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IRS recently released Notice 2014-19 “Application of the Windsor Decision and Rev. Rul. 2013-17 to Qualified Retirement Plans.” The Notice covers issues including effective dates and plan qualification and amendment requirements. More or less at the same time IRS released “Answers to Frequently Asked Questions Regarding the Application of the Windsor Decision and Post-Windsor Published Guidance to Qualified Retirement Plans” (the FAQs), which includes guidance on a key issue – beneficiary designations in profit-sharing plans.
In this article we review the Notice and the FAQs. As we have said before, many of the issues raised by Windsor for retirement plans are technical and complicated – so, apologies in advance for the density of what follows.
In United States v. Windsor (June 2013) the Supreme Court held that section 3 of the Defense of Marriage Act (DOMA) (which defined marriage as “a legal union between one man and one woman as husband and wife”) was unconstitutional. The decision has a significant effect on retirement plan administration.
IRS notes that several Tax Code sections apply special rules to married participants in qualified retirement plans, including:
The qualified joint and survivor annuity (QJSA) and qualified preretirement survivor annuity (QPSA) rules under Tax Code section 401(a)(11) (requiring spousal consent in certain cases).
The required minimum distribution rules under Tax Code section 401(a)(9) and the rollover rules under Tax Code section 402(c) (providing special rules for spousal beneficiaries).
Controlled group ownership attribution rules and certain top-heavy ‘key employee’ rules.
Certain ESOP rules.
Qualified domestic relations order (QDRO) rules.
Generally, a tax qualified plan’s treatment of a ‘spouse’ must conform to these rules, hence the importance of the determination of who is a ‘spouse.’ The change in the rules for recognition of same-sex marriages brought about by the Windsor raises questions about: (1) how a plan should determine whether to recognize a same-sex marriage; and (2) when recognition should take effect.
The first question – how a plan should determine whether to recognize a same-sex marriage – is more complicated than it sounds. In Windsor the Supreme Court struck down the federal rule prohibiting the recognition of same-sex marriages; it did not strike down state laws prohibiting their recognition. Post-Windsor, the status of a same-sex marriage generally depends on state law, at least until, as has happened in some states, federal or state courts strike down state laws prohibiting recognition.
The question thus becomes, for a given same-sex couple, under which state’s law should marriage status be determined? Consider a couple who resides (is domiciled) in State A, where same-sex marriages are prohibited, who travels to State B, where same-sex marriages are allowed, gets married, and then returns to State A. If one member of the couple is covered by a tax-qualified retirement plan, which state’s law (A or B) does the plan apply to determine whether the couple is married?
Addressing this question, on August 29, 2013, IRS issued Revenue Ruling 2013-17, generally adopting, for purposes of the Tax Code, a ‘state of celebration’ rule: if a same-sex couple’s marriage was validly celebrated in the state where it was entered into, the couple is to be treated as married. In our example, under this rule, the marriage would be recognized because the couple was validly married in State B.
With this background, Notice 2014-19 generally addresses the more technical issues of when a plan must begin complying with the new same-sex marriage rule and whether and when plan documents must be amended.
Under Notice 2014-19, the operations of a qualified retirement plan must:
Reflect the outcome of Windsor as of June 26, 2013.
Conform to the ‘state of celebration’ rule of Rev. Rul. 2013-17 as of September 16, 2013.
This treatment may be a little confusing. IRS is saying that for the period June 26-September 15, 2013, a plan must recognize same-sex marriages but may apply, e.g., a ‘state of domicile’ rule. Thus, in our example, for the period June 26-September 15, 2013 the plan need not recognize the same-sex marriage, because the participant was domiciled in State A, and State A does not recognize same-sex marriage. On the other hand, that same plan must, during the period June 26-September 15, 2013, recognize same-sex marriages validly performed in State B for participants domiciled in State B.
In any case, as of September 16, 2013, the plan must, pursuant to the state of celebration rule, recognize all same-sex marriages validly performed in any state, regardless of the couple’s domicile. We assume that, if possible, it will be easiest for most plans to simply adopt a state of celebration rule as of June 26, 2013 rather than apply a separate state of domicile rule for the period June 26-September 15, 2013.
Many plans have a ‘choice of law’ provision, generally providing that legal questions not resolved under federal law will be determined based on the laws of a chosen state. In the FAQs, the IRS states that, as of June 26, 2013, a plan may not apply a choice of law provision if to do so would invalidate an otherwise valid marriage.
Again, the point here may be confusing. As noted above, for the period June 26-September 15, 2013 a plan may choose to not recognize a same-sex marriage if same-sex marriages are not recognized in the participant’s state of domicile. But for participants who, during that period, are validly married pursuant to the laws of their state of domicile, the plan may not apply a non-recognition rule based on a choice of law rule that chooses another state’s laws.
At the risk of belaboring this point: in our State A-State B example, let’s assume the plan had a ‘choice of law’ rule that chose the laws of State A, where same-sex marriages are prohibited. During the period June 26-September 15, 2013, the plan would nevertheless have to recognize marriages valid in State B for participants domiciled in State B. As we said above, however, it would not have to recognize marriages valid in State B for participants domiciled in State A.
The Notice allows a plan to recognize same-sex marriages before June 26, 2013. Doing so may, however, in some cases create problems: “Recognizing same-sex spouses for all purposes under a plan prior to June 26, 2013 … may trigger requirements that are difficult to implement retroactively (such as the ownership attribution rules) and may create unintended consequences.” (Emphasis added.)
A plan may recognize same-sex marriages for periods prior to June 26, 2013 for some purposes and not for others. In this regard the Notice gives the following example:
For example, for the period before June 26, 2013, a plan sponsor may choose to amend its plan to reflect the outcome of Windsor solely with respect to the QJSA and QPSA requirements of section 401(a)(11) and, for those purposes, solely with respect to participants with annuity starting dates or dates of death on or after a specified date.
(Note that recognizing same-sex marriages pre-June 26, 2013 may raise issues under Tax Code benefit restriction rules – see below.)
One of the more difficult issues raised by Windsor is how beneficiary designations are to be treated. Generally, a married participant’s spouse must consent to the designation of a non-spouse beneficiary. As a practical matter, beneficiary designations are particularly important for profit-sharing (including 401(k)) plans because of the way the QJSA rules work. Profit-sharing plans are “exempt from the QJSA and QPSA requirements provided that a married participant’s benefit is payable in full, on the death of the participant, to the participant’s surviving spouse, unless the surviving spouse consents to the designation of a different beneficiary.”
A key question raised by Windsor is: If a profit-sharing plan participant entered into a same-sex marriage before June 26, 2013 that was valid under state law (to keep it simple, let’s assume the marriage is valid in the state of domicile), does that marriage void a beneficiary designation made before June 26, 2013 without the spouse’s consent, if the couple is still married on June 26, 2013? The FAQs seem to say that the answer is ‘yes’ – the previous designation is voided:
To the extent the section 401(a) qualification rules require a married participant’s spouse to be the participant’s beneficiary with respect to all or part of the participant’s benefits (unless the spouse consents to the participant’s designation of another beneficiary), profit-sharing and stock bonus plans must treat a participant who is lawfully married on the date of death to an individual of the same sex as married for purposes of applying those qualification rules with respect to a participant who dies on or after June 26, 2013. Thus, in the case of a participant who is married to a same-sex spouse and who dies on or after that date, to the extent the section 401(a) qualification rules would require benefits to be paid to the participant’s surviving spouse absent consent of the spouse to the designation of another beneficiary, the benefits must be paid to the participant’s same-sex spouse regardless of any conflicting plan terms and regardless of any prior beneficiary or other designation to which the participant’s spouse has not consented that specifies an individual other than the participant’s spouse to receive those benefits (except as provided in a qualified domestic relations order).
Whether a plan must be amended to conform to Windsor and IRS guidance depends on its terms:
If a plan’s terms with respect to the requirements of section 401(a) define a marital relationship by reference to section 3 of DOMA or are otherwise inconsistent with the outcome of Windsor or the guidance in Rev. Rul. 2013-17 or this notice, then an amendment to the plan that reflects the outcome of Windsor and the guidance in Rev. Rul. 2013-17 and this notice is required…
As the IRS observes, however, even where an amendment is not required, “a clarifying amendment may be useful for purposes of plan administration.”
If the plan must be amended, the amendment must be made by the later of (1) December 31, 2014 or (2) the remedial amendment period (generally “the later of the end of the plan year in which the change is first effective or the due date of the employer’s tax return for the tax year that includes the date the change is first effective”).
Where necessary with respect to pre-amendment implementation of the new rule, the FAQs indicate the plan may use “principles similar to those in the Employee Plans Compliance Resolution System (EPCRS) …. For example, if the plan is retroactively amended to apply the spousal consent rules under section 401(a) (11) and 417 consistently with Windsor, Rev. Rul. 2013-17, and Notice 2014-19, a plan may obtain spousal consent to remedy a prior lack of spousal consent under [EPCRS principles].”
PPA added rules that generally limit the ability of sponsors to amend plans if certain funding targets have not been met. Under Notice 2014-19, these restrictions do not apply to a plan amendment that is required because the plan is “inconsistent with the outcome of Windsor or the guidance in Rev. Rul. 2013-17 or this notice” and that takes effect on June 26, 2013. On the other hand, an amendment to, e.g., recognize same-sex marriages for periods prior to June 26, 2013 would be subject to the benefit restriction rules.
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The IRS Notice only deals with Tax Code requirements, and the rules described in it generally only address the issue of tax treatment. With respect to many of the provisions dealt with in the Notice, e.g., the QJSA requirements, there are parallel provisions in ERISA that, arguably, create substantive participant and beneficiary rights. Whether the approach taken by IRS – in effect, no required retroactive application of Windsor for periods prior to June 26, 2013 – will apply under ERISA is, ultimately, for the courts to determine.
We will continue to follow this issue.