Supreme Court’s DOMA Ruling Creates Income Tax and Estate Planning Opportunities for Married Same-Sex Couples by Edward Cooper
Posted on July 08, 2013
The U.S. Supreme Court’s recent decision to overturn the core of the Defense of Marriage Act (DOMA) will narrow the financial gap between gay and straight couples.
Because of the ruling, married same-sex couples will be entitled to a myriad of federal benefits and protections they did not have before, including healthcare, retirement savings, Social Security and transfers of property.
The Supreme Court considered two cases related to same-sex marriages. One was a dispute over a California ballot measure banning the practice. The other was a challenge to part of the 1996 federal Defense of Marriage Act, which defines marriage as solely a union between a man and a woman.
The court stopped short of declaring a constitutional right for gays to marry nationwide, or even ruling directly on California’s voter-approved ban.
Same-sex couples have the right to marry in 12 states and the District of Columbia. Florida is not one of the states that currently recognizes same-sex marriage.
The finances and estate plans of same-sex couples are often complicated by the division between federal and state law in places that recognize their marriages. While they’ve been able to receive employee benefits and file taxes jointly under their state’s laws, the federal government treated them as though they are single.
The DOMA matter hinged on the issue of federal estate taxes. It involved a New York resident who sued the federal government over a $363,000 estate- tax bill imposed after her spouse died. She sought to claim an estate tax exemption for surviving spouses, which allows unlimited amounts to be transferred from a decedent to his or her surviving spouse without incurring estate taxes.
The government refused to allow the exemption on the grounds that she did not qualify as a spouse under DOMA. The Supreme Court ruled against the government by ruling that DOMA violates the constitutional rights of equal protection incorporated in the Fifth Amendment.
Although the court’s decision on the DOMA matter decided an estate tax case, its implications will impact how same-sex married couples can treat their finances and estates in a number of ways. Such couples’ finances were often complicated by the division between federal and state law in places that recognize their marriages.
There are more than 1,100 places in federal law where a protection or responsibility is based on marital status. The ruling striking down DOMA will not be effective until 25 days from the decision (decided June 26, 2013), but even when effective, federal agencies, including the IRS, may need and take some time to change forms, implement procedures, train personnel, and efficiently incorporate same-sex couples into the spousal-based system.
Summarized below are a few of the many tax issues potentially affecting married same-sex couples now that DOMA has been invalidated. In all likelihood, there will be specific guidance forthcoming from the IRS before the next income tax filing deadline for tax year 2013.
Estate and Gift Taxes
One of the most significant benefits for married couples is the ability to pass unlimited amounts of money without it being considered a taxable gift. For example, a same-sex spouse would be able to use the unlimited estate-and-gift marital deduction and preserve their unified credit. The unified credit allows each person to either gift now or bequeath up to $10.5 million in 2013 for married couples or $5.25 million per individual to relatives and loved ones other than their spouse without having to pay gift, estate or generation-skipping transfer taxes.
The effective use of both the marital deduction and unified credit enables a couple to defer federal estate taxes owed until the death of the surviving spouse and, with more sophisticated planning, may avoid the estate tax for transfers to future generations utilizing gifting opportunities that married gay people haven’t been able to use in the past.
For many married same-sex couples the ruling will simplify the titling of financial accounts and let them arrange their finances and effectuate sound estate planning in ways that previously were only available to opposite-sex marriages.
A 2004 government report identified 198 separate Internal Revenue Code provisions tied to marital status, highlighting the dramatic impact of marriage on personal taxes.
Most experts believe that the IRS will instruct married same-sex couples to file their 2013 income taxes as “married,” whether jointly or separately, rather than as “single” or “head of household,” provided that the IRS recognizes the marriage.
For those marriages recognized by the IRS, tax preparation should be simpler and less time consuming than it was with DOMA. The questions that have faced married same-sex couples at tax time, such as “who claims which child” and “how much of the mortgage deduction or charitable deduction do we each take,” are eliminated for married same-sex couples who may now take these deductions together in one joint return.
The ability to file a federal joint tax return may save some married gay couples money, A couple filing a joint return where one spouse has taxable income of $70,000 and the other $30,000 would see a $1,625 tax savings compared with filing two individual returns.
There also may be financial disadvantages from filing jointly. If both spouses earn salaries of $400,000 a year or more, the ruling may mean thousands of dollars in higher income taxes because of the so-called marriage penalty.
Currently, two partners, each earning $400,000 a year in taxable income, pay a lower federal income-tax rate than if they were married. That’s because the top rate of 39.6 percent starts at taxable income above $400,000 for singles and $450,000 for married couples.
If same-sex spouses file jointly under federal law, their combined income is $800,000, of which $350,000 would be subject to the highest federal tax rate. However, for many same-sex couples the added tax burden is of small consequence to their marriage being recognized under federal law.
The implications of the DOMA decision are enormous when at least one member of the couple is a federal employee or in the military. Many advantages will be extended to married same-sex spouses including health care, disability and death benefits that same-sex married couples were previously denied on a federal level. In addition, there are many lesser-known federal benefits that will now be available such the right for married same-sex spouses to be buried in veterans’ cemeteries.
Some spousal provisions, annuities and rollover opportunities in pensions and other retirement accounts will now be available to married gay couples. There will also be positive impacts on accessing a spouse’s Social Security benefits, which can be significant if one spouse worked more years or had a higher salary.
The tax consequences for employee health care benefits will be impactful. Under DOMA, if people put their same-sex spouses on their insurance plan the value of any employer contribution to premiums usually was deemed taxable income for the worker, which isn’t the case for opposite-sex spouses.
Josh Keller of The New York Times estimated that “at least 82,500 gay couples have married since Massachusetts became the first state to legalize gay marriage in 2004 [through 2012].”
The IRS has yet to provide answers to questions about the ability to amend tax returns and receive refunds. For example, if one spouse had capital losses on investments in a year that the other spouse’s gains would offset if they would have been able to file a joint federal return.
In other situations, individuals may want to amend a gift tax return if they made a large transfer of property or assets to their same-sex spouse and used their unified credit because the marital exemption was not previously available. This would potentially free up more of the unified credit to pass on wealth to children or other loved ones.
Generally, for a credit or refund of income taxes, one must file Form 1040X within three years (including extensions) after the date of filing of the original return or within two years after the date the tax was paid, whichever is later. If the original return was filed early (for example, March 1 for a calendar year return), the return is considered filed on the due date (generally April 15). However, if the taxpayer had an extension to file (for example, until October 15) but filed earlier and IRS received it July 1, the return is considered filed on July 1.
However, there are potential downsides of amending prior year returns, including an increased risk of audit, possible assessment of a tax deficiency and, in some instances, the burden, expense and uncertainty of litigation.
Undoubtedly, taxpayers and practitioners will need guidance from the Internal Revenue Service and federal agencies on questions such as whether they can amend tax returns and receive refunds.
The IRS has yet to provide answers to questions about the ability to amend tax returns and receive refunds. A married same-sex couple may be entitled to amend their individually filed returns, for example, if one spouse paid taxes as a result of capital gains on investments in a year that the other spouse’s losses would have offset those gains if they would have been able to file a joint federal return.
Furthermore, there are concerns about whether federal recognition will apply for couples who marry in a state that allows same-sex marriage and move to another state, like Florida, that doesn’t.
The dust has not yet settled on all of the impacts of the Supreme Court’s ruling but we are watching closely. At Berkowitz Pollack Brant and our affiliate Provenance Wealth Advisors, we can assist with navigating the new rules and taking advantage of the estate planning opportunities created by the Supreme Court’s ruling.
About the Author: Edward N. Cooper CPA is a director in the Tax Services practice of Berkowitz Pollack Brant. For more information, call (305) 379-7000 or e-mail email@example.com.