Recently the IRS issued written guidance(1) that significantly impacts all qualified plans and the benefits received under those plans by individuals who have entered into a same‐sex marriage. Among other things, this new guidance impacts 401(k) nondiscrimination testing, the definition of highly compensated employees, beneficiary designations, hardship distributions, participant loans, qualified joint and survivor annuities, rollovers, required minimum distributions, and the overall requirements for a retirement plan to remain “qualified” under the Internal Revenue Code.
These new same‐sex rules affect all sponsors of qualified retirement plans including for‐ profit, non‐profit, governmental, churches, denominations, and para‐church organizations. Furthermore, these rules affect all qualified retirement plans including 401(k), profit sharing, defined benefit, ESOP, money purchase, cash balance plans, etc., as well as ERISA and non‐ERISA 403(b) plans.
On June 26, 2013 the United States Supreme Court issued a landmark ruling (called the Windsor decision) that invalidated Section 3 of the Defense of Marriage Act (DOMA)(2) which stated that for a marriage to be valid under federal law it had to be between a man and a woman.
Following the Windsor decision, the IRS issued guidance(3) on August 29, 2013 (which applied prospectively as of September 16, 2013) which stated that for tax purposes the federal government would determine one’s legal marital status based upon the state of celebration, not the state of residency.
John and James live in Colorado but were married in New Jersey, one of the 16 states that recognize samesex marriage. Although Colorado does not recognize samesex marriage, the federal government considers John and James to be married and entitled to the same federal tax treatments afforded a heterosexual couple.
This IRS Revenue Ruling stated that future IRS guidance would explain how these new rules may impact qualified retirement plans retroactively. IRS Notice 2014‐19, issued April 5, 2014, provides the clarity that we have needed with respect to the Windsor decision.
Summary of IRS Notice 201419
For a retirement plan to remain a “qualified” retirement plan under Section 401(a) of the Internal Revenue Code, the retirement plan must grant a samesex spouse the same rights it would an oppositesex spouse. More specifically, a qualified plan’s operations must reflect the Windsor decision retroactively as of June 26, 2013. However, such plans only have to recognize the above‐referenced state of celebration rule from September 16, 2013 forward.
Impact of Disqualification
A retirement plan that does not comply with these rules will face disqualification by the IRS meaning that, for the period of disqualification, the Plan Sponsor (usually the employer) generally would lose its tax deductions for all contributions to the plan and would potentially need to amend past tax returns and pay additional taxes and penalties. Furthermore, the investment trust account of the retirement plan would lose its tax‐exempt status and have to file Form 990‐T and pay taxes on any trust earnings. Any distributions from this plan would be ineligible for rollover to an IRA or qualified plan, and possibly the account balances of the “highly compensated4” employees would immediately become taxable.
ABC Christian Ministry, which has a personnel policy of not hiring any employee engaged in a samesex relationship, maintains a qualified Money Purchase retirement plan. John, who works for ABC Christian Ministry, unbeknownst to his employer, was married to Steve in New Jersey. On December 1, 2013 John terminated employment with ABC Christian Ministry and received a $100,000 lump sum distribution from the plan without Steve’s written spousal consent, as required by federal law.
This retirement plan has violated the terms of federal law and upon investigation could become disqualified by the IRS. Steve could initiate a claim against the qualified plan and enforce such an action with the assistance of the Department of Labor and IRS. If the plan is unable to recover its lump sum distribution from John, it may need to purchase a Joint and Survivor Annuity with Steve as the spousal, surviving beneficiary.
XYZ ForProfit Company maintains a 401(k) plan with an employee loan provision. Sandy, one of the plan participants, has a samesex spouse. She requests a $25,000 loan from the 401(k) plan (which requires spousal consent for all participant loans) but does not obtain a spousal consent signature for the loan. XYZ ForProfit Company must deny this loan until Sandy provides a written consent from her samesex spouse.
Joe and Bill have a samesex marriage. Joe owns Joe’s Crab Shack and Bill works for him as an employee earning $25,000/year. Once Joe and Bill are determined to have a samesex marriage, Bill is a “highly compensated employee” (HCE) because of the spousal attribution rules, despite the fact that he only earns $25,000/year. This new HCE designation will affect the 401(k) plan’s nondiscrimination testing, ADP test, and many other aspects of the plan’s administration.
Steps Plan Sponsors Should Take:
Obtain new Beneficiary Designation forms from all plan participants, with an explanation of the change in DOMA. It is important that the Plan Sponsor (or a designee of the Plan Sponsor) know who is married, whether in a heterosexual or same‐sex marriage.
Review all plan distribution and loan activity from June 26, 2013 to the present. (This date may change to September 16, 2013 depending on when the plan implemented the state of celebration rule. If the plan discovers that it processed loans or distributions without the required consent of a same‐sex (or opposite sex) spouse, the plan needs to take corrective action with the assistance of an ERISA expert or attorney.
Change policies and procedures so that employees are aware that they must disclose the fact that they are engaged in a same‐sex marriage.
1 IRS Notice 2014‐19.
2 Passed by both houses of Congress, and signed into law by President Clinton on September 21, 1996.
3 Rev. Rul. 2013‐17.
4 Generally anyone who owns more than 5% of the employer or anyone who earns more than $115,000.