By Robert S. Keebler, CPA, MST, AEP (Distinguished)
Section 3 of the Defense of Marriage Act (DOMA) provided that in determining the meaning of any Act of Congress, the word “marriage” meant only the legal union between one man and one woman as husband and wife, and the word “spouse” refers only to a person of the opposite sex who is a husband or a wife. On June 26, 2013, the U.S. Supreme Court invalidated this section of the Act in United States v. Windsor. The decision has far reaching planning implications for married same-sex couples whose marriage is recognized under applicable state law, affecting the income tax, gift tax, estate tax and social security and employee benefits. This article summarizes some of the key ramifications of the decision.
Perhaps the most important change in the income tax area will be the ability of same sex couples to file joint income tax returns. This will generally reduce the total tax payable by the spouses.
Example1. Al and Bill are a same-sex couple whose marriage is recognized in their home state. Al has income of $200,000 and Bill has income of $0. If Al and Bill filed individually, their total tax would be $50,130 ($50,130 for Al and $0 for Bill). If they filed a joint return, however, their tax would be $43,466.
If a same-sex couple’s income is relatively high and the amounts earned by the two spouses are comparable, however, the ability to file a joint return won’t always help them.
Example 2. Assume the same facts as in Example 1 except that Al and Bill each has $100,000 of taxable income. If they filed separate returns, they would each pay $21,293, making the total tax payable $42,586 (2 x $21,293). Thus, they would pay $880 more by filing a joint return ($43,466 – $42,586).
Other income tax advantages and disadvantages of married status are listed below.
- The ability of the surviving spouse to use surviving spouse status after the death of the first spouse.
- The ability to deduct medical and dental expenses paid for spouse.
- Non-recognition of gain on a sale to the spouse.
- The ability to roll over an IRA into a spousal IRA on the death of the first spouse.
- Protected rights in a spouse’s retirement benefits under ERISA.
- A taxpayer loses the ability to step up basis by selling property to the spouse.
- Spouses are jointly and severally liable on joint returns, subject to possible relief under the innocent spouse rules.
- The inability of a taxpayer to recognize loss on a sale of property to a spouse under IRC § 267(c).
- Wider application of the constructive ownership rules under IRC §§ 318 and 267.
Married same-sex couples whose marriages are recognized under the law of their home state can now make unlimited tax-free gifts to each other. Although the marital deduction will no longer be necessary to avoid taxable transfers in most cases given the $5.25 million exemption amount currently in effect, it could be extremely valuable for very large estates. Married same-sex couples can also elect to split gifts, increasing the annual exclusion amount from $14,000 to $28,000.
Married status does eliminate some powerful gift tax strategies that are available only to unmarried individuals, however. For example, the special valuation rules of Chapter 14 do not apply to unrelated individuals. This means that same-sex, unmarried couples can use common law GRITs or GRATs that are not subject to the limitations in IRC § 2702. If the couples are treated as married, though, they become related persons subject to the Chapter 14 rules.
Following Windsor, married same-sex couples will be able to take advantage of the estate tax marital deduction in the same way as opposite sex couples. This effectively increases the exclusion amount from $5.25 million to $10.5 million and will leave very few estates subject to the estate tax. Moreover, even for very large estates, estate tax will be deferred until the death of the surviving spouse. Married same-sex couples will also be able to take advantage of the portability rules.
The Social Security system affords two important benefits to married couples that are not available to single individuals.
(1) The spouse of a retired worker can elect to receive the greater of his or her own Social Security benefit or 50 percent of the retired spouse’s benefit. For families in which one spouse is a homemaker or works only part-time outside the home and who would otherwise have minimal social security payments, this is an important advantage.
(2) Following the death of a spouse, the surviving spouse can choose between receiving his or her own Social Security payment or the payment the surviving spouse would have been entitled to.
Presumably, these benefits will now be available to same-sex married couples as well as to opposite-sex married couples.
Prior to Windsor, employees who added a same-sex spouse to their health plan had imputed income equal to the fair market value of the coverage provided to the spouse, unless the spouse qualified as a dependent. Following the Supreme Court decision, taxpayers will be able to obtain coverage for a same-sex spouse on a pre-tax basis
Windsor leaves a number of issues unclear. Some of the unanswered questions are as follows.
- Can married same-sex couples file amended returns or refund claims for open years?
- How will the decision apply to states that allow only civil unions?
- How will Windsor apply to married same-sex couples who were married in a state recognizing such unions who later move to a state that does not recognize them?
Windsor opens up important new tax planning opportunities for many taxpayers. Their advisors will need to determine how they can maximize these opportunities.
RELATED TRAINING & EDUCATION
- Planning After the Landmark DOMA Decision – – The Impact on Income and Estate Tax Planning
- Estate Planning for Same-Sex Couples – – Complex Property Rights and Drafting Issues After the Repeal of DOMA
You can download the handout materials and the audio recording to these programs.
ABOUT THE AUTHOR
Robert S. Keebler is a partner with Keebler & Associates, LLP. He has received the prestigious Accredited Estate Planners (Distinguished) award from the National Association of Estate Planning Counsels and has been named by CPA Magazine as one of the Top 100 Most Influential Practitioners in the United States. Mr. Keebler is the past Editor-in-Chief of CCH’s magazine, Journal of Retirement Planning, and a member of CCH’s Financial and Estate Planning Advisory Board. Mr. Keebler frequently represents clients before the National Office of the Internal Revenue Service (IRS) in the private letter ruling process and has received over 150 favorable private letter rulings. Mr. Keebler is nationally recognized as an expert in family wealth transfer and preservation planning, charitable giving, retirement distribution planning and estate administration and works collaboratively with other professionals on academic reviews and papers, as well as client matters. He can be reached at (920)593-1701 or at firstname.lastname@example.org.