Guest Article

(From the June 2, 2008 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

When Federal and State Definitions of Marriage Do Not Agree -- An Overview for Employee Benefit Plan Sponsors

California appears poised to become the second state to permit same-sex couples to marry. Almost exactly four years after Massachusetts started issuing marriage licenses to same-sex couples, the California Supreme Court on May 15, 2008 ruled that the state's Constitution prohibits the current legal regime under which same-sex partners can enter into legally recognized domestic partnerships -- but not marriage. Even if California begins recognizing same-sex marriages, the federal Defense of Marriage Act (DOMA) will preclude these couples from being treated as "spouses" under federal law -- including the Internal Revenue Code, ERISA, and other federal laws relating to benefits and employment.

Still, there is uncertainty as to when -- or whether -- California will begin issuing marriage licenses to same-sex couples. An effort is underway to amend the California Constitution to overturn the Supreme Court's decision by way of a ballot initiative in November. Supporters of the proposed amendment have asked the California Supreme Court to stay its ruling until after that initiative is approved or rejected by the voters. A ruling on that motion will be forthcoming in the near future.

Effect on Employee Benefit Plan Sponsors

The different definitions of "marriage" and "spouse" under federal and state law can raise a number of complicated legal questions for employee benefit plan sponsors. For example, what is the appropriate tax treatment of health coverage provided to an employee's same-sex spouse? Because federal law does not recognize same-sex spouses, the value of the coverage is imputed income to the employee for federal income tax purposes. However, the answer is different for state tax purposes in those states that recognize same-sex marriage, and perhaps in others that grant spousal-type rights to same-sex couples.

Not so long ago this seemed to be an issue only for those employers with employees in Massachusetts. The possible addition to this list of California -- the nation's most populous state -- means many more employers soon may be affected. Additionally, five states (Connecticut, New Hampshire, New Jersey, Oregon and Vermont) provide the equivalent of statewide spousal rights to same-sex couples, and four others (the District of Columbia, Hawaii, Maine, and Washington State) offer some statewide spousal rights to same-sex couples.

Further complicating matters is the fact 26 states have amended their constitutions to prohibit same-sex marriage. These constitutional amendments can have employee benefits implications too, as illustrated by recent developments in Michigan. Specifically, the Michigan Supreme Court has ruled that state's constitution prohibits public employers from providing health benefits to employees' same-sex domestic partners.

Finally, 18 states have laws restricting marriage to one man and one woman. This includes six states that also extend at least some spousal rights to same-sex couples. (One state -- Oregon -- has a constitutional amendment prohibiting same-sex marriage but also gives spousal-equivalent rights to same-sex couples.)

The bottom line is, employers need to be aware of the relevant laws in all the states in which they operate -- and how those laws might affect their employee benefit plans and payroll practices. But that is easier said than done in such a dynamic environment.

Following is a brief overview of the interaction between federal and state definitions of "marriage," and some of the potential issues for employers sponsoring benefit plans for their employees.

Federal Law Definition of "Marriage" and "Spouse"

According to the DOMA:

Thus, a same-sex couple legally married in California or Massachusetts still may not claim any of the tax preferences or other rights available to married couples under the Internal Revenue Code, ERISA, or various other related federal laws. The same is true for a same-sex partner with spousal rights under state law. A General Accountability Office (GAO) report identifies 1,138 federal statutory provisions "in which marital status is a factor in determining or receiving benefits, rights, and privileges." Some relevant examples include:

Different Tax Treatment for Employee Benefits

Employer-provided health benefits for employees' spouses and dependents are not included in the employees' gross incomes for both federal and state tax purposes. Likewise, employees can use their employers' IRC § 125 cafeteria plans to pay their share of group health premiums on a pretax basis, including premiums attributable to coverage for the employees' spouses and dependents. Almost all states likewise permit employees to pay group health premiums on a pre-tax basis.

But what is the tax treatment of health benefits provided to an employee's same-sex spouse? Because of the DOMA, federal tax law does not recognize same-sex marriage, so employer benefits extended to same-sex spouses generally will not be tax exempt unless the same-sex spouse qualifies as the employee's dependent under IRC § 152. However, those same benefits will not be taxable income for state income tax purposes in a state that permits same-sex marriage.

What does this mean for the employer's income reporting and withholding requirements? For purposes of the federal income tax, employers generally will have to report the fair market value of benefits provided to employees' same-sex spouses as gross income to the employees, and withhold for applicable federal income and employment taxes. Also, any employee premium contributions on behalf of a samesex spouse must be made on an after-tax basis. By comparison, a state that recognizes same-sex marriage will not treat the value of employer-provided coverage to an employee's same-sex spouse as income for state tax purposes, and may permit the employee to pay his or her entire premium share on a pre-tax basis.

Plan Interpretation

ERISA plan documents frequently refer to a participant's "spouse" without specifically defining that term. For example, as required by IRC § 417(a) (and its counterpart, ERISA § 205(a)), a pension plan will require a married participant's spouse to consent if the participant wants to elect a lump sum distribution in lieu of the qualified joint and survivor annuity. If the participant lives in California or Massachusetts and has a same-sex spouse, should the plan treat the participant as married or single for purposes of this requirement?

Because the question involves interpreting the terms of an ERISA plan, and because ERISA preempts any state laws to the extent they "relate to" ERISA plans, the presumptive answer is that federal law controls. But plan sponsors may want to consider reviewing their plan documents and possibly amending them to clarify the meaning of the terms "spouse" and "marriage" as used in their plans. (Of course, plan sponsors should consult with their attorneys before making any such changes to their plans.)

Other Considerations for Employers

The fact that same-sex spouses are not treated as "spouses" for purposes of these and other federal laws does not mean employers cannot extend many of these same rights to their employees' same-sex spouses. For example, as some employers now do for domestic partners, an employer might create parallel COBRA-type rights for employees' same-sex spouses. Likewise, an employer could create FMLA-type rights for employees to take unpaid leave to care for same-sex spouses.

Additionally, employers should be mindful of state employment and benefit mandates they may have to honor with respect to same-sex spouses. For example, California and Massachusetts are among the states that have enacted a COBRA-type law. To the extent their laws create rights for spouses, those rights would have to be extended to same-sex spouses.

The information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations. If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Mary Jones 202.378.5067, Stephen LaGarde 202.879-5608, Erinn Madden 202.572.7677, Bart Massey 202.220.2104, Mark Neilio 202.378.5046, Martha Priddy Patterson 202.879.5634, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Tom Veal 312.946.2595, Deborah Walker 202.879.4955. Copyright 2008, Deloitte.