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Same-Sex Marriage and ERISA in the Windsor Era

Tuesday, September 10, 2013

By Benjamin Takis, Tax-Exempt Solutions PLLC  

The Supreme Court's landmark ruling in United States v. Windsor,1 invalidating Section 3 of the Defense of Marriage Act (DOMA) , marks a dramatic shift in our legal system's treatment of same-sex couples. By invalidating Section 3's restriction on federal government recognition of same-sex marriage, Windsor returns the determination of spousal status to the states and ensures equal treatment for state-law-recognized same-sex spouses with respect to employee benefits matters, including pension survivor benefits, qualified domestic relations orders, the tax treatment of health and welfare benefits, plan rollovers, and more.

In addition to these immediate consequences under the Employee Retirement Income Security Act (ERISA) and the tax code, Windsor and the recent legislative and judicial developments in the states suggest a wider move toward nationwide recognition of same-sex marriage over the years or decades to come. These trends indicate that same-sex couples are likely to eventually achieve total parity with opposite-sex couples with respect to employee benefits, tax and other legal purposes. Employee benefit plans too should eventually be able to administer benefits in the same manner for all participants, gay or straight.

In the meantime, however, plans will need to grapple with difficult issues that Windsor did not resolve. In particular, Windsor did not address how to determine whether same-sex couples are legally married under state law, or the scope of Windsor‘s retroactive effect. The Internal Revenue Service (IRS) has started to resolve some of these issues with the recent issuance of Revenue Ruling 2013-17 (169 PBD, 8/30/13; 40 BPR 2081, 9/3/13). This article discusses the effect of Windsor and Rev. Rul. 2013-17, and provides an initial exploration of the issues that remain open in the “Windsor era.”

Overview of Windsor and Its Effects

The Supreme Court issued its decision in Windsor on June 26. Windsor was a tax case involving Edith Windsor, who wed her same-sex spouse, Thea Spyer, in Ontario, Canada, in 2007. Windsor and Spyer lived in New York, which recognized the validity of their marriage pursuant to New York law. When Spyer died in 2009 and left her entire estate to Windsor, Windsor sought to avoid paying federal estate taxes on the proceeds through the federal estate tax exemption for surviving spouses. Because DOMA provides that under federal law, “the word ‘marriage’ means only a legal union between one man and one woman as husband and wife, and the word ‘spouse’ refers only to a person of the opposite sex who is a husband or a wife,”2 the IRS denied Windsor the estate tax exemption and she paid $363,053 in estate taxes before seeking a refund in the federal courts. After a questionable ruling on the Supreme Court's jurisdiction to rule on the appeal,3 the high court held that Section 3 of DOMA violates due process requirements under the Fifth Amendment of the U.S. Constitution by denying gay couples the marriage rights afforded to them under state law.4 Accordingly, Section 3 of DOMA is invalid, and state law determinations of spousal status must now be respected for purposes of federal law.

Prior to Windsor, Section 3 of DOMA made same-sex spouses ineligible for a wide range of tax benefits, employment-related protections and other federal rights and entitlements. In the context of employee benefits, Windsor's effects include the following:


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  • Employees may cover their same-sex spouses under health care plans provided by their employers without having to pay taxes on the value of such coverage.5  

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  • Same-sex spouses have full rights to continuation health care coverage under the Consolidated Omnibus Budget Reconciliation Act (COBRA) in the event of a participant's termination of employment, divorce or legal separation.6  

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  • Employees may receive tax-free reimbursement under flexible spending accounts,7health reimbursement arrangements8and health savings accounts9for qualified medical expenses incurred by same-sex spouses.  

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  • Same-sex spouses are entitled to the same special enrollment right under the Health Insurance Portability and Accountability Act (HIPAA) as opposite-sex spouses.10  

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  • Same-sex spouses are entitled to a 50 percent qualified joint and survivor annuity (QJSA) or a 75 percent qualified optional survivor annuity (QOSA) under a participant's pension plan, and the spouse's consent is required to pay pension benefits in any other form.11  

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  • Same-sex spouses are entitled to a 50 percent qualified preretirement survivor annuity (QPSA) where the participant dies prior to commencing pension benefits, unless the spouse consents to waive the benefit.12  

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  • Same-sex spouses are entitled to receive 100 percent of a participant's Section 401(k) account balance at death, unless the spouse consents to another beneficiary.13  

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  • Same-sex spouses are clearly eligible to receive a qualified domestic relations order (QDRO) apportioning pension benefits upon divorce.14  

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  • Same-sex spouses may roll over plan distributions to their own individual retirement account or employer plan, rather than only being able to roll over to an “inherited IRA” (which is subject to more restrictions).15  

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Implications for Future Cases

Under Windsor, these federal rights apply only to same-sex spouses recognized under applicable state law—there is no requirement that all states recognize same-sex marriage.16 Windsor held only that the federal government's lack of recognition of state-approved same-sex marriages violated the Fifth Amendment's due process and equal protection principles, which do not apply to the states. Only a ruling under the Fourteenth Amendment would have the effect of requiring the states to recognize same-sex marriage, and the majority was careful to emphasize that this was not part of its opinion. As of today, states are thus free to continue to limit marriage to opposite-sex couples and deny recognition of same-sex marriages celebrated in other states.17

Notwithstanding the limitations of the majority opinion, Windsor may have implications for future cases addressing the validity of state law limitations on same-sex marriage. The majority's reasoning relied largely on the premise that DOMA's purpose was a “bare … desire to harm” gay couples “whose moral and sexual choices the Constitution protects.”18 This language bears a striking resemblance to Fourteenth Amendment principles and may provide the framework for a future decision requiring nationwide recognition of same-sex marriage.

While the majority stressed that DOMA's unique abrogation of traditional state law determinations regarding spousal status was crucial to its decision,19 Justice Antonin Scalia's dissent, in fact, accused the majority of obscuring the true rationale behind its opinion and predicted that the majority's opinion would lead directly to a decision requiring states to recognize same-sex marriage.20 Time will tell whether Justice Scalia's prediction comes true, but such a result would not be surprising.

Determining Spousal Status

How to determine whether same-sex couples are legally married for federal tax purposes was a key issue left unresolved by Windsor. The Supreme Court had no need to address this issue in Windsor because it was clear that New York, the state of Edith Windsor's and Thea Spyer's residence, recognized the validity of their marriage, which was celebrated in Canada. The issue is more difficult when a same-sex couple gets married in a state that recognizes same-sex marriage but lives in or moves to a state that does not recognize it. Since Section 2 of DOMA remains intact and each state can make its own decision on whether to recognize same-sex marriage, it was not initially clear whether a same-sex marriage would be considered valid if the couple's state of residence limits marriage to opposite-sex couples. In fact, the Department of Labor's Wage and Hour Division and the Social Security Administration recently issued guidance requiring these agencies to look to the law of the couple's state of residence to determine whether same-sex marriages are valid (a “state-of-residence” rule).21 Moreover, most of the ERISA cases addressing the validity of marriages for purposes of spousal benefits (which generally involve participants with multiple possible spouses) have followed a state-of-residence rule.22

The prospect of a state-of-residence rule caused some consternation among employee benefit plans. Such a rule would have required plans to keep track of rapidly evolving state laws and alter plan administration as participants and spouses covered under the plan moved from state to state. Fortunately, the IRS recently issued Rev. Rul. 2013-17, which makes it clear that same-sex marriages will be considered valid for all tax and employee benefit purposes as long as the couple was married in a state that recognizes same-sex marriage (a “state-of-celebration” rule).23

In Rev. Rul. 2013-17, the IRS held that the terms “spouse,” “marriage,” “husband” and “wife” would all be interpreted in a gender-neutral manner under the tax code to include valid same-sex marriages. Additionally, the IRS extended Rev. Rul. 58-66, a 55-year-old ruling applying a state-of-celebration rule, for purposes of determining the validity of common law marriages, to same-sex spouses.24 The IRS reasoned that “[g]iven our increasingly mobile society, it is important to have a uniform rule of recognition that can be applied with certainty by the Service and taxpayers alike for all Federal tax purposes.” The IRS further cited the administrative problems that a state-of-residence rule would raise, particularly for employee benefit plans, explaining that “the need for and validity of spousal elections, consents, and notices could change each time an employee, former employee, or spouse moved to a state with different marriage recognition rules,” and “plan administrators would need to continually track the state of domicile of all same-sex married employees and former employees and their spouses.” Accordingly, “individuals of the same sex will be considered to be lawfully married under the [tax code] as long as they were married in a state whose laws authorize the marriage of two individuals of the same sex, even if they are domiciled in a state that does not recognize the validity of same-sex marriages.”

The IRS noted, however, that the terms “marriage” and “spouse” would not be interpreted to include domestic partnerships, civil unions or other similar formal relationships recognized under state law that are not denominated as “marriage” under the laws of that state.

In light of Windsor and Rev. Rul. 2013-17, plans should begin reviewing their plan documents and administrative procedures to ensure compliance with the post-Windsor definitions of “marriage” and “spouse.” Plans should also make sure that they follow a state-of-celebration rule in determining the validity of same-sex marriages. The IRS stated in Rev. Rul. 2013-17 that future guidance will be issued providing sufficient time for any such plan amendments or corrections, but the sooner that plans can identify needed corrections, the better.

Retroactive Application of Windsor

The possible retroactive effect of Windsor raises more difficult issues that may take some years to fully resolve. Edith Windsor will presumably receive a $363,053 refund for the prior tax year at issue in the litigation. The IRS also stated in Rev. Rul. 2013-17 that the post-Windsor definitions of “marriage” and “spouse” will apply retroactively for purposes of amended returns, adjusted returns or claims for credit or refund, provided the statute of limitations under Section 6511 of the tax code has not expired, including for purposes of determining the taxability of spousal health and fringe benefits.25 But Windsor and Rev. Rul. 2013-17 were silent as to the general retroactive effect of the decision for other federal law purposes. It is therefore unclear at this point how Windsor will be applied to the tricky issue of retroactive surviving spouse rights under ERISA.

Problems With Full Retroactivity

Fully retroactive application of Windsor in the context of ERISA's QJSA and QPSA rights would raise numerous problems. If Windsor is interpreted to grant these rights to same-sex spouses retroactively, plans could potentially be required to pay pensions to the spouses of participants who died years ago, adjust the pensions of participants who have long since retired and commenced payment of pension benefits, or divert pension benefits that may have been paid to nonspouse beneficiaries named without the consent of the same-sex spouses.

An additional problem is that plan administrators, having necessarily relied on the validity of DOMA, may not have incorporated these spousal benefits into their actuarial calculations. Plans would therefore appear to have a compelling argument to make about the hardship of requiring retroactive compliance with Windsor, based on the necessity of their reliance on DOMA and the unique difficulty of unwinding and adjusting pension benefits after they have accrued and/or commenced.

Supreme Court Jurisprudence

Despite these reliance arguments, the current state of the Supreme Court's jurisprudence favors full retroactivity of constitutional determinations under civil law for cases not foreclosed by statutes of limitations or res judicata. The traditional common law view, as summarized by the Supreme Court in 1886, was that “[a]n unconstitutional act is not a law; it confers no rights; it imposes no duties; it affords no protection; it creates no office; it is, in legal contemplation, as inoperative as though it had never been passed.”26 This view reflects the notion that the Supreme Court's decisions do not make new law, but discover the true state of the law that has always been. As courts are only authorized to interpret the law, prospective rulemaking is considered the sole province of the legislative branch. Under this view, Section 3 of DOMA has been unconstitutional ever since it was passed, and the federal government's attempt to treat same-sex spouses differently pursuant to DOMA has never been valid.

The Supreme Court's adherence to the common law view has fluctuated over the years, due in large part to recognition of the reliance interests that may warrant protection when a law is invalidated. The Supreme Court had for some years followed a flexible approach to retroactive application of civil law decisions, as set forth inChevron Oil Co. v. Huson, a case involving the application of a decision that had the effect of imposing a more strict statute of limitations to certain personal injury claims governed by federal law.27 Chevron required consideration of three factors in determining whether a decision can have nonretroactive effect: (1) whether the decision establishes a new principle of law; (2) the prior history of the rule in question, its purpose and effect, and whether retrospective operation will further or retard its operation; and (3) the injustice or hardship that would be imposed by retroactive application.28

The Supreme Court has since retreated from the flexible approach in Chevron, and full retroactivity is currently the norm for all cases in which the high court does not specifically reserve the question of retroactivity, aside from cases otherwise barred by res judicata or a statute of limitations. In James B. Beam Distilling v. Georgia, the Supreme Court reversed a lower court decision limiting the retroactive effect of an earlier Supreme Court ruling invalidating under the U.S. Constitution's Commerce Clause a state tax statute favoring local alcohol producers.29 Writing for a fractured Supreme Court in a case that spawned multiple written opinions without a clear majority, Justice David H. Souter concluded, without application of the Chevron factors, that the normal rule of full retroactivity applied because the Supreme Court's earlier Commerce Clause ruling did not reserve the question of whether the retroactive effect decision was open for limitation.30

A more unified Supreme Court addressed retroactivity again in Harper v. Virginia Department of Taxation, 509 U.S. 86 (1993), in which it considered the retroactive application of a prior ruling that states violate the constitutional doctrine of intergovernmental tax immunity when they tax retirement benefits paid by the federal government while exempting retirement benefits paid by the state or its political subdivisions.31 The Harper court declined to apply the Chevron factors with respect to a prior ruling that did not reserve the question of retroactivity, concluding that “[w]hen this Court applies a rule of federal law to the parties before it, that rule is the controlling interpretation of federal law and must be given full retroactive effect in all cases still open on direct review and as to all events, regardless of whether such events predate or postdate our announcement of the rule.”32

Because Windsor was silent as to the possibility of nonretroactive application, the rules established in Beam and Harper would appear to require fully retroactive application of Windsor, despite the apparent injustice to employee benefit plans.

Tax Code Provision Regarding Retroactivity

The tax code has a specific provision that may authorize certain limitations on Windsor's retroactive effect on employee benefit plans, notwithstanding Beam and Harper. Section 7805(b)(8) of the tax code authorizes the Treasury Department to “prescribe the extent, if any, to which any ruling (including any judicial decision or any administrative determination other than by regulation) relating to the internal revenue laws shall be applied without retroactive effect.”

Section 7805(b)(8) was most recently applied with respect to employee benefits following the Supreme Court's decision in Central Laborers' Pension Fund v. Heinz,33 in which the high court held that a plan's expansion of the types of post-retirement employment that trigger suspension of benefits under the plan violates ERISA's anti-cutback rules. Plans had previously relied on IRS representations indicating that such plan amendments were permissible, and the Supreme Court noted in Heinz the agency's power under Section 7805(b)(8) to limit the retroactive effect of the decision on employee benefit plans.34

The IRS subsequently issued Rev. Proc. 2005-23, providing a transition period for plans to adopt complying amendments, and stating that the adoption of the types of plan amendments prohibited by Heinz prior to the date of the Heinz ruling would not cause plans to be disqualified for tax purposes.35 However, Rev. Proc. 2005-23 addressed only the tax-qualification of employee benefit plans under the tax code. It did not affect the rights of participants to sue under the anti-cutback provisions,36 and participants who subsequently sued under Heinz had their benefits restored retroactively.37

The IRS indicated in Rev. Rul. 2013-17 that it intends to issue further guidance concerning the retroactive application of Windsor to employee benefit plans, which will “take into account the potential consequences of retroactive application to all taxpayers involved, including the plan sponsor, the plan or arrangement, employers, affected employees and beneficiaries.”38 There are two major questions as plans await this IRS guidance: (1) whether the IRS will follow the approach in Rev. Proc. 2005-23 and limit its guidance to affect only the tax-qualification of employee benefit plans, or alternatively whether this guidance will purport to affect the rights of same-sex surviving spouses to sue under ERISA; and (2) if the IRS guidance does rule on the retroactivity of surviving spouse rights under ERISA, whether such guidance is authorized by Section 7805(b)(8) and valid in light of Beam and Harper.

Courts have not addressed whether Section 7805(b)(8) authorizes the IRS to limit the rights of participants to sue to enforce ERISA rights.39 Arguably, the surviving spouse rights set forth in Section 205 of ERISA “relate[] to the internal revenue laws” within the meaning of Section 7805(b)(8), insofar as such rights are also set forth as a condition of tax-qualified plan status under sections 401(a)(11) and 417 of the tax code. Moreover, the IRS has exclusive authority to issue regulations, rulings, opinions, variances and waivers under Section 205 of ERISA pursuant to Reorganization Plan No. 4, which Congress ratified in 1984.40 On the other hand, it is not clear whether Section 7805(b)(8) authorizes the IRS to do anything more than protect the tax-qualified status of plans that relied on the validity of DOMA. It is also not clear whether Section 7805(b)(8) trumps the retroactivity rules of Beam and Harper. Until the IRS issues further guidance on the retroactivity issue and courts rule on the permissible scope of such guidance, the prospect of retroactive liability for same-sex surviving spouse benefits under ERISA remains a very real possibility for employee benefit plans.

Conclusion

In time, it is likely that the questions regarding the application of Windsor will fade from relevance, as recognition of same-sex marriage evolves throughout the country and subsequent court decisions and administrative guidance clarify unresolved issues. With the issuance of Rev. Rul. 2013-17, the IRS has resolved one of the major issues in a manner very favorable to plans and same-sex couples by adopting a state-of-celebration rule for determining the validity of same-sex marriages. Other difficult issues remain, however, particularly involving the possibility of retroactive liability for same-sex surviving spouse benefits.

For now, plans should review their plan documents and administrative procedures for compliance with the post-Windsor definitions of “marriage” and “spouse” and the state-of-celebration rule announced in Rev. Rul. 2013-17. Additionally, plans should assess their potential liability for retroactive same-sex surviving spouse benefits and watch carefully for further guidance from the IRS and/or the DOL.

Benjamin Takis (btakis@taxexemptsolutions.com) is the founder and principal attorney of Tax-Exempt Solutions PLLC.  

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Disclaimer  

This document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. The Bureau of National Affairs, Inc. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy.  

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