The recent Supreme Court decision to invalidate a section of the Defense of Marriage Act has far-reaching tax implications.
Section 3 of the Defense of Marriage Act (DOMA) defines marriage for federal law purposes as the “legal union between one man and one woman as husband and wife.” The Supreme Court case reviewed a surviving same-sex spouse’s claim seeking an estate tax refund based on the disallowance of the marital deduction. The Internal Revenue Service’s position was that a marital deduction was not available because the federal government does not recognize the couple’s marriage under DOMA.
The Supreme Court ruled that DOMA violates the right to equal protection under the Fifth Amendment of the U.S. Constitution. While this case was based on estate tax matters, the ripple effect is significant for other federal tax laws relating to income taxes, compensation and benefits afforded to married couples.
Registered domestic partners are not married for federal purposes. Civil unions are also not recognized. The only way to qualify for these federal tax benefits is to enter into a lawful marriage.
For federal purposes, same-sex married couples will now be treated the same as a heterosexual married couple. Their filing options will be married filing jointly or married filing separately. They will not be able to file two single returns.
Federal rules currently stipulate that an income tax return that was originally filed under the status of married filing separately may be amended to married filing jointly. However, the filing status of an original return filed under the status of married filing jointly cannot be changed to married filing separately by amending the return. As decisions are made on how to file both amended returns and future returns, this will need to be considered.
Another important item to remember: When using the married filing separately status, if one spouse itemizes deductions, both must itemize. The standard deduction would be zero to a non-itemizing spouse. Same-sex spouses will now be able to deduct alimony and pursue innocent spouse protection if they meet all the legal requirements of deductibility.
Both Congress and the IRS will need to clarify a number of items:
- Are married same-sex couples who filed federal tax returns as single individuals prior to the ruling required to amend those returns? Will this be optional?
- Will the IRS accept married filing jointly returns on a going-forward basis? Will it be retroactive to Jan. 1, 2013, or will the couple have to amend prior years’ returns?
- If they are required to amend returns, will they have to amend only those within the three-year statute of limitations?
Those who don’t have the luxury of waiting until the issues are clarified should file protective refund claims for open tax years as soon as possible.
Ultimately, some couples will benefit from a joint return while others will be subject to additional taxation. Married same-sex couples could now be impacted by the marriage penalty as well as the phaseout of deductions and exemptions.
The exclusion of gain from the sale of a principal residence at the $500,000 level is now available for same-sex spouses. And now that joint filing is allowable, couples should consider amending a return if one spouse previously had capital gains that could have been offset by the other spouse’s capital losses.
How will same-sex married couples file their taxes if the state they reside in does not recognize their marriage? If the state doesn’t recognize same-sex marriages, the couple may need to file a joint federal return and potentially two single state returns.
How will the federal government treat a same-sex couple who married in a state that allows same-sex marriage but moved to a state that doesn’t recognize the out-of-state marriage?
In states that do not recognize same-sex marriage, couples may not enjoy all of the benefits available to residents of states that do recognize these marriages. This could change a couple’s decision-making process when considering which state they want to live in. Although same-sex couples have won a major victory, until the states they reside in recognize their marriage, they will have additional hurdles to navigate.
Estate tax benefits will include the unlimited marital deduction and portability of the deceased spouse’s unused exclusion deduction. For gift tax purposes, they will benefit from the spousal exemption and the ability to split gifts made to non-spouses. We will have to wait and see the effect on property transactions in community property law states.
Wills, trusts and any other planning that has been done in the past will have to be reviewed to make sure it is still valid. Planning related to state issues, depending on where the couple resides, will need to be considered. Same-sex married couples should review their beneficiary designation forms to make sure they are including the spouse on their retirement accounts. If they aren’t, they will need to obtain the correct signatures. Spousal rollovers of retirement accounts will be available.
From a benefits perspective, same-sex couples will be eligible to collect Social Security based on their spouse’s earning record and receive survivorship benefits on retirement plans. If a spouse served in the military, spousal benefits will now apply.
Same-sex couples will be eligible to receive health benefits tax free. In the past, the premium that was deducted from an employee’s paycheck for same-sex spouse coverage was not considered a pretax deduction and was therefore subject to tax. The same coverage for a heterosexual spouse has always been treated as a tax-free benefit. Other results of the Supreme Court’s DOMA decision include the following:
- Same-sex couples will benefit from the Family and Medical Leave Act if necessary to care for their spouse.
- The couples will have the same immigration benefits available to heterosexual couples.
- If a state-maintained plan for qualified long-term care coverage provides for coverage of a spouse, same-sex spouses will also be eligible to receive this benefit.
When you consider these issues, take into account the current state of our economy and the current status of our Social Security system. The question of retroactive treatment and its impact will be huge. This law change will have implications that probably haven’t even been considered yet.