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Tuesday, April 8, 2014

Cain & Herzig: Notice 2014-19 and the Application of Windsor to Qualified Retirement Plans

Cain HerzigPatricia A. Cain (Santa Clara) and David Herzig (Valparaiso) have written op-eds for TaxProf Blog on Notice 2014-19, Application of the Windsor Decision and Rev. Rul. 2013-17 to Qualified Retirement Plans:

The purpose of this notice is to provide guidance on the application (including the retroactive application) of the decision in United States v. Windsor, 570 U.S. ___, 133 S. Ct. 2675 (2013), and the holdings of Rev. Rul. 2013-17, 2013-38 I.R.B. 201 (Sept. 16, 2013), to retirement plans qualified under section 401(a) of the Internal Revenue Code (Code).

Patrica Cain (Santa Clara):

In Windsor v. United States, decided on June 26, 2013, the Supreme Court struck down the Defense of Marriage Act, ruling that it violated the Fifth Amendment’s Due Process Clause. On August 29, 2013, the Internal Revenue Service released Rev. Rul. 2013-17, explaining the consequences of the Court’s decision on tax laws that apply to married couples. In that ruling, the IRS announced that it would recognize as valid any marriage entered into by a same-sex couple so long as the marriage was valid in the place of celebration. The IRS also ruled that same-sex married couples could rely on the Windsor opinion’s holding retroactively and thus could amend tax returns for any tax year that was open under the statute of limitations (but were not required to do so).  As to qualified plans, the Service ruled that individual taxpayers, who were covered by employer health plans, could amend to claim refunds on imputed income that may have been reported in earlier years. Taxpayers could also claim refunds for their share of payroll taxes paid on such imputed income (unless the employer was making the claim on behalf of the taxpayer). But the ruling left open for future guidance questions about how Windsor might or might not be applied retroactively to affect a plan’s status as qualified.

On April 4, 2014, IRS and Treasury released Notice 2014-19 which provides that anticipated further guidance. Basically, the Notice sets June 26, the date of the Windsor opinion, as the date on which qualified plans must recognize the rights of same-sex spouses in the operation of their retirement plans, including the spousal benefits available under ERISA. The primary benefits for spouses are the right to receive a joint and survivor annuity from the plan (or a qualified preretirement survivor annuity if the participant spouse dies before retirement) or, in the case of a defined contribution plan, the right to receive the death benefit payable at the death of the participant spouse. There are, however, many additional rules that apply to spouses, such as allocating stock ownership by a spouse to the participant to determine whether an employee is a 5% owner under Section 416(i)(1). And so plan administrators must be careful to include all spouses when applying these rules post June 26.

However, on June 26, we did not know which marriages would be recognized by the IRS. Windsor was a case involving a married couple whose marriage was recognized by the state of domicile. We didn’t know of the IRS place of celebration rule until Revenue Ruling 2013-17 was released, and that ruling did not become fully effective until September 16, 2013. Because of this, it would have been reasonable for some employers to take the position that a plan should only cover same sex couples who were married and domiciled in a recognition state. And so the Notice concludes that if employers have taken this position, their plans remain qualified. However, as of September 16, all plans must abide by the place of celebration rule.

Plans that include language defining spouse in accord with the Defense of Marriage Act (e.g., only a man and a woman) MUST amend their plans to cover all spouses in accord with the IRS position in the 2013 ruling, i.e., spouses married in a jurisdiction that recognizes their marriage, regardless of where the spouses live. Plans whose language does not define spouse or otherwise does include same-sex married couples will not have to amend their plans. But if a plan wants to provide spousal benefits under the plan for any period before June 26, 2013, it must amend the plan to do so. The amendment can be to recognized such spouses for a limited purpose (e.g., for purposes of the joint and survivor annuity) and the amendment can choose an effective date for that amendment. All amendments must be completed by December 31, 2014 (unless the employer has a longer period available under the normal rules for amending plans set forth in Rev. Proc. 2007-44).

Note that these rules all go to the issue of whether or not a plan is qualified. The IRS has no authority to enforce the spousal rights that are created under these various provisions. Its authority is limited to determining whether a plan has included the provisions that it needs to include in its plan in order to remain qualified.

There are several claims being pursued around the country by surviving spouses whose same-sex spouse died before June 26, 2013. In one case, the death occurred just four days before the Windsor case was handed down. How does this Notice affect these claims? Well, if an employer wants to extend the death benefit rights to the surviving spouse, the Notice says that an employer may amend. Amendments to the plan must be made by December 31, 2014. But what if the employer refuses to amend the plan, even to extend the benefit to someone whose spouse died shortly before Windsor? Clearly, the IRS does not think that the employer must amend the plan in such a case. But upon refusal to do so, it is expected that some of these surviving spouses will take their claims to the courts. And we will have to wait and see whether the courts agree with the IRS. More interesting times ahead in the legal world of tax and same-sex spouses.

David Herzig (Valparaiso):

This op-ed is about the newest Treasury guidance, Notice 2014-19, on qualified retirement plans after Windsor. I last posted here and here when the Windsor decision came out in June. In those posts, I wondered how, without DOMA, the federal government would define marriage for same-sex couples for the purposes of the tax code. The U.S. Department of the Treasury (“Treasury”) issued Rev. Rul. 2013-17 (the “Ruling”), in which Treasury (and thus the IRS) stated that, for federal tax purposes, same-sex couples legally married in jurisdictions that recognize their marriages will be treated as married regardless of whether the state of domicile recognizes that marriage. In my previous posts, I explored whether Treasury was correct in applying the state of domicile test.

The Ruling was the first of many anticipated to be issued by Treasury. Although, I criticized the Ruling for potential problems, including, not including alternative marriage arrangements, only using state of domicile and the potential estate tax consequences, the Ruling was important not only for individuals but for retirement planning purposes. The Ruling stated that from September 16, 2013 forward, couples validly married in the state of ceremony would be married for retirement plan purposes. The practical effect of the ruling was that for employer-sponsored retirement plans, the state of ceremony would control. There were many unanswered questions as evidenced by Pat Cain’s op-ed here. Moreover, the Ruling was only prospective in application. Until last week, it was unclear if there would be retroactive application, and if so, how would that work.

Until 1996, retroactivity would be presumed. As part of the Taxpayer Bill of Rights 2, Section 7805(b) was changed to reverse the presumption that regulations would operate retroactively. Thus, the statute retains a presumption of retroactivity for Revenue Rulings only to be changed by the Commissioner. Because the IRS views revenue rulings as interpretations of existing, more authoritative legal sources, it generally applies these rulings retroactively, except where a revenue ruling revokes or modifies another published ruling.

Last week, Treasury issued Notice 2014-19 in which Treasury retroactively applies the rule of Rev. Rul. 2013-17 for retirement plan purposes to the date of Windsor. The Notice is rather straightforward by stating essentially that ERISA qualified retirement plans would not be in violation of the statute because they relied on a definition of spouse using DOMA or similarly restrictive terminology. The purpose of the Notice was to aid plan sponsors in the administration and application of the plan.

The Notice, affected both the participants of plans and the plan sponsors. From September 16, 2013 (the prospective date of the Ruling), legally married same-sex couples had the same spousal rights in tax qualified or ERISA-governed retirement plans regardless of state of domicile. Those rights included: (i) application of the spousal consent rules under qualified joint and survivor annuity (QJSA) and qualified pre-retirement survivor annuity (QPSA) benefits; (ii) that a same-sex spouse may request a qualified domestic relations order (QDRO) during a divorce; (iii) that hardship distributions could now be made to the same-sex spouse; (iv) the more favorable qualified minimum distribution rules would apply; as well as (v) the roll-over rules. There are additional rules clarifying the attribution rules for ESOPs and Section 414(b) plans. For plan sponsors, until this recent notice, they merely had to ensure that their plan was in compliance with ERISA. Now, they have to amend the plan and make corrections since the Notice is retroactive to at least Windsor.

The most troubling aspect of the Notice is the limited retroactivity. From a practical standpoint, this was to be expected. But the Notice did not require plans to correct what should be in an incorrect tax reporting position. This result is rather curious given that the Court held that DOMA was unconstitutional. To build upon Windsor, it would seem that all plans were not in compliance. But the Notice takes the position that under Section 7805(b)(8), the Commissioner is believed to have flexibility in the decision to apply retroactivity to a court decision. I am not so convinced.

The first question the notice answered is if plans were out of compliance ab initio since the plans did not recognize valid marriages. The Notice stated that “[a] retirement plan will not be treated as failing to meet the requirements of [S]ection 401(a) merely because it did not recognize the same-sex spouse of a participant as a spouse before June 26, 2013.” Since the Court in Windsor held DOMA unconstitutional, plans that relied or referenced spouse in relation to the statute, were out of compliance from the date of including the language. The Notice gave plan sponsors and participant a pass on this violation as long as the plan is amended to be in compliance to cover same-sex spouses prior to the date of Windsor. The Notice requires that plans be amended to apply at least to the date of the Windsor decision.

However, plan sponsors may amend further back. By doing so, a myriad of rules would then be initiated that will be quite burdensome on the plan sponsor and may result in unintended tax consequences because of various attribution rules. Treasury does not make further retroactive amendment an all-or-nothing proposition. The door is left open to partially amend the plan. It would seem that Treasury envisions plan amendment prior to June 26, 2013 for limited purposes such as the QJSA and QPSA requirements and annuity payouts. In order to amend plans, it must be done the later of (i) the otherwise applicable deadline under section 5.05 of Rev. Proc. 2007-44, or its successor, or (ii) December 31, 2014.

Administratively, it makes sense to apply the limited retroactivity seen here. Many plan sponsors are inevitably breathing a sigh of relief. However, the tax effect is to discriminate against couples to who an equal benefit should have been conferred. For example, after the Ruling, it was unclear whether a legally married same-sex spouse who was denied an annuity benefit under a QJSA plan before September 16, 2013, would receive this benefit following the Windsor decision. The Notice would cover the period between the Windsor decision and the Ruling. However, if the denial was on June 1, 2013, then the Notice was not applicable. The essence of the Windsor decision was that this result should also be impermissible. For more commentary on this, I would direct you to Pat Cain’s accompanying op-ed. She highlights that a same-sex couple could sue to be treated equally. But the Notice certainly will not help their position.

Further, the limited retroactivity of the Notice is also problematic because it still leaves unanswered the fundamental questions about even application of the tax rules. For example, one of the most unsettling questions that remained after the Ruling was for employers whose employees live in a variety of states. It is likely that some employees will live in states that recognize same-sex marriage while other employees will live in nonrecognition states. Further, even if an employer has a single location in a nonrecognition state, if the employees had a valid state of ceremony marriage or relocated from a state that did recognize same-sex marriage the Ruling and Notice would appear to apply. This is an anomaly for administering qualified plans under ERISA, which typically rely on a uniform federal standard. State of ceremony is a uniformed standard for same-sex spouses, but most plans do not tether the definition of spouse to state of ceremony, the typical language is “spouse.” That language was interpreted through the lens of DOMA for the application of the plan. So after the Notice and Ruling, are employers required to amend the plan to deal with the different marriage definitions for employees depending on if the are same-sex? These problems are not resolved by the Notice.

The Notice still does not answer fundamental questions about even application of the principals of the tax laws. It attempts to make administratively convenient answers that are still not within the spirit and rules established in Windsor. Hopefully, there will continue to be guidance.

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