As of Sept. 2, 2016, same-sex married couples have certainty with regard to the Internal Revenue Code's recognition of their married status for tax purposes. On that date, the IRS issued final regulations (T.D. 9785) to reflect the holdings in two recent Supreme Court cases.
Historically, the status of marriage was determined under state law. In 1996, however, Congress enacted the Defense of Marriage Act (DOMA), P.L. 104-199, which defined marriage for all federal purposes as a legal union between one man and one woman as husband and wife and defined "spouse" as referring only to a person of the opposite sex who is a husband or wife. As a result, the IRS was prohibited from treating partners or spouses in same-sex marriages, which became legal under certain states' laws, as husband and wife, and thus same-sex couples were not permitted to file a joint federal income tax return (see, e.g., Mueller, 39 Fed. Appx. 437 (7th Cir. 2002)). Uncertainty for same-sex couples in federal taxes ensued during the 2000s, until the U.S. Supreme Court became involved in 2013.
In Windsor, 570 U.S. 12 (2013), the Supreme Court struck down the definition of marriage in Section 3 of DOMA as only between a man and a woman. Two years later, the Supreme Court in Obergefell v. Hodges, 135 S. Ct. 2584 (2015),went a step further and held that, under the Fourteenth Amendment, same-sex couples have a fundamental right to marriage. As such, the Court held that the Fourteenth Amendment requires a state to license a marriage between two people of the same sex and requires states to recognize same-sex marriages lawfully performed outside the state, effectively striking down Section 2 of DOMA.
In 2016, the IRS issued final regulations reflecting the holdings of Obergefell and Windsor, as well as some portions of IRS guidance issued in response to both cases. Under Regs. Sec. 301.7701-18(b)(1), a marriage of two individuals is recognized for federal tax purposes if the marriage is recognized by the state, possession, or territory of the United States in which the marriage is entered into, regardless of the married couple's place of domicile.
In addition, under Regs. Sec. 301.7701-18(b)(2), two individuals entering into a relationship denominated as marriage under the laws of a foreign jurisdiction are married for federal tax purposes if the relationship would be recognized as a marriage under the laws of at least one state, possession, or territory of the United States. This rule enables couples who are married in foreign jurisdictions to determine marriage for federal tax purposes regardless of where they are domiciled and regardless of whether they ever reside in the United States, and it prevents taxpayers from having to review the laws of all states to determine whether they would be treated as married. Instead, a couple only need to be treated as married in one jurisdiction.
Tax Return Filing Status
In general, pursuant to Sec. 6013(a) and the regulations thereunder, a married couple may elect to make a single return jointly, even if one spouse has no income or deductions. Under Sec. 6013(d)(1)(A), whether two individuals are a married couple eligible to make a joint return is determined as of the close of the tax year if both individuals have the same tax year. Therefore, to the extent a same-sex couple are legally married at the close of their individual tax year (typically, Dec. 31) in any jurisdiction in the United States that recognizes the marriage (or foreign jurisdiction but recognized in the United States, as noted above), that couple can file their U.S. federal income tax return with a status of married filing jointly.
The status of married filing jointly is generally more beneficial than the married-filing-separately status, but taxpayers need to weigh the pros and cons and decide for themselves which is better. IRS Publication 501, Exemptions, Standard Deduction, and Filing Information, advises, "If you and your spouse decide to file a joint return, your tax may be lower than your combined tax for the other filing statuses. Also, your standard deduction (if you don't itemize deductions) may be higher, and you may qualify for tax benefits that don't apply to other filing statuses."
By filing a joint tax return, both spouses report all their income, deductions, and credits on one tax return. Both spouses must sign the return, and both spouses accept full responsibility for the accuracy and completeness of the information reported on the tax return. If any tax is unpaid, each spouse is held personally responsible for the underpayment.
In Publication 501, the IRS cautions:
Both of you may be held responsible, jointly and individually, for the tax and any interest or penalty due on your joint return. This means that if one spouse doesn't pay the tax due, the other may have to. Or, if one spouse doesn't report the correct tax, both spouses may be responsible for any additional taxes assessed by the IRS. One spouse may be held responsible for all the tax due even if all the income was earned by the other spouse.
In certain circumstances, the IRS may grant relief from joint liability for taxes through innocent spouse relief, separation of liability, or equitable relief.
State Tax Returns
Prior to the 2016 final regulations, the complexity of various state laws and filing obligations created a tax filing nightmare for many same-sex couples. Taxpayers in same-sex relationships had to wade through state tax laws to determine how to properly file their state tax returns, which could include a different filing status from their federal income tax return. (In a handful of states, the issue of treating same-sex couples as married for state income tax purposes did not arise, either because the state has no income tax or because the state taxes only interest and dividends and does not provide a separate rate structure for single and married taxpayers. These states include Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming.)
The issue of same-sex marriage has been addressed by many states over the past 15 years. The first state to officially provide for same-sex marriage by statute was Vermont in 2009, following court decisions in Massachusetts, California, and Connecticut that held that those states' constitutions required recognition of same-sex marriage. Various other states then adopted statutes or their state courts ruled in favor of some form of recognition for same-sex couples. At the time of the Obergefell decision, the following states allowedsame-sex couples to file tax returns as married: Arizona, California, Colorado, Connecticut, Delaware, District of Columbia, Hawaii, Idaho, Illinois, Indiana, Iowa, Maine, Maryland, Massachusetts, Minnesota, Montana, New Jersey, New Mexico, New York, North Carolina, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, Utah, Vermont, Virginia, West Virginia, and Wisconsin.
In Arkansas, Michigan, and Mississippi, same-sex marriage was not recognized, and there is no conformity between federal and state taxes, so prior to Obergefell, same-sex married couples in these states had to file state tax returns as if they were single.
Another set of states did not recognize same-sex marriage but conform to federal tax law. These states include Georgia, Kentucky, Kansas, Louisiana, Missouri, Nebraska, North Dakota, and Ohio. In Alabama, the filing status was unclear until the Obergefell decision.
Prior to the Obergefell decision, some states, such as Michigan, required each individual who had income attributable to Michigan and who had filed a joint return with the IRS as a member of a same-sex couple to separately report adjusted gross income (AGI) for Michigan income tax as a single filer. Further guidance then directed each individual to recalculate his or her federal AGI as if he or she had filed a single federal return—in essence requiring the preparation of "dummy" federal returns. The Obergefell decision essentially makes Windsor applicable for not only the federal returns but also for all state tax returns, including Michigan. Thus, those in a same-sex marriage will be considered married for state and federal return purposes, eliminating the need for the preparation of dummy returns.
Also, prior to Obergefell, same-sex couples with filing obligations in more than one state continued to face the possibility that they would have to file as married in one state and as unmarried in another state. By requiring each state to recognize same-sex marriages lawfully performed outside of the state, Obergefell has nowalleviated these types of state tax law complexities, and same-sex couples now have the same tax filing options as opposite-sex couples.
Previously Filed Tax Returns
It also may be possible—and advantageous—for married same-sex couples to file amended tax returns for open tax years. The general federal statute of limitation provides that tax returns remain "open" for the three preceding tax years. Therefore, taxpayers seeking a tax refund or credit must file Form 1040X, Amended U.S. Individual Income Tax Return, within three years (including extensions) after the date the original return was filed, or two years after the tax was paid, whichever is later. This could be different for each taxpayer due to his or her individual filing history, so taxpayers should carefully consider whether amending past tax returns is possible and beneficial.
Furthermore, if a federal income tax return is amended, it will be necessary to amend the state income tax returns to reflect the change(s). The statute(s) of limitation on amending state tax returns can differ from the federal statute of limitation, so taxpayers should consider relevant state requirements with respect to amended tax returns prior to amending their federal income tax return.
After Obergefell and the 2016 final regulations, not only is there more certainty around the income tax filing obligations of same-sex couples, there is also now more certainty around estate tax planning. An in-depth analysis of all the estate planning considerations that are available for same-sex couples is beyond the scope of this item. However, it is important for these couples to become familiar with the basic estate planning now afforded married couples. Some of the major estate planning considerations are:
Marital deduction: The federal estate tax marital deduction is one of the most important estate planning tools available to a married couple. In general, the marital deduction allows, upon the death of the first spouse, the value of any interest in property passing to the surviving spouse to be deducted from the decedent spouse's gross estate. This means that the amount passing to the surviving spouse escapes taxation in the decedent spouse's estate.
There is no limit on the value of the property that can qualify for the marital deduction. By transferring sufficient assets to the surviving spouse in the proper manner, couples can completely avoid estate tax liability upon the first spouse's death.
Portability election: Portability refers to the right of a surviving spouse to claim the unused portion of the federal estate tax exemption of the deceased spouse and add it to his or her own exemption. Since in 2017 the federal estate tax exemption is $5.49 million per person, a married couple can potentially pass on almost $11 million to their heirs free from federal estate taxes. It is important to note that portability must be elected on the estate tax return of the first deceased spouse, even if that spouse does not owe estate tax.
Gift splitting: Gifts are generally subject to the gift tax, but most people never pay this tax due to the $14,000 per donee annual exclusion and the $5.49 million lifetime exemption (for 2017). In addition, gift splitting allows a married couple to double their annual exclusions by making joint gifts to third parties for gift tax purposes. For example, if a husband makes a lump-sum $28,000 gift to his son, the couple can elect to split the gift, and the entire gift will be free of gift tax because it falls under the annual exclusion after taking into account the split. The top federal estate tax rate is 40%, so employing the annual gift tax exclusion can save a significant amount of tax.
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Alex Brosseau is a senior manager in the Tax Policy Group of Deloitte Tax LLP’s Washington National Tax office.
For additional information about these items, contact Mr. Brosseau at 202-661-4532 or email@example.com.
Unless otherwise noted, contributors are members of or associated with Deloitte Tax LLP.