Hawley Troxell recently issued a client alert concerning guidance the IRS had issued in the wake of the Supreme Court’s invalidation of the federal prohibition on same-sex marriage, which was contained in the Defense of Marriage Act (DOMA). As described in that Alert, the IRS has held that where same-sex spouses have been married in a state that recognizes the legality of such marriages, the spouses will be considered husband and wife for all purposes under the Internal Revenue Code. This conclusion applies even if a couple now resides in a state where same-sex marriage is not recognized. The alert observed that there are important effects of this ruling for employee benefit plans, where such features as the requirement to obtain the consent of a spouse to designate a beneficiary other than a spouse will now apply to the same-sex spouse.
Employment tax consequences
The ruling also affects employment taxes paid by employers for and on behalf of employees in same-sex marriages. In yet another new release on September 24, 2013 (IRS Notice 2013-61), the IRS has provided guidance on how employers may correct prior employment tax filings that treated same-sex spouse benefits as taxable for employment-tax purposes. Corrections might be necessary in situations involving employer-provided benefits that are based in part on an employee’s marital status, and include accident and health plans (Code § 106), scholarship plans (§ 117), cafeteria plans (§ 125), dependent care assistance (§ 129), and various fringe benefits (§ 132). Refunds are generally available for taxes paid during the last three tax years.
The guidance gives an example of a cafeteria plan in which the employee made a pre-tax contribution for himself and an after-tax contribution for his same-sex spouse. That employee will now be entitled to a refund of the employment taxes paid on the after-tax amounts for the same-sex partner.
Under Notice 2013-61, employers can follow normal procedures for amending employment tax returns and seeking refunds of taxes paid in error based on prior law. After reimbursing the employee for the over-collection of employment tax, the employer may file a Form 941-X to correct a previously filed Form 941, for each quarter that needs to be corrected. The new guidance includes special procedures which the employer may elect to use to amend returns and claim refunds, in lieu of filing amended returns for each quarter of each year that is affected:
- Where the employer overstated employment taxes in the first three months of 2013 because of the incorrect classification of a same-sex couple, the employer may, after reimbursing the employee, make the correction for all quarters on the fourth quarter Form 941.
- Where the employer does not make the correction during 2013 as provided above, it may, after reimbursing the employee, file a Form 941-X for the fourth quarter of 2013, to make adjustments and claim credits for all quarters in 2013.
- For years prior to 2013 (that are still within the statute of limitations for refunds), the employer may file one Form 941-X for the fourth quarter of the relevant year, and show the adjustments and credits that relate to this issue for the entire year. For both this and the previous procedure, the taxpayer must write “WINDSOR” on the first page of the Form 941-X.
There are other requirements that must be observed for all these procedures, including attention to the fact that the social security wage base may still be exceeded for the employee even after the adjustment, so no refund would be due. The employer should consult Notice 2013-61 to identify all the specific requirements.
In addition to employment taxes, there are ramifications of the DOMA invalidation to virtually every other type of federal tax. Same-sex spouses may now take advantage of (or will be burdened by) all income tax provisions that apply to spouses, such as dependency exemptions, transfers between spouses, and the “related party” rules. Relevant gift and estate tax provisions include the ability to make tax-free gifts to a spouse and the unlimited marital deduction.
State tax issues
Among the most difficult and uncertain new issues will be how to file state income tax returns for same-sex spouses residing in a state that does not recognize same-sex marriage. Each same-sex couple will need to consult the laws of the state of their residence, since each approach may be different even among states that are alike in their non-recognition of same-sex marriage.
In Idaho, the Tax Commission has promulgated a temporary rule providing that same-sex marriages will not be recognized for any purpose. For example, same-sex spouses cannot file a joint Idaho income tax return, even if they file a joint federal income tax return. Also, if an employer provides health coverage for same-sex spouses (married in a state that allows same-sex marriage, but living in Idaho), for federal purposes the same-sex spouse coverage is not taxed, but for Idaho income tax purposes, the value of the same-sex spouse coverage will continue to be imputed income to the employee. This will affect how wages need to be reported by employers on W-2 forms. Arguably, statutory changes will be needed to give effect to this temporary rule, since Idaho uses federal taxable income as a starting point, subject to adjustments that do not presently include adjustments to change the federal treatment of same-sex couples.
For more information about the DOMA invalidation, employee benefits, or other tax implications, please contact Rick Smith or call us at 208.344.6000.