The Tax Implications of Windsor, for You and Your Clients
Windsor v. United States
The story behind the landmark ruling began simply when Edie Windsor met Thea Spyer in 1963. Thea proposed to Edie in 1967 with a diamond broach. Ms. Spyer and Ms. Windsor were legally married in Toronto, Canada in 2007. Edie Windsor and Thea Spyer shared their lives together until Thea Spyer died from multiple sclerosis in 2009.
Ms. Spyer’s will left Edie as the sole heir of her estate. Because the laws did not recognize the validity of their marriage, Ms. Windsor had to pay $363,053 in taxes to the federal government, and $275,528 to the State of New York. If federal law had recognized the validity of their marriage, Windsor would have qualified for an unlimited spousal deduction and paid no federal estate taxes.
After unsuccessfully searching for counsel for a period of time, Ms. Windsor was referred to Roberta Kaplan, a partner at Paul, Weiss, Rifkind, Wharton & Garrison LLP, who took the case. On November 9, 2010, Paul, Weiss, Rifkind, Wharton & Garrison, in conjunction with the American Civil Liberties Union (ACLU), filed the case in the U.S. District Court for the Southern District of New York on behalf of Windsor as executor of Spyer's estate.
U.S. District Court Judge Barbara S. Jones ruled on June 6, 2012, that a rational basis test analysis of Section 3 of DOMA showed that the law in question violated plaintiff's rights under the equal protection guarantees of the Fifth Amendment. Therefore, as Section 3 violated the equal protection clause, it was unconstitutional. Judge Jones’ further ordered that Windsor receive the tax refund due to her.
At the Court of Appeals, Judge Dennis Jacobs, and Judges Straub and Droney heard oral arguments in the case on September 27, 2012. On October 18, 2012, the Second Circuit Court of Appeals upheld the lower court's ruling that Section 3 of DOMA is unconstitutional. The majority opinion held that laws which classify people based on sexual orientation should be subject to heightened scrutiny based on four factors: “A) homosexuals as a group have historically endured persecution and discrimination; B) homosexuality has no relation to aptitude or ability to contribute to society; C) homosexuals are a discernible group with non-obvious distinguishing characteristics, especially in the subset of those who enter same-sex marriages; and D) the class remains a politically weakened minority.” Windsor v. United States, 699 F.3d 169, 181-182 (2d Cir. 2012).
On June 26, 2013, the U.S. Supreme Court ruled in a 5-4 decision that section three of the so-called "Defense of Marriage Act" (DOMA) is unconstitutional and that the federal government cannot discriminate against married lesbian and gay couples for the purposes of determining federal benefits and protections.
This decision impacts many aspects of the legal landscape, but particularly those which deal with tax, for individuals and their employers. This article will explore the tax issues and solutions facing same sex marriages, and employers in a state which does not recognize same sex marriage.
Federal Taxes
Place of Celebration Principle: Revenue Ruling 2013-17
In response to the Windsor decision, the Internal Revenue Service (“IRS”) issued Revenue Ruling 2013-17, which provides that the IRS will recognize “all legal same-sex marriages… for federal tax purposes.” In so doing, the IRS explained that a same-sex couple will be considered “married” under federal tax laws if their marriage certificate was issued by a domestic or foreign jurisdiction having the legal authority to approve marriages that, at the time, recognized same-sex marriages. Once married, the IRS will deem the couple to be married, even if they are domiciled in a state that does not recognize the validity of same-sex marriages. This recognition for federal tax purposes is known as the “place of celebration” principle. However, this does not apply to registered domestic partnerships, civil unions or similar formal relationships recognized under state laws.
Individual Federal Income Tax Return Procedures Following Windsor: Forms 1040 – Filing Status for Same-Sex Couples
For the tax year ended December 31, 2013, same sex couples who were legally married before or during the tax year 2013 can take advantage of filing their Form 1040, U.S. Individual (joint) Income Tax Return (“Form 1040”), using the filing status of married filing jointly or married filing separately.
Same sex couples who have been legally married for some time should file Forms 1040X, Amended Individual Income Tax Returns (“Forms 1040X”), changing their filing status of single, head of household or qualifying widow(er) to married filing jointly or married filing separately. By filing a Form 1040X, same-sex couples may be entitled to a federal refund. Under Internal Revenue Code § 6511, the statute of limitations for filing a refund claim is either (i) three (3) years from the time the return was filed or (ii) two (2) years from the payment of tax, whichever is later. Consult with your tax advisor to determine whether you may qualify for a refund.
North Carolina State Taxes
Individual State Income Tax Return Procedures Following Windsor: North Carolina Forms D-400 – Filing Procedures
On October 18, 2013, the North Carolina Department of Revenue (“NCDR”) issued Directive Number PD-13-1, which addresses the impact of IRS Revenue Ruling 2013-17 on North Carolina individual income and withholding taxes.
Under this Directive, the NCDR states that it cannot adopt the new definitions that the IRS announced in Revenue Ruling 2013-17, as the State of North Carolina, pursuant to N.C. Gen. Stat. Section 51-1.2, does not recognize same-sex marriage. As a result, the NCDR will not accept Forms D-400, North Carolina Individual Income Tax Returns, using the filing status of married filing jointly or married filing separately, even if that same-sex couple was legally married in a jurisdiction that recognizes marriage between same-sex couples. Unfortunately, this will complicate North Carolina tax return filings for same-sex couples who are entitled to file Forms 1040 using the filing status of married filing jointly or married filing separately pursuant to Revenue Ruling 2013-17.
In North Carolina, pursuant to this Directive, each individual making up a same-sex couple and filing a Form 1040 as married filing separately or married filing jointly will have to file a Form D-400 using the filing status of single (or head of household or qualifying widow(er)). Since North Carolina income tax uses Federal adjusted gross income (“AGI”) as its starting point, each such individual will be required to file a pro forma Form 1040 using the filing status of single (or head of household or qualifying widow(er)) in order to determine that individual’s proper and correct AGI, deductions and tax credits allowed for North Carolina purposes. This pro forma Form 1040 must be attached to the Form D-400. If taxpayers wish to file their Form D-400 electronically, each taxpayer will be required select the “state only” return for North Carolina purposes. The website will then prompt that Taxpayer to complete a pro forma Form 1040 with the North Carolina filing status which will be required as an attachment to the “state only” return transmission to North Carolina.
IRS Special Procedures and Additional Guidance After Windsor
Employer Refunds or Adjustments: Special Administrative Procedures Pursuant to IRS Notice 2013-61
The IRS issued Notice 2013-61 in response to Windsor and Rev. Rul. 2013-17 in order to provide guidance for employers making claims for refunds or adjustments of overpayments of Federal Insurance Contributions Act (FICA) taxes and Federal income tax withholding (employment taxes) pertaining to certain benefits provided to same-sex spouses and reimbursement paid to same-sex spouses resulting from the Windsor decision and Rev. Rul. 2013-17. Employers should discuss the simplified procedures set forth in IRS Notice 2013-61 with their tax advisor.
Cafeteria Plans, FSA’s and HSA’s: IRS Notice 2014-1
On December 16, 2013, the IRS issued Notice 2014-1 to provide direction that specifically addresses cafeteria plans, flexible spending arrangements (FSAs) and health savings accounts (HSAs).
Mid-Year Election Changes Under Cafeteria Plans
Pursuant to IRS Notice 2014-1, an employer cafeteria plan may treat a participant that was married to a same-sex spouse as of June 26, 2013, the Windsor decision date, as if the participant had a change in legal marital status for purposes of the mid-year election change rules. As a result, a participant may revoke their current election and make a new election consistent with the change in marital status. An election to revoke and make a new election pursuant to the Windsor decision will be accepted by a cafeteria plan if filed at any time during the cafeteria plan year that includes June 26, 2013 or the cafeteria plan year that includes December 16, 2013.
IRS Notice 2014-1 also provides guidance on when and under what circumstances an employer must begin treating the amount that an employee pays for same-sex spousal coverage as a pre-tax salary reduction. An employer who, prior to the end of the cafeteria plan year including December 16, 2013, receives notice that a participant is married to the individual receiving health coverage must begin treating the amount that the employee pays for the same-sex spousal coverage as a pre-tax salary reduction under the plan. The employer must do so on (i) the date that a change in legal martial status would be required to be reflected for income tax purposes, or (ii) a reasonable period of time after December 16, 2013, whichever is later.
It is critical to understand that Notice 2014-1 requires the participant to provide notice to the employer. The employer has no duty to seek out such participants. For these purposes, a participant may provide notice to an employer (i) by making an election under the employer’s cafeteria plan to pay for the employee cost of spousal coverage through salary reduction or (ii) by filing a revised Form W-4 stating that the participant is married.
FSA Reimbursements
According to the IRS in its Notice 2014-1, a cafeteria plan may permit a participant’s FSA, including health, dependent care or adoption assistance, to reimburse covered expenses of the participant’s same-sex spouse or a dependent of the same-sex spouse. In order to qualify for reimbursement, the expenses must have been incurred during the period beginning on a date that is no earlier than (i) the beginning of the cafeteria plan year that includes the date of the Windsor decision or (ii) the date of the marriage, if later.
Contribution Limits for HSAs
With regard to HSA contribution limits, Notice 2014-1 states that a same-sex married couple is subject to the joint deduction limitation, which is $6,450.00 for tax year 2013 and $6,550.00 for tax year 2014. If the combined contributions by the same-sex married couple exceed the applicable limits, contributions from one or both of the spouses may be reduced for the remaining portion of the tax year in order to prevent excess contributions. Should the combined contributions to the HSAs of the married couple exceed the limits, any excess may be distributed to one or both spouses no later than the due date of the tax return for the spouses. Any excess undistributed HSA contributions as of the due date of the return will be subjected to excise taxes.
Contribution Limits for Dependent Care Assistance Programs
Similarly to the contribution limits to HSAs, same-sex married couples will be subject to the exclusion limit for contributions to a dependent care FSA, which is $5,000.00 for a married couple. This limit applies to couples who are considered married for federal tax purposes as of the last day of the taxable year, including tax year 2013. Additionally, if the combined dependent care FSA contributions provided by the same-sex spouses exceed the contribution limit for a married couple, $5,000.00, contributions by both or either of the spouses may be reduced for the remaining portion of the tax year. If the combined contributions to the dependent care FSAs of the married same-sex couple exceed the $5,000.00 contribution limit, the excess contributions will be includable in the spouses’ gross income.
Written Plan Amendment
Notice 2014-1 states that a cafeteria plan containing written terms allowing a change in election upon a change in legal marital status generally is not required to be amended to permit a change in status election with regard to a same-sex spouse pursuant to the Windsor decision. However, if a cafeteria plan sponsor chooses to permit election changes that were not previously authorized in the written plan document, the cafeteria plan must be amended to permit such election changes on or before the last day of the first plan year beginning on or after December 13, 2013. The amendment to the written plan document may be effective retroactively to the first day of the plan year, including December 16, 2013, as long as the cafeteria plan operates in accordance with the guidance provided in Notice 2014-1.
Conclusion
The Windsor decision has made an impermeable mark on the legal landscape, and will continue to affect individuals on a personal and business level for years to come. By following the guidelines and procedures set out by the IRS in its recent publications, we can assist our clients in both applying the Place of Celebration rule, and assisting them with complying with federal law. However, due to the differences remaining under state law, same-sex couples who will be subject to favorable federal tax law treatment may encounter burdensome state tax law treatment in those states not recognizing same-sex marriage.
Jon Espinola is an associate on the Tax Team in the Charlotte Office of Wishart Norris. He focuses his practice on Internal Revenue Service (IRS) and North Carolina Department of Revenue (NCDR) tax controversy matters for individuals and closely held businesses. In addition to controversy matters, Jon also advises individuals and closely held businesses on the tax consequences of various business and non-business decisions as well as the reporting requirements of such decisions.
Rachel M. Blunk is an associate on both the Commercial and Litigation Teams in the Burlington office of Wishart Norris. In her litigation practice, she handles business disputes, such as breach of contract actions, intellectual property disputes, and enforcing and defending covenants not to compete. In her transactions practice she focuses on the needs of closely held corporations, particularly the protection of intellectual property, federal contracting, succession planning, and employment issues.
