FAQs, and highlights some of the implications for individual taxpayers and employers.

Background

Revenue Ruling 2013-17 implements the federal tax aspects of the Supreme Court's decision in United States v. Windsor, which held Section 3 of the 1996 Defense of Marriage of Act (DOMA) to be unconstitutional.

Section 3 of DOMA provides that, for purposes of interpreting federal laws, including the Internal Revenue Code, the word "marriage" means only a "legal union between one man and one woman as husband and wife" and the term "spouse" means only a "person of the opposite sex who is a husband or wife." In the Windsor case, the taxpayer, Edith Windsor, had married her same-sex spouse in Canada but resided in New York, which recognizes same-sex marriages under its laws. Windsor's spouse died and she inherited her spouse's entire estate. Under DOMA, Windsor was required to pay an estate tax on this inheritance without any benefit of the federal estate tax marital exemption. Windsor filed for a refund, based on her same-sex marital status, but was denied by the IRS because estate tax marital exemption only applied to spouses recognized under DOMA. In a 5-4 decision, the Supreme Court ruled that section 3 of DOMA is unconstitutional because it deprives the equal liberty of persons that is protected under the Fifth Amendment. (See Tax Alert 2013-1288 for more background.)

Section 2 of DOMA provides that no State is required to recognize a same-sex relationship that is considered a legal marriage in another State. Section 2 was not at issue in Windsor and remains valid federal law. Until the issuance of Revenue Ruling 2013-17, it was unclear how a legally married, same-sex couple who resides in a state that does not recognize marriage would be treated for federal tax law purposes. Revenue Ruling 2013=17 resolves this issue.

Revenue Ruling 2013-17

Revenue Ruling 2013-17 holds that, for federal tax purposes, the marriage of same-sex individuals in a state whose laws authorize the marriage is recognized, even if the married couple resides in a state that does not recognize the validity of same-sex marriages. For purposes of the ruling, the term "state" means any domestic or foreign jurisdiction having the legal authority to sanction marriage. Under the ruling, same-sex couples are treated as married for all federal tax purposes, including income, gift and estate taxes. The ruling applies for all federal tax purposes for which marriage is a factor, including filing status, claiming personal and dependency exemptions, taking the standard deduction, contributing to an IRA and employee benefits. The ruling further holds that, for federal tax purposes, registered domestic partners, individuals who enter into a civil union or other similar formal relationship are not treated as a married couple.

Treasury and the IRS based the ruling on the Supreme Court's Windsor decision, a detailed explanation of the statutory context in the Internal Revenue Code of the terms "marriage," "spouse," "husband," and "wife," and related terms, and the prior precedent of Revenue Ruling 58-66. In Revenue Ruling 58-66, the IRS formally recognized that, for federal tax administration, an individual's marital status is based on state law. Revenue Ruling 58-66 further concludes that a couple who entered a common-law marriage in a state that recognized such relationships is considered married even if the couple moves to a state that does not recognize common-law marriage.

Perhaps most importantly, Revenue Ruling 2013-17 is based on the need for the IRS and taxpayers to efficiently and fairly administer the federal tax laws. The ruling states:

Although states have different rules of marriage recognition, uniform nationwide rules are essential for efficient and fair tax administration. A rule under which a couple's marital status could change simply by moving from one state to another state would be prohibitively difficult and costly for the Service to administer, and for many taxpayers to apply.

The ruling posits that there are more than two hundred Code provisions and Treasury tax regulations that include the terms "spouse," "marriage," "husband" and "wife." A state-of-domicile rule, the ruling concludes, would present serious administrative issues. By way of example, the ruling cites to the federal tax rules that treat spouses as related parties and attribute one spouse's ownership interest in property to the other spouse. If the IRS did not adopt a uniform rule, the attribution of property could change when a same-sex spouse moves from one state to another with potential adverse consequences for not only the married couple, but also others involved in the transaction. A state-of-domicile rule would also raise significant employee benefit administration challenges for multi-state employers and employers with employees (or former employees) who live in more than one state or move between states with different marriage recognition rules. The "place-of-celebration" standard applied by Revenue Ruling 2013-17 provides for a uniform rule that results in more effective and fair federal tax administration

The holdings of Revenue Ruling 2013-17 will apply prospectively as of September 16, 2013. Legally married, same-sex couples must comply with the ruling for 2013 tax filings. Same-sex couples may rely on the ruling for purposes of filing original returns, amended returns, adjusted returns or claims for credit or refund for any overpayment of tax, provided that the applicable limitations period for filing a refund claim has not expired and subject to all items on the affected tax returns being adjusted in a manner consistent with the marital status reported on the return or claim. Thus, a taxpayer cannot seek a refund with respect to fringe benefit treatment in a prior year based on recognition of a same-sex marriage unless the taxpayer's return for that year is amended to reflect married-filing-jointly or married-filing-separately status.

Implications

States recognizing same-sex marriage

The Human Rights Campaign reported that, as of August 8, 2013, same-sex marriages are recognized in 13 states and the District of Columbia.

State Effective date
California Re-established June, 20131
Connecticut October 1, 2010
District of Columbia March 9, 2010
Delaware July 1, 2013
Iowa April 24, 2009
Maine December 29, 2012
Maryland January 1, 2013
Massachusetts May 17, 2004
Minnesota August 1, 2013
New Hampshire January 1, 2010
New York July 24, 2011
Rhode Island August 1, 2013
Vermont September 1, 2009
Washington December 6, 2012

Federal income, gift and estate tax planning

Revenue Ruling 2013-17 presents immediate and widespread federal income, gift and estate tax implications for same-sex married couples. These couples should immediately review the status of their 2012 income tax and foreign asset information reporting responsibilities. Opportunities may exist for amending previously filed income, gift and estate returns, which could yield significant tax savings. Indeed, same-sex married couples, as well as same-sex couples contemplating marriage, should consider undertaking a holistic review of their income tax and wealth transfer planning goals and objectives.

How does Revenue Ruling 2013-17 affect federal income tax returns to be filed?

Same-sex spouses who file an original tax return for tax year 2012 on or after September 16, 2013, (the effective date of Revenue Ruling 2013-17), generally must file using one of the two filing statuses available for married couples; i.e., married filing jointly or married filing separately. Consequently, same-sex married couples who have not yet filed their 2012 tax returns and for whom filing using either married filing status would result in a greater tax liability than the total of their separate tax liabilities if they each file individually, should consider filing their individual federal tax returns before September 16, 2013.

For tax year 2013 and beyond, same-sex married spouses who have been filing as individual taxpayers will now be required to file their federal income tax return using either married filing jointly or married filing separately filing status. Individuals who are in registered domestic partnerships, civil unions or other similar formal relationships that are not marriages under state law are not considered as married or spouses for federal tax purposes. Such couples may not file a federal return using a married filing jointly or separately filing status.

Should same-sex married spouses amend previously filed, federal income tax returns?

Same-sex spouses who have already filed federal tax returns for 2012 or for any previous tax year for which the statute of limitations for filing an amended return has not yet expired have the option to amend the returns for these years using either married filing jointly or separately filing status. Same-sex married couples should calculate their combined income tax liability that would have been due had they been able to file using either married filing status. They should consider amending returns for tax years if filing jointly or as married filing separately would have resulted in a lower tax liability than the total of the tax liabilities reported on the individual returns they previously filed.

A taxpayer generally may file a claim for refund for three years from the date the return was filed or two years from the date the tax was paid, whichever is later. Same-sex spouses, who were legally married (i.e., in a domestic or foreign jurisdiction whose laws authorized same-sex marriage) during a tax year for which the statute of limitations for filing an amended tax return is now closed, may be able to pursue refunds through judicial means.

Reevaluate unfiled 2012 foreign asset information reporting

Many information returns for reporting foreign assets (e.g., Form 8938, Form 5471 and Form 8865) include thresholds or constructive ownership rules to determine whether an individual is required to file. The filing thresholds for a married couple are often lower than the combined filing thresholds for two unmarried individuals, and the constructive ownership rules apply to spouses, but generally do not apply for two otherwise unrelated individuals. Therefore same-sex married spouses with foreign assets should reconsider their foreign information reporting requirements.

What actions should same-sex married spouses consider taking now for federal gift and estate tax purposes?

The marital deduction for spousal gifts and bequests now applies to married same-sex spouses. Therefore, any individual who had previously reported a taxable gift to a same-sex spouse or any individual who received a taxable bequest from a same-sex spouse should consider filing an amended gift or estate tax return to request a refund for any return for which the statute of limitations remains open. Moreover, because the determination that DOMA's spousal definition is unconstitutional rendered it void from inception, an affected individual may be able to pursue a refund of overpaid gift and estate tax through judicial means, if the statute of limitations for requesting a refund is closed. Further, same-sex married spouses should now seek legal counsel regarding the need to update their estate planning documents.

What are some other planning areas same-sex couples should now consider?

A same-sex couple who is not currently married, should evaluate for income tax purposes whether marriage will improve or in some cases disadvantage the taxpayers — the marriage penalty. Since marital status affects dozens of sections of the Internal Revenue Code, a case-by-case analysis is needed for each same-sex couple. This single change in the interpretation of the federal definition of marriage requires reconsideration of all federal tax-planning opportunities for same-sex couples.

For estate and gift planning, the ability for same-sex spouses to be consider "married" is a highly significant tax savings development. In addition to the fundamental issues of filing status and gift and estate tax marital deductions discussed above, here is preliminary list of other issues affected:

  • Electing portability of a deceased spouse's unused applicable lifetime exemption amount
  • Simplifying the basis and contribution determinations for jointly owned property
  • Splitting of lifetime gifts
  • Application of Section 1041(a) on the transfer of property subject to a qualified marriage settlement agreement, which allows the tax-free transfer of appreciated property between US resident spouses upon divorce
  • Availability of certain Social Security, Medicare and Medicaid benefits2
  • Applying the retained interest rules on transfers to related persons under Sections 2701 and 2702, which treat certain restricted transfers of property between related persons as a completed taxable gift of the property, while transfers between unrelated persons may not be a taxable gift at all
  • Applying the adoption tax credit (previously same-sex spouses could both claim the credit)
  • Applying the thresholds for the tax penalties and health insurance subsidies available under the Patient Protection and Affordable Care Act
  • Community property treatment of income under Section 66
  • Section 469(i)(5), the $25,000 offset for passive activity losses for rental real estate

Global Mobility

In addition to the implications addressed above for the taxation of individuals, employers with a globally mobile workforce will need to consider the effect of the Windsor decision and the IRS ruling on their tax equalization and other employee policies for their mobile workforce. The policies should be reviewed not only from a US perspective. Other countries may have similar laws that could affect the cost of assignments and tax equalization. Employers may need to adjust the assignment cost estimates and 'hypothetical tax' withholding for their employees whose income tax liability may change under these new rules.

Employee Benefit Plans

Numerous employee benefit plan rules provide more favorable tax treatment of spouses. Revenue Ruling 2013-17 simplifies the administration of employee benefit plans for federal tax purposes. However, employers may confront challenges administering their employee benefit plans due to differences in application of state income tax and employment tax rules.

Tax-qualified retirement plans

Tax-qualified retirement plans under Section 401(a) provide a number of benefits for spouses. For example, a tax-qualified retirement plan may be required to offer survivor annuities to spouses. The timing of required distributions under Section 401(a)(9) differs for spouses than for other beneficiaries. Same-sex spouses may now be eligible for qualified domestic relations orders and their consent may be required for certain non-annuity distributions from tax-qualified plans, including 401(k) plans.

The FAQs that were issued simultaneously with Revenue Ruling 2013-17 make clear that qualified retirement plans are required to treat same-sex spouses as a "spouse" and must recognize a legal same-sex marriage, even if the married couple lives in a jurisdiction that does not recognize the validity of same-sex marriages. Tax-qualified plans must comply with these rules prospectively as of September 16, 2013. However, plans are not required to be amended by that date. The IRS expects to issue further guidance on plan amendment requirements and any necessary corrections relating to plan operations for periods before the future guidance is issued. The future guidance is expected to provide sufficient time for plan sponsors to make plan amendments and any necessary corrections. Employers need to review their tax-qualified plans to identify those provisions affected by the ruling in Windsor.

With respect to employee benefits, Revenue Ruling 2013-17 applies retroactively only to certain enumerated fringe benefit provisions (discussed below) and, as already noted, indicates that additional guidance will be issued as to the retroactive application of Windsor to other employee benefit plans and arrangements. Thus, it is still unclear whether or how Windsor will be applied to prior-year, qualified plan payments that were made based on unmarried status, retirement payments made based on elections out of joint and survivor annuities that were made without spousal consent, and numerous other qualified retirement plan operational provisions.

Health and welfare benefits

Prior to Windsor, health benefits provided to same-sex spouses (who were not tax-dependents) were not eligible for the federal income tax exclusion provided to spouses under Sections 105 and 106. With the issuance of the Supreme Court's decision and Revenue Ruling 2013-17, all legally married employees will not be subject to federal taxation on coverage or benefits provided to their same-sex spouse. In addition, an employee who received health care coverage for a same-sex spouse may be entitled to file a claim for a refund of the federal income tax paid on the value of the health coverage.

The FAQs make clear that a legally married employee may file a refund claim for all years for which the period of limitations is open. Generally, a taxpayer may file a claim for refund for three years from the date the return was filed or two years from the date the tax was paid, whichever is later. The FAQs further provide that an employee who participates in an employer's cafeteria plan allowing employees to purchase health care coverage on a pre-tax basis may file a refund claim for income taxes paid on premiums paid on an after-tax basis for health coverage of the employee's same-sex spouse.

The FAQs includes the following example to illustrate an employee's right to file an amended return:
Example: Employer sponsors a group health plan covering eligible employees and their dependents and spouses (including same-sex spouses). Fifty percent of the cost of health coverage elected by employees is paid by Employer. Employee A was married to same-sex Spouse B at all times during 2012. Employee A elected coverage for Spouse B through Employer's group health plan beginning January 1, 2012. The value of the employer-funded portion of Spouse B's health coverage was $250 per month.

The amount in Box 1, "Wages, tips, other compensation," of the 2012 Form W-2 provided by Employer to Employee A included $3,000 ($250 per month x 12 months) of income reflecting the value of employer-funded health coverage provided to Spouse B. Employee A filed Form 1040 for the 2012 taxable year reflecting the Box 1 amount reported on Form W-2.

In this case, Employee A may file an amended Form 1040 for the 2012 taxable year excluding the value of Spouse B's employer-funded health coverage ($3,000) from gross income. The employer may also claim a refund for the social security taxes and Medicare taxes on the value of the benefit, provided that the period of limitations for filing a claim for refund is open. (See "Federal Income and Employment Tax Refunds" below.) The employer may not claim a refund for over-withheld income tax for prior years; however, the employee may file for any refund of income tax due on Form 1040X, provided the period of limitations for claiming a refund is open. It is unclear at this time if employees must obtain a Form W-2c from their employers showing a reduction in federal taxable wages (box 1) before filing for a federal income tax refund.

Employees may also file a refund claim for overpayment of federal income and employment taxes with respect to other employer-provided fringe benefits under Sections 117(d) (qualified scholarships), 119 (meals and lodging for the employer's convenience), 129 (dependent care assistance), and 132 (employee discounts and no-additional-cost services).

If a same-sex partner is legally a spouse, there may also be ramifications under the Affordable Care Act. Dependents, but not spouses, are required to be offered coverage in order to avoid the Section 4980H(a) tax. Spouses who are offered coverage, however, may not be eligible for premium tax credits for coverage through state exchanges.

Finally, same-sex spouses also would be eligible for COBRA coverage upon a qualifying event and coverage under flexible spending accounts.

Federal income and employment tax refunds

The IRS has indicated that it intends to issue streamlined procedures that employers may follow for employee and employer Social Security and Medicare tax (collectively referred to as "FICA tax") refunds for prior years. The IRS has also clarified that FICA refunds will apply only for tax years 2010, 2011 and 2012, unless the statute of limitations remains open for earlier years (e.g., a protective FICA refund claim was filed).

At the same time, as noted above, affected taxpayers have been told that they may now claim federal income tax and FICA tax refunds for prior-year fringe benefits, creating an immediate need for employers to begin the process of identifying Forms W-2 that are implicated by the retroactive effect of Windsor, and quantifying the adjustments that will need to be made to wages previously reported in boxes 1, 3 and 5. Part of this analysis should also include 2013 wage and tax overstatements pursuant to same-sex partner benefits that have been treated as taxable and how federal income tax and FICA withholding adjustments will be made.

For now, Revenue Ruling 2013-17 confines the scope of potential prior-year adjustments to the fringe benefits identified above — that is, health and accident benefits including employee pre-tax contributions under a Section 125 plan, health savings accounts, health reimbursement arrangements and long-term care; qualified scholarships, meals and lodging for the employer's convenience, dependent care assistance, no-additional-cost services, and qualified employee discounts.

State and local tax

With few exceptions (e.g., New Jersey and Pennsylvania), federal taxable wages (Form W-2, box 1) are currently the starting point for determining state taxable income. For states that do not recognize the validity of same-sex marriages, the effect of the Service's ruling that legally married, same-sex couples are married regardless of the jurisdiction where they now reside is unclear. For states that do not recognize same-sex marriages and do not treat same-sex spouses as spouses for state tax law purposes, a change in the state tax law likely will be necessary. Further, where states choose to depart from following the federal treatment, the "place-of-celebration" rule set forth in Revenue Ruling 2013-17 will result in conflicts between the filing status on federal and state/local income tax returns.

Affected states are no doubt determining at this time how these issues will be resolved, and taxpayers, including employers, will need to respond to a flurry of changes in withholding allowance certificate procedures and Form W-2 reporting requirements.

Endnotes

1 In Hollingsworth v Perry, the Supreme Court ruled that it lacked jurisdiction to decide the constitutionality of Proposition 8, California's ban on same-sex marriage, because the proponents of Proposition 8 lacked legal standing to defend the law after the California government refused to do so. The case was remanded to the Ninth Circuit with instructions to dismiss the appeal. Same-sex marriages resumed in California on June 28, 2013.

2 Note that the "place-of-celebration" rule set forth in Revenue Ruling 2013-17 governs only the federal tax treatment of same-sex couples, unless specified otherwise by the responsible government agency. For example, the Social Security Administration issued instructions that claims would be paid to a same-couples who were legally married based on their state of residency, and Health and Human Services issued a statement that Medicare benefits for same-sex spouses will be determined based on the state of celebration.

For additional information with respect to this Alert, please contact the following:

Compensation and Benefits Group
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Federal Employment Tax Controversy Group (a subgroup of TCRMS)
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Indirect Tax
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Human Capital
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