September 5, 2013 by msquaredlaw
Recently, the IRS answered a lingering question since the Supreme Court’s historic June 26 decision on same-sex marriage: In determining whether a same-sex couple is married for federal tax purposes, will the IRS apply the law of the state where the couple lives, or the law of the state where they got married? The IRS announced that same-sex married couples will be treated as married for federal tax purposes regardless of whether the couple resides in a state recognizing same-sex marriage or one that doesn’t. However, the couple has to be married in a state or foreign country that recognizes same-sex marriage, as this treatment does not apply to civil unions or registered domestic partnerships. This ruling means that same-sex married couples are free to move throughout the U.S. without changing their federal filing status.
This ruling applies to all federal tax provisions where marriage is a factor, including filing status, claiming personal and dependency exemptions, taking the standard deduction, employee benefits, contributing to an IRA and claiming the earned income tax credit or child tax credit. Same-sex couples will also be treated as married for gift and estate tax purposes.
How this Ruling Affects Income Taxes
For the 2013 tax year, legally married same-sex couples must file their federal income tax return using either the married filing jointly or married filing separately filing status. For past years, same-sex married couples may, but are not required to, file original or amended returns as married. They can also file claims for refunds for prior tax years still open under the statute of limitations for filing a refund claim (generally three years from the date the return was filed or two years from the date the tax was paid, whichever is later). This gives affluent same-sex couples some very good choices for income tax planning purposes and they should consult with a tax advisor to help determine what years they should amend and what years they should not amend.
Additionally, employees who purchased same-sex spouse health insurance coverage from their employers on an after-tax basis may treat the amounts as pre-tax and excludable from income. The IRS states that employers can expect streamlined procedures to file refund claims for payroll taxes paid on previously-taxed health insurance and fringe benefits provided to same-sex spouses. For cafeteria plans, qualified retirement plans and other tax-favored arrangements, the IRS plans to issue guidance in the near future.
How this Ruling Affects Estate and Gift Taxes
The marital deduction now applies to same-sex married couples, meaning these couples can now transfer assets to each other, either during life or at death, without having to pay any federal estate or gift tax, provided the recipient spouse is a U.S. citizen. Same-sex couples who filed a gift tax return that involved a transfer to a spouse that used up any portion of the donor spouse’s estate tax exemption should see a tax advisor in order to determine if it would be beneficial to amend such gift tax return to regain the exemption amount.
Additionally, same-sex widows and widowers can also take advantage of the “portability” of the unused estate tax deduction (now $5.25 million) of the spouse who died so that, together, the spouses can transfer up to $10.5 million tax-free to other individuals. Not that portability is not automatic. The estate of the deceased spouse will need to transfer the unused exclusion to the survivor spouse by filing an estate tax return when the first spouse dies, even if no tax is owed. This return is due nine months after the death (a six month extension is allowed). It would be a good idea for a survivor spouse to file the estate tax return even if they are below the exclusion amount at the date of death of deceased spouse. After all, who knows what the future holds?
Same-sex married couples can also take advantage of the gift-splitting rules. Currently, an individual can give up to $14,000 each year to as many recipients as you would like without incurring any gift tax. Spouses can combine this annual exclusion to jointly give $28,000 to any person gift tax-free.
Social Security Considerations
The Social Security Administration also announced that it has started processing retirement spouse claims for same-sex couples and paying benefits that were due. Although the Social Security Administration is still working out some of the kinks in applying the new laws, individuals who believe they may be eligible for benefits are encouraged to apply for them now so that they can establish their effective date for the start of any benefits that become available after the agency makes its official rulings.
Estate Planning for Same-Sex Couples
Despite the IRS and Social Security Administration announcements, please be aware that there are still state laws that govern non-tax issues, such as inheritance under the state laws of intestacy. Same-sex married couples should strongly consider having an attorney draft an estate plan, including a living trust and/or will and a healthcare surrogate, in order to protect themselves in the event of the death or incapacity of one spouse.
If you are a same-sex married couple and would like assistance with filing or amending returns or drafting your estate plan, please contact us for more information.