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Private IRS ruling, in Cal. case, leads Miami Beach to ditch gay benefits

The insurance trust funds that administer health insurance benefits for police and firefighters in Miami Beach notified the city in January that they would stop accepting contributions on behalf of domestic partners of employees on advice of their accountant, who believes that providing such benefits “would jeopardize the tax-exempt status of the funds.”

The January 6 letter from the funds led City Manager Jorge M. Gonzalez to inform the mayor and City Commission on January 31 that domestic partnership benefits had been “terminated” as of January 15 for firefighters and February 1 for police officers.

The letter from the funds referred vaguely to “private letter rulings” by the Internal Revenue Service “indicating such coverage would jeopardize the tax-exempt status of the funds.” The funds’ accountant was evidently relying on two Private Letter Rulings issued on June 17, 2005, involving government employers in California seeking advice about the tax-qualified status of deferred compensation plans they were administering for their employees.

Under California’s Domestic Partnership law, registered domestic partners are to be treated as spouses for purposes of state law. That statute also provides that if state provisions adopt, refer to, or rely on provisions of federal law in a way that would cause registered domestic partners to be treated differently than spouses, then the domestic partners are supposed to be treated under the state law as if federal law recognized their partnership and a civil marriage identically.

Deferred compensation plans are mechanisms by which employees have some of their current income routed into a special investment fund to be paid out after retirement. The money is excluded from the employee’s current taxable income until it is withdrawn after retirement. In case the employee dies before withdrawing money from the fund, their surviving spouse—including, under California law, a domestic partner—would be entitled to the money. In order for the current contributions to the fund to be excluded from taxable income, the fund must comply with special tax rules, including that the deferred income goes only to surviving spouses and dependents.

In advising the two California employers, Robert D. Patchell, the IRS chief of the Qualified Plans Branch, wrote that “in the event that the Spouse Provisions [of the deferred compensation plan] are not interpreted and applied in a manner consistent with the Defense of Marriage Act, the operation of the Plan will not be in compliance with [the Internal Revenue Code.]”

Evidently, the accountant for the Miami Beach employee trust funds concluded that the IRS would take the same position regarding employee health benefits, treating any plan that provides benefits, including insurance coverage, to unmarried domestic partners as out of compliance with the tax code. Such a ruling, if upheld by the federal courts, could result in substantial financial penalties to employees covered by these health plans in the form of taxes due on benefits. The benefit funds themselves might be subject to tax on the gains realized on their investment portfolios if they lost their qualified tax-exempt status.

Even before DOMA was passed, there were concerns about how the IRS would deal with municipal benefit plans that covered domestic partners, but most of the concern was focused on whether benefits provided to domestic partners would be entitled to the same preferred treatment under federal tax laws as those given to spouses. In a series of Letter Rulings in the early 1990s, the IRS decided that the value of benefits provided to domestic partners would have to be treated as income to the employee, fully taxable as such, but the IRS never suggested that payment of benefits to domestic partners would disqualify a plan from its overall favorable tax status.

However, these early rulings predated DOMA, and it does not appear that the IRS has addressed the impact of the 1996 law until these 2005 letter rulings.

IRS Private Letter Rulings, although made public and accessible on various tax service databases, are technically not legally binding rulings, but merely advice provided from the IRS central administration to the regional offices in response to specific questions posed by taxpayers. Both of the June 2005 letters conclude, “This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.”

The Tax Court, and regular federal courts, and ultimately Congress have the last word on how benefit plans that cover domestic partners are treated, but so far Congress has shown no willingness whatsoever to modify the Tax Code to facilitate the existence of such plans, even though scores of cities and a handful of states, as well as thousands of private sector employers, now provide them to their employees. There are a few federal court decisions rejecting attempts by gay taxpayers to claim spousal status for purposes of the federal income and estate taxes. Since 1996, those decisions have prominently cited and relied upon DOMA, which is, as of now, Congress’ most recent missive on the subject.

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Updated 5:17 pm, July 20, 2018
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