In the Wake of DOMA: Taxation of Same-Sex Married Couples
In 1996, Congress passed the Defense of Marriage Act (DOMA), which had two main functions: (1) it prevented the federal government from recognizing same-sex marriages, and (2) it absolved states from having to legally recognize same-sex marriages that took place outside their borders.
On June 26, 2013, the U.S. Supreme Court in U.S. v.Windsor found unconstitutional the portion of DOMA that prevented the federal government from recognizing same-sex marriages. It held that this portion of DOMA violated principles of equal protection and due process by denying same-sex couples who reside in states that recognize same-sex marriages the benefits and responsibilities that come with the federal recognition of their marriages. While the ruling allows the federal government to recognize same-sex marriages in some states, it did not legalize same-sex marriage in all states.
While the decision was groundbreaking, it left many unanswered questions. The article below explores the effect of the repeal and also raises some unresolved concerns. The federal government – the Internal Revenue Service in particular – is currently working on regulations to resolve some of these unresolved questions.
To Whom do these New Federal Rights Apply?
As mentioned above, the repeal of DOMA does not result in the legalization of same-sex marriage in all states. Instead, the term “marriage” is left to each state to define.
a. Legally Married Couples Living in a Same-Sex Marriage State
Same-sex couples who were married in a jurisdiction that permits same-sex marriage and who currently reside in a state that recognizes same-sex marriages are considered married at both the state and federal levels. For example, Washington State, Massachusetts and New York currently recognize same-sex marriages. Therefore, a couple who married and currently reside in Washington State are considered married at both the federal and state levels. Additionally, a couple who married in Massachusetts and currently reside in New York are considered married at the state and federal levels.
b. Legally Married Couples Living in a Non-Recognition State
From the Windsor case, we know that the federal government will recognize marriages if they are recognized by the state of residency. It is unclear, however, whether this means that the federal government will recognize the marriage of couples who were married in a jurisdiction that permitted same-sex marriage, but who now live in a state that either (1) is silent on the issue of same-sex marriage or (2) bans same-sex marriage. For example, New Mexico neither prohibits nor allows same-sex marriage. If a same-sex couple married in Washington and moved to New Mexico, it is unclear whether the federal government would recognize their marriage. Likewise, if a same-sex couple marries in Washington and moves to Arizona, a state which bans same-sex marriage, it is clear that the couple would not be able to file joint state income tax returns or be considered “spouses” under state law, but it is unclear whether they would be recognized as married by the federal government.
If the federal government adheres to each state’s definition of marriage to determine the application of federal benefits (such as income and estate tax, veterans’ benefits, Social Security, Medicare, Medicaid and the Family Medical Leave Act), then the application of these benefits may be inequitable. For example, a couple that marries in Washington and remains there would be eligible to receive each other’s Social Security benefits, while a similar couple that marries in Washington and relocates to Arizona would not be entitled to each other’s Social Security benefits.
Without further legislation to clarify the federal government’s intent, future litigation will be inevitable. Until then, in order to take advantage of the federal benefits available to opposite-sex married couples, a same-sex married couple should, if possible, reside in a state that recognizes their marriage.
c. Civil Unions and Domestic Partnerships
Same-sex couples who are parties to a state-sanctioned civil union or a registered domestic partnership are not considered legally married at the federal level. Regardless of whether these unions and partnerships provide all state rights that opposite-sex married couples receive, they are not considered marriages. In order to take advantage of these new rights and responsibilities, a same-sex couple must formally marry.
On December 6, 2012, Washington State passed a law allowing same-sex couples to marry. As of June 30, 2014, all same-sex couples remaining on Washington’s domestic partner registry will automatically be deemed “married” unless: (1) the couple has already legally married; (2) the couple has removed itself from the registry; or (3) one partner is 62 years of age or older. If a couple is deemed married, Washington recognizes the marriage effective as of the date the couple became registered domestic partners (rather than the date of the actual wedding ceremony). While Washington has made the marriage date retroactive, it is unclear whether the federal government will provide federal benefits retroactively to a Washington same-sex married couple.
The status of same-sex married couples living in non-recognition states and the effective date of the application of benefits are just some of the unanswered concerns that will be determined as the effect of the DOMA repeal unfolds.
Wealth Transfer and Estate Planning
Now that many same-sex married couples have federal recognition of their marriages, there are a number of estate and gift tax benefits of which they should be aware.
a. Unlimited Marital Deduction
The unlimited marital deduction allows a taxpayer to transfer an unlimited amount of assets to his or her U.S. citizen spouse, during life or after death, with no gift or estate taxes. Prior to the repeal of DOMA, this only applied to opposite-sex married couples. If a typical married man left his entire estate to his spouse when he passed away, then there would be no erosion by transfer taxes. Because same-sex marriages were not recognized by the federal government, if one spouse in a same-sex marriage passed away, then his or her estate would have been subject to federal estate tax, and only the after-tax amount would have passed to his or her spouse.
With DOMA’s repeal, married same-sex couples who reside in a state that recognizes their marriages can claim the unlimited marital deduction and pass unlimited amounts to their spouses, tax free.
It is unclear whether same-sex married couples in non-recognition states will qualify for the unlimited marital deduction. However, that may not be their only concern. Many states have their own state estate tax. Same-sex married couples living in a non-recognition state may be subject to state estate tax as well.
Washington State imposes a state estate tax on any Washington resident who dies with an estate in excess of two million dollars (in 2013). Similar to the federal government’s deduction against federal taxes, Washington State grants same-sex married couples an unlimited marital deduction against state estate taxes. As of January 1, 2014, Washington will extend the unlimited marital deduction to those unmarried same-sex and opposite-sex couples who have chosen to remain on the domestic partnership registry.
Under the unlimited marital deduction, a married couple can transfer an unlimited amount of assets to his or her spouse. Transfers to anyone other than a spouse may be subject to federal gift tax (if the transfer was made during life) or estate tax (if the transfer was made at death) if such transfers are in excess of the lifetime federal estate tax exclusion amount. In 2013, this exclusion amount is $5,250,000.
If one spouse dies without using all of his/her federal estate tax exclusion, the unused portion of the exclusion may be transferred to the surviving spouse. The ability to transfer a deceased spouse’s unused federal estate tax exclusion to the surviving spouse is known as “portability.”
Prior to the repeal of DOMA, same-sex married couples were not able to take advantage of portability because of the federal government’s refusal to recognize same-sex marriages. With the repeal of DOMA, same-sex married couples in recognition-states will now have access to portability.
For example: Joe is a doctor, with an estate of $7 million. His spouse, Tom, is an engineer with an estate of $2 million. Joe and Tom are living in Washington when Tom unexpectedly dies, leaving his entire estate to Joe. Under DOMA, Tom’s estate would have passed to Joe and at Joe’s subsequent death, he would have had an estate of $9 million, and an exemption of $5,250,000. Joe’s estate would have tax due on $3,750,000.
With the repeal of DOMA, Joe would now inherit Tom’s $2 million estate, tax free, under the unlimited marital deduction. With the portability benefit, Joe will also receive Tom’s $5,250,000 exemption. At Joe’s subsequent death, he still has a $9 million estate. However, he can offset any taxes with his $5,250,000 lifetime estate tax exclusion plus Tom’s ported $5,250,000, for a total of $10,500,000. His entire estate would be sheltered and he would owe no taxes.
c. Titling of Real Property
Married couples often wish to create a sense of unity and community within the household and often desire to own a house jointly. Titling of real property has been one of the more difficult issues for same-sex couples because of gift tax issues.
With the repeal of DOMA, same-sex married couples residing in states that recognize same-sex marriage will be able to share title to real property between them without incurring federal gift tax. However, it is currently not clear how the federal government will treat transfers of real property between same-sex married couples that prior to the repeal of DOMA.
Other Potential Issues
In addition to estate planning benefits and concerns, there are other issues of which same-sex married couples should be aware:
a. Filing Protective Claims for Income Tax Refunds
Under DOMA, the value of employer-provided benefits, such as health and long term care insurance, were considered taxable income to a same-sex spouse. Now that some same-sex marriages are recognized, some individuals may be entitled to a refund of past taxes paid on these benefits. Until we get guidance from the IRS, some taxpayers may want to file protective claims for potential refunds from taxes paid in previous years.
b. Filing Federal Tax Returns
With the repeal of DOMA, some married same-sex couples will have the opportunity to jointly file a federal tax return. However, whether they file “married filing jointly” or “married filing separately” may have an effect on the overall amount of federal income tax due. Married same-sex couples should consult a qualified accountant to determine their best filing status. If the same-sex couple lives in a state that does not recognize same-sex marriages, these couples should proceed with caution until further guidance is provided.
c. Federal Benefits
Prior to the repeal of DOMA, same-sex married couples were denied the federal benefits that were provided to opposite-sex married couples, including veterans’ benefits, Medicare, Medicaid, Family Medical Leave Act and Social Security.
With the repeal of DOMA, these benefits will be conferred on same-sex married couples residing in states that recognize their marriages. The effective date of these benefits remains unknown. They could be effective on a state-by-state basis, starting with the date when that state first recognized same-sex marriage. Or they could be effective starting on June 26, 2013 (the date of the Supreme Court decision), or a certain number of days after that. Again, more guidance is needed from the federal government.
U.S. v. Windsor was a milestone case bringing same-sex marriages closer to parity with opposite-sex marriages. Same-sex married couples living in a non-recognition state, such as Arizona, will need to wait until the dust settles and the federal agencies have issued their regulations. Depending on the result, more litigation may follow. Same-sex married couples living in a recognition state, such as Washington, will receive full federal rights and responsibilities, but the effective date is still unknown. This new equality and responsibility granted in Windsor provides an important opportunity for same-sex married couples to review their estate plans and their property titles with their estate planning attorneys and financial advisors.