Federal Taxation of Healthcare Benefits for Same-Sex Couples: Current Status and Ongoing Developments
Current Status of State Law
Currently, the legal status of same-sex relationships is treated in a variety of ways at the state level. Washington D.C., Massachusetts, Connecticut, Iowa, Vermont, New Hampshire and New York have legalized same-sex marriages, and attorney generals in Maryland, New Mexico, Rhode Island and Wyoming have issued opinions declaring that their states will recognize valid same-sex marriages performed in others states or jurisdictions. In addition, several states that do not provide for same-sex marriage do provide “marriage equivalent” status to same-sex couples that is intended to be the equivalent of state-level spousal rights. These include California, New Jersey, Illinois, Delaware, Hawaii, Nevada, Oregon and Washington. Yet another group of states provide some, but not all, state-level benefits to same-sex couples as they do to opposite-sex couples, including Colorado, Maine and Wisconsin.
Current Status of the Federal Defense of Marriage Act
Until 1996, the federal government generally recognized marriages conducted legally in any state for the purpose of federal legislation. However, in 1996, over fears that states were legalizing same-sex marriage, Congress passed and President Clinton signed into law the Defense of Marriage Act (“DOMA”). Section 3 of DOMA excludes same-sex marriages and domestic partnerships from the definition of ‘marriage’ and same-sex partners from the definition of ‘spouse’ for all federal law purposes.
On February 23, 2011, Attorney General Eric Holder announced that the Department of Justice would no longer defend Section 3 of DOMA. On March 4, 2011, Speaker of the House John Boehner (R-OH) stated that the House of Representatives would defend DOMA in court if the Department of Justice refused to do so.
Impact of DOMA on Federal Tax Law
The plain language of DOMA requires that Section 3 of DOMA applies to the Internal Revenue Code, as well as guidance issued thereunder. Under current federal tax law, employees whose employer provides subsidized medical coverage for opposite-sex spouses may exclude the value of this coverage from their taxable wages for federal tax purposes. Additionally, under flexible spending accounts, health reimbursement accounts and health savings accounts, employees can generally use pre-tax dollars to pay for health benefits for their opposite-sex spouses and exclude such amounts from their taxable wages for federal tax purposes.
However, as a result of DOMA, same-sex couples are not currently eligible for the same tax treatment. As a result, the value of subsidized medical coverage for a same-sex spouse or partner is reportable as imputed income to an employee and is therefore taxable at a federal level (and often at a state level, depending on the state1). Also, an employee currently may not use pre-tax dollars under flexible spending accounts, health reimbursement accounts and health savings accounts to pay for health benefits for their same-sex spouse or partner.
Same-sex spouses or partners may receive subsidized medical coverage without the value of such coverage being reportable as imputed income if the same-sex spouse or partner is a “dependent” of the employee for federal tax purposes. Additionally, pre-tax dollars under flexible spending accounts, health reimbursement accounts and health savings accounts may be used to pay for health benefits for dependents. However, in order to qualify as a dependent for federal tax purposes, (1) the same-sex spouse cannot be the employee’s dependent child or the dependent child of anyone else for federal tax purposes, (2) the same-sex spouse must live with the employee for the entire year as a member of the employee’s household or be related to the employee, (3) the same-sex spouse must have less than $3,700 in gross income for the year, and (4) the employee must provide more than half of the same-sex spouse’s total support during the calendar year. Obviously, such a definition would generally exclude a working same-sex spouse earning in excess of $3,700 per year.
Impact of DOMA on State Tax Law
As described above, some states have passed state laws relating to same-sex marriage and domestic partnerships, and some states have passed state laws that require equal treatment for same-sex and opposite-sex couples. The result is that employee plans, including health plans, that do not address the potential conflict between state and federal definitions of ‘marriage’ and ‘spouse’ in plan documents and plan administration run the risk of inadvertently violating either federal law (DOMA) or state law. In addition, employers may be caught in an impossible position where their plans cannot comply with federal law (which requires disparate treatment) and state law (which requires equal treatment), depending on the state where benefits are provided.
On March 16, 2011, the Respect for Marriage Act was introduced in both houses of Congress. It would repeal DOMA as it applies to federal law and provide that ‘marriage’ and ‘spouse’ be defined for federal purposes via applicable state law, but would not require any state to recognize same-sex marriages. President Obama announced his support for the bill on July 19, 2011.
In addition, some employers and plan sponsors have dealt with the current state of affairs by providing tax gross ups to same sex-spouses or partners for the value of the imputed income reported to employees as a result of subsidization of same-sex partner medical coverage so as to put such employees in the same position, tax-wise, as their colleagues with opposite-sex partners. Employers who have currently taken such action include Bain & Co., Barclays Capital, Cisco Systems, Inc., Credit Suisse USA Inc., Discover Communications, Inc., Facebook, Inc., Google Inc., Kimpton Hotels & Restaurants and a number of national law firms.
Other Tax Issues for Same Sex Couples
This Alert addresses only the federal taxation of health benefits for same-sex couples. There are many additional federal and state tax issues for such couples, including with respect to the taxation of retirement plan benefits and income in community property states, which are not covered here.
Plan Sponsor Next Steps
Plan sponsors should review and amend their plan documents to address whether and how to recognize same-sex relationships and how to address conflicts between federal and state law in this area in plan documents and administration. In addition, plan sponsors need to keep abreast of both federal and state law developments to ensure that their plans are being operated in compliance with these laws.
1 Some states have passed laws eliminating taxation of subsidized medical coverage for same-sex spouses on a state level, including Massachusetts, Vermont, Connecticut and Rhode Island.