Supreme Court DOMA Decision—Part II: Wage Overstatements and Tax Refunds

In part one of this two-part series, “Supreme Court DOMA Decision—Part I: Fringe Benefits and Other Tax Implications,” I reviewed the fringe benefit and tax implications of the United States v. Windsor decision. In the second part of this series, I discuss the tax refunds that may be available to employers and employees  as a result of the Supreme Court’s ruling, in Windsor, that the federal Defense of Marriage Act (DOMA) is unconstitutional.

Refund Opportunity

The value of fringe and spousal health benefits that were included in wages because of DOMA represent a wage overstatement, presumably entitling both employers and employees to Federal Insurance Contributions Act (FICA) tax refunds and entitling employees to income tax refunds, at least with respect to employees residing in states where same-sex marriages are recognized. Current tax adjustment and refund procedures prohibit employers from refunding or adjusting employee income tax withholdings (but not FICA tax withholdings) for a tax year after the end of the calendar year. Accordingly, employers are precluded from providing employees refunds of income taxes that were withheld with respect to benefits provided before 2013.

Pending guidance from the Internal Revenue Service (IRS), employers should consider making same-year income tax and FICA withholding adjustments with respect to benefits provided to same-sex spouses in 2013. Employers should also consider whether to file for a FICA tax refund or adjustments for benefits provided to same-sex spouses in 2010, 2011, and 2012, as well as whether to perfect any protective FICA tax refund claims that may have been filed for tax years before 2010. If a protective refund has not already been filed, a refund claim cannot be filed with respect to taxes paid on imputed income before 2010, as the statute of limitations on refunds has expired for those years. Although there is a standard procedure for requesting FICA tax refunds or adjustments, it is possible that the IRS will provide special refund procedures, as it did for employers in Notice 2013-8 after Congress passed the American Taxpayer Relief Act of 2012, which retroactively increased the mass transit monthly benefit cap for 2012.  Because any over-withholding of federal income or FICA taxes that has already occurred in 2013 should be correctable before year-end and the statute of limitations for FICA refunds/adjustments for 2010, 2011, and 2012 does not expire until 2014 (or later), employers may wish to wait for IRS guidance before they adjust affected employees’ withholdings.

The current challenge for employers is identifying the population of affected employees to determine whether the potential amounts at stake support filing refund claims. As noted in part one of this series, employers may not have adequate information to know whether their employees with same-sex partners are legally married. Employers need to determine how they are going to identify same sex spouses of present and past employees. Employers should consider communicating the Supreme Court’s decision to employees and ask any employees in same-sex marriages to identify themselves. Once an employer has identified all employees who are in same-sex marriages, employers can start by considering taxes imputed after 2009 to employees or former employees (as a result of benefits provided to same-sex spouses) who live in states that recognize same-sex marriages. Depending on future guidance, the relevant population may include employees who were married in a state that recognizes same-sex marriages, without regard to whether their state of residence recognizes these marriages.

It is important to note that employers are not required to apply for a refund or adjustment of FICA taxes that they paid and the employee portion of FICA taxes that they withheld. (But note that an employer typically cannot apply for a refund of its portion of FICA taxes without first attempting to obtain employees’ consent to obtain FICA tax refunds on their behalf.) However, employers may be required to provide affected employees with a Form W-2c showing the amount of taxable wages for income and FICA tax purposes so that the employees can obtain an income tax and FICA refund on their own behalf. Employers that decide not to file a FICA tax refund claim should consider notifying all employees of their decision and providing them with a Form W-2c.

Employees should also be entitled to income tax refunds with respect to taxes paid on imputed income under DOMA. Pending guidance, individual employees may amend their income tax returns to request a refund for the years 2010, 2011, and 2012, as the statute of limitations on refunds is still open for those years. Additionally, individuals who filed timely protective income tax refund claims for tax years before 2010 may be eligible for income tax refunds for earlier years.

Conclusion

There are many significant and unanswered questions resulting from the Windsor decision that impact all employee benefits plans, not just the taxation of employer-provided fringe and health benefits. Hopefully these issues will be addressed soon by administrative guidance; however, the full scope and implications of the Windsor decision may not be known for some time.

Note: this two-part blog series reflects the status of guidance with respect to the Windsor decision as of July 23, 2013.