The U.S. Supreme Court has upheld a lower court decision declaring Section 3 of the federal Defense of Marriage Act (“DOMA”) unconstitutional. Section 3 of DOMA defines a “marriage”, for most federal purposes, as “a legal union between one man and one woman as husband and wife”, and provides that “the word ‘spouse’ refers only to a person of the opposite sex who is a husband or a wife.”
The case, United States v. Windsor, involved a same-sex couple who, while living in New York, a state that recognized the validity of same-sex marriages contracted in other jurisdictions, were married in Canada. Two years later (and before New York legalized same-sex marriage in that state), one of the partners died, leaving her entire estate to her spouse. If the federal Internal Revenue Code had recognized this marriage, the estate would not have been subject to any federal estate tax as a result of the estate tax marital deduction for amounts left to a spouse. Because of DOMA, however, the marriage was not recognized, and the survivor was not considered to be a surviving spouse. As a result, federal estate tax of more than $363,000 was assessed. The survivor claimed a refund of the estate tax paid on the basis that DOMA violates the constitutional guarantee of equal protection.
In a five-to-four decision in favor of the surviving spouse, the Supreme Court noted that “regulation of domestic relations is an area that has long been regarded as a virtually exclusive province of the States.” It went on to say that “when the State used its…authority to define the marital relationship [to include same-sex marriage], its role and its power in making the decision enhanced the recognition, dignity and protection of the class in their own community….DOMA operates to deprive same-sex couples of [these] benefits and responsibilities and…seeks to injure the very class New York seeks to protect. By doing so it violates basic due process and equal protection principles applicable to the Federal Government.” It concluded that “though Congress has great authority…it cannot deny the liberty protected by the Due Process Clause of the Fifth Amendment.”
The Supreme Court decision did not address the validity of Section 2 of DOMA, which gives individual states the right to recognize, or not recognize, same-sex marriages of other states. Moreover, the decision was specifically limited to same-sex marriages, and does not address civil unions or domestic partnerships. With this decision, same-sex couples in states that recognize such marriages will obtain marriage-based federal rights and benefits, as described below, under employer-sponsored benefit plans. The effect of the decision on same-sex spouses who reside in states that do not recognize same-sex marriage is less clear, and must await regulatory guidance.
As the Supreme Court majority opinion pointed out, “DOMA’s sweep involves over 1,000 federal statutes and a myriad of federal regulations.” No doubt, it will take many agency rulings and many further court cases before all of the issues can be resolved. In the meantime, the following are the areas in which employee benefit plans are impacted by this important decision, as well as some of the questions it leaves unanswered. A subsequent Newsletter will discuss the impact of the Windsor decision on the federal estate tax.
Retirement Plans
All tax-qualified retirement plans and most plans subject to the Employee Retirement Income Security Act of 1974 (ERISA) are required to contain a number of provisions that hinge upon the marital status of the plan participant. They include the following:
Spousal Death Benefit – A retirement plan may not pay a death benefit to a beneficiary other than the participant’s surviving spouse unless the spouse consents to the designation of a non-spouse beneficiary, and the participant’s spouse is generally the default beneficiary if there is no beneficiary designation. As a result of the Windsor decision, a participant who has designated a beneficiary other than his or her same-sex spouse, or wishes to designate such an individual as his or her beneficiary, must now obtain the consent of his or her same-sex spouse to the designation.
Defined benefit pension plans must provide an annuity to the surviving spouse if the participant dies before retirement benefits begin, unless a different beneficiary has been designated with spousal consent or the survivor rights have been waived with spousal consent. Same-sex spouses in recognizing states now have the right to receive a preretirement survivor annuity unless they have consented to its waiver.
Spousal Annuity – A pension plan (both defined benefit and money purchase pension plans) must pay lifetime benefits in the form of a joint and survivor annuity with the participant’s spouse as the survivor, unless the participant’s spouse consents to a different form of payment. For these plans, same-sex spousal consent will now be required in recognizing states for non-annuity benefit payments or annuity payments that do not provide for a survivor annuity to the spouse.
Qualified Domestic Relations Order – Domestic relations orders requiring the payment of a participant’s benefit to his or her same-sex spouse or their children will now be enforceable against the plan.
Hardship Distributions – Under the hardship distribution rules applicable to 401(k) plans, the rules allowing such distributions for certain medical or educational expenses of spouses will now apply to same-sex spouses.
Plan Loans – Many tax-qualified retirement plans that permit participant loans require spousal consent to any such loan. A state-recognized same-sex spouse’s consent will now be required.
Required Minimum Distributions – Under the minimum distribution requirements applicable to tax-qualified retirement plans, spouses of deceased plan participants may delay the commencement of benefits for a longer period after the participant’s death than non-spouse beneficiaries. State-recognized same-sex spouses will now be able to take advantage of this opportunity to defer payment of death benefits.
Rollovers – A state-recognized same-sex spouse who is entitled to receive a death benefit distribution from a tax-qualified retirement plan will now be able to roll over the distribution to an employer plan, as well as certain other retirement vehicles, and will no longer be limited to making a rollover to an inherited IRA.
Health and Welfare Plans
Imputed Income – As a result of DOMA, employers have had to impute income to an employee when health benefits, which are otherwise tax-free for spouses and dependents, are provided to a same-sex spouse and his or her child, unless the covered individuals qualified as the employee’s dependents which is only rarely the case. Income imputation is no longer required for same-sex spouses in recognizing states, and employers should stop imputing income as soon as possible.
Any over-withholding of federal income or FICA taxes that has occurred in 2013 is likely to be correctable, so most employers will wish to wait for IRS guidance on this point before they adjust affected employees’ withholding. Similarly, refund claims (for the employer’s share of FICA taxes and, with the employee’s consent, the employee’s share of such taxes) for the last three years may also be possible, but we recommend employers await IRS guidance on the issue before they claim refunds.
Cafeteria Plan Contributions and Reimbursements – Prior to the Supreme Court’s decision, employee contributions for health care coverage for same-sex spouses through a premium conversion plan, as well as flexible spending account reimbursements of same-sex spouses, were required to be made on an after-tax basis, unless the covered individual separately qualified as the employee’s dependent. Same-sex spouses and their children in recognizing states may now be covered under an employer’s cafeteria plan, flexible spending account or health reimbursement account on a pre-tax basis.
Cafeteria Plan Change in Status Events – Generally, a cafeteria plan participant may not change his or her cafeteria plan election during a plan year unless there is a change in status event. One such status change occurs when an employee’s “legal marital status” changes. A change in status event allowing a mid-year election change can also occur as a result of changes in a spouse’s coverage or employment. Since same-sex spouses and their children are now eligible for cafeteria plan coverage on a pre-tax basis, this may constitute a change in status event in recognizing states that would permit the enrollment of these individuals in a cafeteria plan under the plan’s existing terms (or under an amendment to the plan if the plan does not currently provide for this as a change in status event).
COBRA – The COBRA continuation rules provide continuation coverage only to employees, spouses and children of employees upon certain qualifying events, such as termination of employment; death, divorce or legal separation of the employee; and the employee’s becoming entitled to Medicare. As a result of the Supreme Court decision, the COBRA continuation rules will apply to state-recognized same-sex spouses in the same way as they previously applied to opposite-sex spouses.
HIPAA – Under the Health Insurance Portability and Accountability Act (HIPAA), a group health plan must permit a newly married participant to add his spouse to his or her coverage, and a spouse must be permitted to enroll in the plan if he or she loses his or her own coverage under another plan. This rule should now apply to same-sex spouses. It is unclear whether the HIPAA special enrollment rules will be applied to same-sex spouses who are newly recognized as spouses for HIPAA purposes as a result of the Supreme Court ruling. No doubt guidance will be forthcoming from the Internal Revenue Service and the U.S. Departments of Treasury, Labor and Health and Human Services.
Nonqualified Deferred Compensation Plans
Many of the IRS rules under Section 409A of the Internal Revenue Code, for example, the ability of an employee covered by such a plan to receive an early payment on account of “unforeseeable emergency”, relate to a participant’s marital status. Moreover, since nonqualified plans are often designed to supplement the benefits under tax-qualified plans that are limited by the tax-qualification rules, the impact of the Windsor decision will also likely be felt by nonqualified plans.
Unanswered Questions
The effect of the Windsor decision on employer plans maintained by employers based in states that recognize same-sex marriage and covering employees resident in that state or another state that recognizes same-sex marriage is relatively clear, at least as to the future. Benefit plan documents that import the definition of a spouse previously required by DOMA will, to the extent they apply in those states, need to be amended to reflect the effective repeal of Section 3 of DOMA. Many plan documents do not incorporate the DOMA definition and will therefore require no amendment. Plan practices will, however, need to change to comply with the applicable non-DOMA rules governing the plan, such as the Internal Revenue Code, HIPAA and COBRA. Thus, beneficiary designations by a participant who is in a same-sex marriage will need to include spousal consent if the designated beneficiary is other than his or her same-sex spouse. Similarly, the imputation of income to same-sex spouses under health and cafeteria plans should cease, and same-sex spouses should be provided appropriate notices under COBRA and/or HIPAA.
At the other end of the scale, an employer based in a non-recognizing state and employing only residents of that state should be unaffected by the Windsor decision, at least with respect to its current workforce. It is between these two extremes that the uncertainty exists. While Section 2 of DOMA, which is unaffected by the Windsor decision, continues to permit a non-recognizing state to treat an individual with a same-sex spouse as unmarried for its state law purposes, the application of federal law, such as Internal Revenue Code and ERISA, to employees in such a state will remain unclear until guidance is forthcoming from, principally, the Internal Revenue Service and the Department of Labor. How the Internal Revenue Code and ERISA will apply to employers based in a non-recognizing state who have employees in same-sex marriages performed in another state and resident in either the non-recognizing or the other state, will require regulatory guidance or further judicial clarification. A similar lack of clarity applies to the reverse situation: an employer based in a recognizing state that has employees resident in a non-recognizing state. One can well imagine the Internal Revenue Service, having lost the uniformity that DOMA was enacted to impose, deciding to apply its own uniform rules for tax purposes, including the rules applicable to employee benefit plans, to employees in all states. If it does, future litigation under Section 2 of DOMA seems inevitable.
The second major area of uncertainty engendered by the Windsor decision is as to its retroactive effect. Generally, when a statute is held to be unconstitutional, it is considered to have been unconstitutional, and therefore void, from its effective date. In the employee benefit plan context, where the applicable law (Internal Revenue Code and ERISA) requires a plan to follow certain rules in practice, there is concern that there may be liability for failing to follow these rules in the past. For example, will a defined benefit pension plan that failed to pay benefits in the form of a qualified joint and survivor annuity to a now-deceased participant, or failed to pay his (same-sex) spouse a qualified pre-retirement survivor annuity, now be required to pay those benefits? In the past, the Internal Revenue Service has given relief to retirement plans from the retroactive imposition of liability for failure to follow tax-qualification rules. It does not, however, have the power to prevent certain parties, such as the surviving same-sex spouse of a deceased participant, from pursuing claims against a benefit plan or its sponsor.
Recommendations
As is evident from the above discussion, there are many uncertainties at present as to the impact of the Supreme Court’s decision. While swift regulatory action to address some of these uncertainties has been promised, budget constraints and competing priorities, such as the Affordable Care Act, make it doubtful that such guidance will be immediate. In the meantime, there are at least five steps that any affected employer should now be considering:
- Stop imputing income for federal income and FICA tax purposes on health plan coverage provided for a same-sex spouse, but continue imputing income for state income tax purposes if the employee resides in a non-recognizing state.
- Communicate the Supreme Court’s decision to employees, and request that any employees in same-sex marriages that may not be known to the employer identify themselves.
- Offer a mid-2013 enrollment right under welfare plans for same-sex spouses not previously eligible.
- Identify all employee plan provisions that may be affected by a changed definition of the term “spouse”.
- Identify all past and present employees who are in a same-sex marriage.
We would be pleased to assist employers in taking any or all of the above steps, and in changing their employee benefit plans and practices to the extent necessary to comply with this important decision.
Please contact us if you need help in implementing any of the recommendations or if you have any questions.