On June 26, the U.S. Supreme Court held 5–4 that Section 3 of the Defense of Marriage Act (DOMA), P.L. 104-199, is unconstitutional. The decision requires the federal government to recognize as married same-sex couples who are legally married under state law.
While the Court did not explicitly rule on any tax issues beyond the eligibility of a same-sex surviving spouse to claim a marital estate tax deduction, the decision results in significant changes to a broad range of federal tax laws for same-sex couples. Since these marriages are now recognized by the federal government, same-sex married couples will be granted additional rights and protections previously available only to opposite-sex married couples. The most significant of these new rights and protections involve federal income tax, estate and gift tax, and employee benefits.
DOMA was passed in 1996 by Congress and signed into law by President Bill Clinton. Section 3 of DOMA defined marriage as a legal union between one man and one woman. Consequently, same-sex marriages have not been recognized for federal purposes.
Section 3 of DOMA was challenged in Windsor, No. 12-307 (U.S. 2013), a case that dealt with the estate tax marital deduction set forth in Sec. 2056(a). Edith Windsor and Thea Spyer were a same-sex couple from New York state who were married in Canada in 2007. New York did not permit same-sex marriages at the time, but the state recognized same-sex marriages if they were valid where performed. (New York state gave full legal recognition to same-sex marriages in 2011.) In 2009, Thea Spyer died and left her estate to Windsor. The estate did not qualify for the marital deduction under Sec. 2056(a) because the marriage was not valid under federal law. Without the marital deduction, Spyer’s estate paid $363,053 in federal estate tax.
Windsor sued the federal government, arguing that Section 3 of DOMA was unconstitutional. After she prevailed in a district court and the Second Circuit, the case was heard by the Supreme Court.
In ruling Section 3 of DOMA unconstitutional, the Court ordered the federal government to recognize same-sex marriages if a state recognizes them. At this writing, 13 states (California, Connecticut, Delaware, Iowa, Maine, Maryland, Massachusetts, Minnesota, New Hampshire, New York, Rhode Island, Vermont, and Washington) and the District of Columbia recognize same-sex marriages.
Broad Federal Tax Implications
Same-sex married couples living in states that recognize same-sex marriage face many changes related to federal income tax, estate and gift tax, and employee benefits.
Federal income tax: As a result of the Windsor decision, same-sex spouses married under valid state law must file either married filing jointly or married filing separately. Often, couples end up owing less tax when filing jointly and are able to combine their income, deductions, and credits. This is usually the case when one spouse has a high income but the other spouse earns substantially less or does not work at all. Conversely, some couples may be hit with the so-called marriage penalty when the spouses have similar taxable incomes that, combined, exceed the 15% marginal bracket.
For instance, the top income tax bracket in 2013 is 39.6%. Single filers reach that bracket when their adjusted gross income (AGI) exceeds $400,000, while married couples reach that bracket if they have a combined AGI that exceeds $450,000. Same-sex couples in upper income ranges who file joint returns may see their tax liability rise under these changes.
Estate and gift tax: Opposite-sex couples had substantial advantages over same-sex couples when it came to estate and gift taxation before the Windsor decision, including the availability of the estate tax Sec. 2056(a) marital deduction, which allows an unlimited deduction for property passing from a decedent to a surviving spouse. In Windsor’s case, this tax-free transfer was not allowed. Moving forward, the estates of same-sex spouses will be able to use the marital deduction.
Gift splitting allows a spouse to increase his or her total annual gift tax exemption by combining both spouses’ exemption amount. For the 2013 tax year, the gift tax annual exclusion is $14,000 per individual gift. Gift splitting allows one spouse to make a gift to an individual and split the gift with the other spouse, thus allowing one spouse to donate up to $28,000 before potentially being taxed on the gift. Same-sex married couples are encouraged to amend current estate plans to take advantage of the marital deduction and gift splitting now available to them.
Employer/employee benefits: In states that allow or recognize same-sex marriage, group health benefits for same-sex spouses are no longer subject to federal tax. In addition, spousal benefits offered under group health plans must be extended to same-sex spouses. Qualified retirement plans are also now required to allow same-sex spouses to claim survivor benefits. Employers in states that recognize same-sex marriage will presumably need to amend plans to cover same-sex spouses.
IRS Guidance and Practitioner Actions
The IRS will need substantial time to develop new policies and issue guidance covering all affected areas of federal tax law. The IRS issued its first guidance on Aug. 29 (Rev. Rul. 2013-17). This ruling said that the IRS will treat legally married same-sex couples as married for all federal tax purposes.
The main issues the ruling addressed are:
- Taxpayers will be allowed to apply the holding in Windsor retroactively to tax years that are still open, and not just prospectively.
- Marriages of same-sex couples who were married in a state that permits same-sex marriages but who now live in states that do not recognize them will be recognized for federal tax purposes.
Same-sex spouses who filed separate federal income tax returns in the past due to DOMA should consider filing amended returns. The statute of limitation for amending a tax return is generally the later of three years from the filing due date (including extensions) or two years after the taxes are paid. Also, same-sex married couples should look at previously filed estate and gift tax returns to see if they can be amended to reflect the changes.
Rev. Rul. 2013-17 did not address procedures for employers who wish to file refund claims for payroll taxes paid on previously taxed health insurance and fringe benefits provided to same-sex spouses. It also did not provide guidance on cafeteria plans and on how qualified retirement plans and other tax-favored arrangements should treat same-sex spouses for periods before the revenue ruling’s effective date.
Practitioners should be aware of the changes for same-sex couples and any retroactive claims that should be made prior to expiration of the statute of limitation. In addition, practitioners should contact affected clients to amend tax planning strategies and any estate tax plans that are already in place.
Mark Cook is a partner with SingerLewak LLP in Irvine, Calif.
For additional information about these items, contact Mr. Cook at 949-261-8600, ext. 2143, or firstname.lastname@example.org.
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