Individuals
The Defense of Marriage Act (DOMA), P.L. 104-199, enacted on Sept. 21, 1996, is a federal law that defines marriage as the legal union of one man and one woman. Section 3 of DOMA results in the nonrecognition of same-sex marriage for all federal purposes including insurance benefits, Social Security benefits, the filing of joint tax returns, and the unlimited marital estate tax exemption available to opposite-sex married couples.
On May 31, 2012, the First Circuit declared Section 3 of DOMA unconstitutional, upholding a district court decision ( Massachusetts v. United States Dep’t of Health and Human Servs. , 682 F.3d 1 (1st Cir. 2012)). The appeals court held that DOMA’s denial of federal benefits to same-sex couples lawfully married in Massachusetts violates the Equal Protection Clause of the U.S. Constitution.
The appeals court found that DOMA does not prohibit states from allowing same-sex marriage. However, it found that DOMA does unconstitutionally limit the ability of same-sex couples to participate in federal benefits such as Social Security and favorable tax rates.
The court of appeals affirmed the district court’s holding but continued the stay of relief, which included ordering the payment of federal tax refunds with interest, and set the stage for the Supreme Court to decide the issue in the coming months.
Another DOMA constitutional challenge involving the right of a same-sex surviving spouse to use the estate tax marital deduction ( Windsor , 833 F. Supp. 2d 394 (S.D.N.Y. 2012), aff’d, No. 12-2335-cv(L) (2d Cir. 10/18/12), S. Ct. Dkt. No. 12-63 (petition for cert . filed 7/16/12)) may also be headed to the Supreme Court. On June 6, the U.S. District Court for the Southern District of New York ruled that the IRS’s denial of an unlimited marital deduction under Sec. 2056(a) to the surviving spouse in a same-sex marriage was unconstitutional. The judge ruled that Section 3 of DOMA unconstitutionally discriminates against same-sex couples, and the Second Circuit affirmed the decision on Oct. 18. On July 16, the attorneys for the Windsor case applied for certiorari and requested the justices consider the case as a more comprehensive challenge to DOMA.
These court decisions, as well as several other court cases challenging DOMA, open the door to an opportunity and responsibility for tax practitioners to assist their clients in same-sex marriages with protecting their rights to federal and state tax refunds as well as providing additional advice regarding income and gift and estate tax planning in light of DOMA’s uncertain future.
Filing Protective Refund Claims for Same-Sex Couples
Practitioners should discuss with their same-sex married clients whether to file protective individual income tax refund claims with the IRS using the married-filing-jointly status and other tax benefits that are currently available to opposite-sex married taxpayers.
A protective refund claim can be submitted as a formal written claim or as an amended return on Form 1040X, Amended U.S. Individual Income Tax Return . A protective claim is filed by a taxpayer when the right to the refund is contingent upon the finalization of litigation proceedings such as the constitutionality of DOMA. A protective refund is filed for a taxpayer when the resolution of the litigation will extend beyond the statute of limitation for filing an accurate amended tax return (IRS Publication 556, Examination of Returns, Appeal Rights, and Claims for Refund , p. 14 (2008)).
The same-sex couple must be legally married under state law at the end of the year for which the amended return for the protective claim is filed. A document, such as a marriage certificate, confirming the marriage should be attached to the amended return.
The practitioner should attach a statement to the amended tax return stating that the legally married couple is submitting the protective claim for refund based on the unconstitutionality of Section 3 of DOMA. The statement should also indicate that the constitutionality of DOMA is currently being litigated and that the litigation is expected to extend beyond the statute of limitation for filing the amended return. The practitioner should include the words “Protective Claim for Refund” in the top margin of the amended tax return.
It is important to inform the IRS that the taxpayer is filing a protective claim for refund. The IRS generally delays refunds on protective claims until the litigation on the issue is resolved. The protective claim preserves the right to the refund regardless of the length of the litigation proceedings. Same-sex married couples should consider filing federal protective refund claims for all open tax years for which they have been legally married under state law. Practitioners should also evaluate whether filing protective refund claims with the state will result in a reduction of the couple’s income tax liability.
In addition, practitioners should consider whether protective refund claims for estate or gift tax may be beneficial for their clients.
Income Tax Planning Opportunities for Same-Sex Couples
It could be a year or longer before the Supreme Court rules on DOMA’s constitutionality. In the interim, there are several income tax planning techniques that can be implemented to reduce the tax burden of same-sex couples.
Same-sex married couples who have a child can use the head-of-household filing status to reduce their tax liability, which is an opportunity not available to opposite-sex married couples. Same-sex married couples typically experience maximum tax savings when the partner with the higher taxable income elects the head-of-household filing status. However, practitioners should evaluate the tax savings associated with the head-of-household filing status for the partner with the lower taxable income. The partner with the lower taxable income may qualify for additional tax benefits including the child tax credit, an increased dependent care credit, and education credits or deductions. These additional tax benefits may result in a lower tax liability overall for the couple.
Married couples of the opposite sex who file their income tax returns using the married-filing-separately status are not allowed to take advantage of both itemized deductions and the standard deduction. However, with proper planning, same-sex couples can allocate the itemized deductions to one partner’s tax return while deducting the standard deduction on the other partner’s tax return, since same-sex couples must file using either the single or head-of-household filing status.
Tax practitioners should be cautious when deciding on the allocation of dependent exemptions, child care credits, and itemized deductions on the tax returns for same-sex married couples. They should make sure that the taxpayer who is claiming the child as a dependent is either the biological parent or that he or she is the legal parent and has formally adopted the child in a second-parent adoption.
Tax practitioners should also trace the source of funds used to pay the costs for which the taxpayer claims itemized deductions and child care expenses. The partner who reports the itemized deductions or child care credit should pay the expenses with his or her own funds.
Gift and Estate Tax Planning Considerations for Same-Sex Couples
Gift and estate tax planning for same-sex couples can be complex and challenging. However, there are several current opportunities available to assist same-sex couples with reducing their gift and estate tax burden as the courts continue to consider DOMA’s constitutionality.
Because DOMA does not recognize a marriage between same-sex couples, gifts in excess of the annual gift tax exclusion of $13,000 ($14,000 in 2013) under Sec. 2503 between spouses in same-sex marriages are subject to gift tax and require the filing of a gift tax return. For example, a taxable gift may result if one partner provides more than $13,000 toward the other partner’s expenses during the year. Expenses paid directly to an educational or medical institution are not considered gifts and do not reduce the available annual gift exclusion. Couples in same-sex marriages should maintain detailed documentation of the expenses that they pay on each other’s behalf to ensure accurate preparation of yearly gift tax returns.
Practitioners should advise same-sex married couples to consider using the $5.12 million maximum lifetime gift tax exclusion for 2012 under Sec. 2505(a)(1). The gift tax exclusion is scheduled to revert to $1 million on Jan. 1, 2013, so same-sex couples should act quickly in balancing their asset holdings and transferring assets to the partner with the lower net worth. But the practitioner should also discuss the ramifications of such a gift in the event the relationship breaks down. Same-sex couples should be advised to have a cohabitation agreement in place that establishes how assets will be split and addresses custody issues for the children in the event the relationship ends.
Because same-sex couples do not qualify for the unlimited marital estate tax deduction under Sec. 2056, they are unable to transfer an unlimited amount of assets to the surviving partner upon the death of the first partner. The assets are subject to estate tax upon the death of the first partner, and the same assets are subject to estate tax again upon the death of the second partner in the relationship.
To minimize the estate tax burden of same-sex couples, practitioners may suggest the couple establish an irrevocable trust for the surviving partner’s benefit. The assets transferred into the irrevocable trust are subject to estate tax upon the first partner’s death but are not subject to estate tax when the second partner dies.
Conclusion
The courts are unlikely to resolve DOMA’s constitutionality in the near future. Same-sex couples will continue to be subject to the strict language in Section 3 of DOMA until the courts finalize the status of its constitutionality.
In the meantime, practitioners should be aware of the various avenues to protect the tax rights of their same-sex married couple clients with regard to income and gift and estate tax if DOMA is declared unconstitutional. Unless and until that happens, tax practitioners should also use additional tax planning opportunities that comply with Section 3 of DOMA. This can make a significant economic difference for same-sex couples.
EditorNotes
Michael Koppel is with Gray, Gray & Gray LLP in Westwood, Mass.
For additional information about these items, contact Mr. Koppel at 781-407-0300 or mkoppel@gggcpas.com .
Unless otherwise noted, contributors are members of or associated with CPAmerica International.
