What are the tax implications of the DOMA Ruling?

July 2, 2013 — Leave a comment
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The Supreme Court’s ruling that section 3 of the Defense of Marriage Act (DOMA) is unconstitutional should be good news for tax paying same-sex couples; but, they, along with their employers, are left in a cloud of uncertainty as to how the IRS and other tax authorities will implement the changes.

“We will be working with the Department of Treasury and Department of Justice, and we will move swiftly to provide revised guidance in the near future,” the IRS said.

A central issue is whether the IRS will recognize same-sex couples living in states that do not recognize gay marriage as married for federal tax purposes.  Previously, federal agencies have used state law to determine whether to recognize a couple as married.  That means same-sex couples who reside in states that don’t recognize gay marriage may still not be eligible for joint filing, or any of the 1,137 other federal statutes concerning rights of married couples.

There’s also the issue of amended tax returns, which could net same-sex couples a belated wedding gift: $200 million in refunds.  While there is no way to know exactly how many couples would have been eligible for marriage bonuses and thus paid lower taxes, the IRS can expect thousands of amended returns for newly recognized couples.

The timing of relevant changes is also uncertain, and employers and employees should consider how their benefit plans, including health insurance and pensions, may be affected.

Read on to see a Reuters outline of major employer-provided benefits that are affected by the Supreme Court’s decision.

Spousal coverage under employer-provided health plan. An employee can exclude from gross income amounts received from his employer, directly or indirectly, as reimbursement for expenses for medical care. But the exclusion is available only for the medical expenses of the employee, his/her spouse, and his/her dependents. The exclusion also applies to any child of an employee who hasn’t attained age 27 as of the end of the year. (Code Sec. 105(b)) (These amounts are excludable even where a sole proprietor employer is the employee’s spouse, and the amounts received are for the employer-spouse’s medical care.)

RIA observation: Some employers provide health coverage to domestic partners of employees. However, employers had to tax employees for the benefits provided for their partners. Before DOMA, this was so even if the partners were legally married. Now, as a result of DOMA, there would be no tax for coverage provided for a same-sex spouse. But it is not clear whether this changed treatment will apply prospectively only or whether employers will have to modify their payroll systems to eliminate the income for months in the current year before the ruling came down. It is also not clear whether employees may qualify for refunds of any such tax imposed in prior years that remain open.

Spousal entitlement to health plan coverage under COBRA continuation rules. Employers generally must provide qualified beneficiaries with the opportunity to participate for a specified period of time in the employer’s health plan after that participation otherwise would have terminated due to a qualifying event (e.g., termination of employment). (Code Sec. 4980B(f)(4)) The qualified beneficiary pays for the post-termination coverage. The general COBRA rule is that a qualified beneficiary is the spouse or dependent child of the covered employee. (Code Sec. 4980B(g)(1)) The health care continuation rules generally don’t apply to employers that normally employed fewer than 20 employees on a typical business day in the preceding calendar year. (Code Sec. 4980B(d)(1))

Spousal right to a qualified joint and survivor annuity from an employer-sponsored pension plan. A pension plan (and certain other plans) must in general pay a married participant’s benefits in the form of a qualified joint and survivor annuity (QJSA), unless the participant elects otherwise. If the participant is married, his/her spouse must consent in writing to the participant’s election out. (Code Sec. 417(b))

Spousal consent necessary for qualified plan payments to nonspouse beneficiary. A participant in a defined contribution plan (e.g., 401(k) plan) can choose to leave the remaining balance in his/her account at death to any beneficiary. However, if the participant is married, he/she can leave the account balance to a nonspouse beneficiary only if the participant’s spouse consents in writing. (Code Sec. 401(a)(11))

Spousal consent necessary for certain plan-related actions. A qualified plan participant’s ability to take certain actions relating to his/her account may be constrained if the plan participant is married. For example, if a qualified plan is subject to survivor annuity requirements, a plan participant must obtain spousal consent for any plan loan to a married participant if more than $5,000 of the account balance (present value of the accrued benefit in a defined benefit plan) is used as security for the loan. (Reg. § 1.401(a)-20, IRS’s “Retirement News for Employers,” Fall 2012 Edition – December 13, 2012)

Also, a qualified pension plan may provide for lump-sum distributions under certain conditions. However, if the present value of a QJSA or qualified pre-retirement survivor annuity is more than $5,000, a lump-sum distribution can only be made with the participant’s (and spouse’s, if applicable) written consent. (Code Sec. 417(e)(2))

More favorable distribution options apply. In general, the required minimum distribution (RMD) rules are more liberal for defined contribution plan participants who are married than for defined contribution plan participants who are not married. For example:

  • A uniform table generally is used to calculate lifetime RMDs whether or not the participant’s designated beneficiary is the participant’s spouse, and regardless of the age differential between the IRA owner and designated beneficiary. However, if the participant’s spouse is the sole designated beneficiary of the account, and the spouse is more than 10 years younger than the owner, the distribution period is the longer of: (1) the distribution period found by using the regular uniform table, or (2) the distribution period measured by the joint life and last survivor life expectancy of the IRA owner and the owner’s spouse, determined by using the IRA owner’s and spouse’s attained ages in the distribution year. (Reg. § 1.401(a)(9)-5, Q&A 4(b)(1))
  • The spouse of a deceased employee can roll over a distribution attributable to the employee made by a qualified trust under a Code Sec. 401(a) qualified plan subject to the same rollover rules as if the spouse were the employee. (Code Sec. 402(c)(9))
  • If the plan account owner dies after required distributions begin, and his spouse is the account’s sole designated beneficiary, the rules for RMDs to the spouse are similar to, but more liberal than, the rules that apply to nonspouse beneficiaries. (Reg. § 1.401(a)(9)-5, Q&A 5(a)(1) and Q&A 5(a)(2))

QDRO eligibility. A spouse’s pension benefits are often part of a property settlement. When this is the case, the commonly preferred method to handle the benefits is to get a qualified domestic relations order (QDRO). This gives one spouse the right to share in the pension benefits of the other and taxes the spouse who receives the benefits. Without a QDRO, the spouse who earned the benefits would still be taxed on them even though they are paid out to the other spouse. (Code Sec. 414(p))

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