In a 5 to 4 decision, the United States Supreme Court has found that Section 3 of the federal Defense of Marriage Act (DOMA) violates the equal protection clause of the Fifth Amendment of the U.S. Constitution as applied to persons of the same sex who are legally married under the laws of their state (U.S. v. Windsor).
This decision opens the door for same-sex married couples to enjoy many federal tax-related benefits previously available only to opposite-sex married couples. These include income tax benefits, estate and gift tax benefits, taxpayer-friendly employee benefits, and more. Same-sex couples must now also deal with circumstances under the tax law that may create a so-called “marriage penalty.” Employers must prepare for extensive changes in the treatment of same-sex couples, and provisions under the Patient Protection and Affordable Care Act are also affected.
The Supreme Court did not extend same-sex marriage nationwide. So the Windsor decision leaves many additional issues unresolved or unclear. Among them are the status of “domestic partnerships” and “civil unions” under state law in connection with federal benefits, the status of a same-sex couple married in one state but now residing in a state in which same-sex marriage is not recognized, and the ability of married same-sex couples to divorce without first moving back to a state that recognizes same-sex marriage.
The IRS will eventually provide guidance in reaction to the Supreme Court’s decision. In the meantime, there are several strategies that same-sex couples may want to follow up on, including filing amended returns before the applicable limitations periods expire on back tax years. But the decision to strike down DOMA goes beyond refunds. Same-sex couples need to consider many other tax implications.
INCOME TAX BENEFITS AND DISADVANTAGES<
Because of the Supreme Court’s decision, the same tax benefits and disadvantages faced by just-married, opposite-sex couples—in changing from filing as separate, unmarried individuals to filing as married filing jointly (or married filing separately)—are now shared by same-sex married couples. Likewise, however, those same-sex couples not married under state law continue to be subject to the same disadvantages and benefits, and face many of the same strategic decisions, faced by unmarried heterosexual couples under the federal tax law.
FILING STATUS<
A taxpayer’s filing status depends in large part—if not exclusively in most cases—on the taxpayer’s marital status. Taxpayers may be single, surviving spouse, head of household, married filing joint returns, or married filing separately. Filing status, in turn, determines the right to many tax benefits, both in terms of access and amount. Income tax rate bracket levels, the standard deduction, personal exemptions, and the adjusted gross income (AGI) amounts at which many tax benefits “phaseout” all hinge upon filing status.
Joint Return Status. Because of the Supreme Court’s Windsor decision, same-sex couples who currently are married under state law are presumably now also barred for federal tax purposes from filing separate returns as single (or as head of household, in some cases); they must file either jointly or married filing separately for 2013, unless they are divorced or have a final separation agreement in place by the end of 2013. Because same-sex marriage is relatively new, the tax implications of divorce of a same-sex couple are only starting to manifest.
The Marriage Penalty. The benefits of filing a joint return may not always be greater than filing separately as unmarried individuals. Both differences in tax rate bracket amounts and a variety of income floors and thresholds used to determine the right to certain tax breaks come into play in determining whether some same-sex couples were better off, income tax-wise, before the Supreme Court’s decision; and what they should do now.
For example, individuals in a relationship who are not married and who each realize approximately the same level of income and have similar tax deductions (at least in amount) have generally been better off tax-wise filing as unmarried individuals. However, that assessment tilts in favor of marriage and filing a joint return if one partner earns or deducts the greater portion of any otherwise combined amounts.
Innocent Spouse Status. Married taxpayers who file joint returns are jointly and severally responsible for the tax and any interest or penalty due on the joint return. Same-sex married partners cannot turn a blind eye to any item that is listed on a joint return. A decision to file joint returns retroactively for prior tax years as the result of the Supreme Court’s decision, therefore, should include consideration of the joint and several liability that would be triggered. Separate return status would eliminate the issue of joint liability entirely.
Surviving Spouse Claims. A surviving spouse computes tax using the same rate brackets as married couples filing joint returns. Rules for surviving spouse status for same-sex married couples now presumably follow the same rules as for opposite-sex couples. If a taxpayer is a surviving spouse, the year the spouse died is the last year for which the taxpayer can file a joint return with that spouse. A taxpayer can also qualify as surviving spouse for two tax years following the year in which his or her spouse dies if the taxpayer maintains a household for certain dependents (a child, adopted child, foster child, or stepchild), has not remarried, and filed or could have filed a joint return with the spouse for the year in which his or her spouse died.
OTHER SAME-SEX COUPLE INCOME TAX ISSUES<
Being married for federal tax purposes—exclusive of the right to any particular filing status—also can give rise to additional tax benefits and restrictions. The following situations may be particularly relevant in the case of married same-sex couples after the Supreme Court’s Windsor decision:
Dependency Exemptions. The Supreme Court decision will presumably trigger tie-breaker rules and divorce settlement agreements previously available only to opposite-sex married couples.
Education Benefits. Access to a number of education tax credits by same-sex couples has been limited, both because of a student’s status as a member or non-member of the taxpayer’s family and because lower phase-out levels that apply to unmarried filers.
Post-Death IRA Payments. A beneficiary of an inherited individual retirement account (IRA) is allowed to defer tax by taking distributions over a period of up to five years. A surviving spouse who is the sole beneficiary, however, may elect to treat the IRA as his or her own, and roll it over into his or her own IRA. If the surviving spouse instead decides to be treated as a designated beneficiary, the spouse’s life expectancy beginning in the year in which the owner would have been age 70½ is used to determine the required minimum distribution. DOMA had foreclosed these more favorable spousal benefits for same-sex married spouses. The Supreme Court’s decision in Windsor presumably opens up these distribution benefits to same-sex spouses.
Resident And Non-Resident Aliens. Presumably, the Supreme Court’s decision applies to same-sex resident or nonresident aliens to the extent they are considered married under the law of a foreign jurisdiction. Further clarification of the application of the Supreme Court’s Windsor decision to these taxpayers may be needed.
ESTATE AND GIFT TAXATION<
The Windsor case, involved the estate tax marital deduction. The marital deduction is a key planning tool to defer or eliminate transfer taxes until the surviving spouse dies. Because of DOMA, same-sex married couples could not take advantage of the estate tax marital deduction and other provisions, such as portability. DOMA also precluded same-sex married couples from the benefits of special rules for gifts between spouses and from spouses.
Marital Deduction. The relatively high $5.25 million estate tax exclusion for 2013 for all estates makes addition of a marital deduction unnecessary in the majority of cases. However, as Windsor showed, it is a valuable tax benefit for larger estates. Many same-sex married couples may find it valuable to revisit their estate plans to make certain that interests passing to the other spouse qualify for the marital deduction and other tax benefits.
Portability. The American Taxpayer Relief Act of 2012 extended permanently the concept of portability, which generally allows the estate of a surviving spouse to utilize the unused portion of the estate tax applicable exclusion amount of his or her last predeceased spouse. Because of DOMA, only opposite-sex married couples could take advantage of portability. The IRS is expected to issue guidance. However, the Supreme Court’s decision presumably enables same-sex married couples to include portability in their estate planning.
Gifts. Because of DOMA, only opposite-sex married couples are allowed to “split” gifts to take advantage of a doubled annual gift tax exclusion (for 2013 at $14,000, for a total tax-free gift of $28,000). Even more of a disadvantage for same-sex married couples under DOMA is the rule that only transfers between spouses where both individuals are U.S. citizens are allowed an unlimited gift tax exclusion.
Same-sex married couples can now presumably transfer assets between themselves with no concern of lifetime gift tax consequences. This creates considerably greater flexibility for estate planning. Again, the IRS is expected to issue guidance.
EMPLOYEE BENEFITS<
Perhaps in no area outside of income taxes is the impact of the Supreme Court’s decision more expansive than on employee benefits. Because of DOMA, employers that allow an employee to add his or her same-sex spouse to their health plan had to impute income to the employee for federal income tax purposes equal to the fair market value of health coverage provided to the same-sex spouse. If the same-sex spouse qualified as a dependent, this rule did not apply. DOMA also precluded same-sex married couples from sharing the same benefits of health flexible spending accounts, health savings accounts and health reimbursement arrangements available to opposite-sex married couples.
Therefore, employers in states that allow same-sex marriage will presumably need to amend plans to cover same-sex married spouses. The IRS is expected to provide guidance on the timing of plan amendments, including the issue of whether benefits need to be made retroactive or only prospective from the date of the Windsor decision.
Tax Treatment. Domestic partners who are not married under state law are not treated as spouses for federal income tax purposes. As a result, an employee must continue to pay taxes on the fair market value of the coverage for the employee’s domestic partner (whether the domestic partner is a same-sex partner or an opposite-sex partner). However, domestic partner benefits are tax-free if the employee’s partner qualifies as a dependent.
The Supreme Court’s decision may open the window to refunds of taxes paid by employees on income imputed to employees for same-sex married spouse and refunds of payroll taxes paid by employers on that income.
AFFORDABLE CARE ACT<
The Patient Protection and Affordable Care Act, signed into law by President Obama in 2010, set in motion a host of changes to the delivery of health care and health insurance coverage. Some of the changes already in place affect health savings accounts. Other changes are scheduled to take effect after 2013.
Individual Mandate and Penalty. Beginning in 2014, the Affordable Care Act imposes a penalty on individuals who do not carry minimum essential health coverage, subject to some exceptions. Now that DOMA has been struck down, same-sex married couples presumably will be treated the same as opposite-sex married couples for purposes of the individual mandate and its penalty.
Premium Assistance Tax Credit. Beginning in 2014, the premium assistance tax credit is scheduled to be available to qualified individuals and families who are not offered minimum essential coverage and obtain coverage through a health benefit exchange. The Affordable Care Act provides for advance payment of the credit. Taxpayers who are married at the end of the tax year must file a joint return to claim the credit. Same-sex married couples will presumably need to file a joint return to claim the credit.
SOCIAL SECURITY BENEFITS<
Because of DOMA, same-sex married couples did not have the same benefits under Social Security that opposite-sex married couples have had for many years. Unlike opposite-sex couples, there are no survivor benefits for the surviving spouse of a same-sex married couple. Also, the divorced spouse of a formerly married same-sex couple cannot not claim benefits based on the earnings of his or her ex-spouse.
The Social Security Administration (SSA) has based federal rights to benefits on whether marital rights exist in the couple’s current residence rather than necessarily the state in which they may have been married. The impact of Windsor on how federal agencies will treat Social Security benefits remains to be sorted out.
EFFECTIVE-DATE ISSUES<
Same-sex married couples who were not considered married under federal law prior to the Supreme Court decision are presumably not just considered married starting on June 27, 2013, the date of the Supreme Court’s decision. Rather, they are considered married retroactively to the date of their marriage under state law.
Therefore, in anticipation of the Supreme Court’s decision, many same-sex couples filed protective income tax refund claims using married filing jointly status. A protective refund claim is a claim filed to protect the taxpayer's right to a potential refund based on a contingent event for a taxable period for which the period of limitations is about to expire. Now that the Supreme Court’s decision is out, full refund claims, rather than protective claims, could be filed going forward.
However, taxpayers who have already filed their 2012 tax year returns before June 27, 2013, as separate unmarried individuals, may not need to change their filing status to married filing joint if it would be less favorable to their overall tax liability. Once a return is filed, a taxpayer is generally under no obligation to file an amended return because of subsequent circumstances. The Supreme Court decision could be viewed as a subsequent circumstance.
On the other hand, taxpayers who are on extension until October 15, 2013 for filing their 2012 tax year returns appear to be required to file either jointly or married filing separately.
We will keep you informed as the IRS and other federal agencies provide more guidance in response to the Supreme Court decision. In the meantime, please call our office as soon as possible to make an appointment to review your prior year tax returns for a potential refund. In addition, we encourage you to consider new options for both your tax and estate planning in view of this significant ruling.
George V. Famiglio, Jr, CPA/PFS, CFP, CFS, CGMA. Est. 1971
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