A reported decision from Ohio last week (Obergefell v. Kasich, 2013 U.S. Dist. LEXIS 102077 (S.D. Ohio July 22, 2013)) sets the stage for the continuing discussion about financial and tax planning for same-sex couples. Many advisers are uncovering the conflicts that exist between a federal system, with a definition of marriage that includes same-sex marriages, and certain state regimes that explicitly limit the definition of marriage to exclude same-sex marriages. The federal estate tax figured prominently in the recent U.S. Supreme Court decision in Windsor v. United States, __U.S.__, 133 S.Ct. 2675 (2013), which was issued on June 26, but was rarely mentioned in the intense public and political debates that resulted. The decisions in Windsor, and Hollingsworth, et al. v. Perry et al., __U.S.__, 133 S. Ct. 2652 (2013), issued on the same day as Windsor, sparked a national discussion about the rights of same-sex couples to marry. In the wake of those decisions, same-sex couples celebrated their eligibility for the many federal benefits available to married couples.

Windsor

Edith Windsor served as the executor of the estate of her deceased spouse, Thea Spyer. Windsor and Spyer had lived in a committed relationship for decades. The same-sex couple registered as domestic partners in the City of New York when that was made available to same-sex couples. They were legally married in 2007, in Ontario, Canada. At the time, New York recognized same-sex marriages performed in other jurisdictions, but the state did not allow same-sex couples to marry in New York until 2011. When Spyer died in 2009, Windsor filed an estate tax return claiming the full marital deduction for assets that passed to her under Spyer’s estate plan. The Internal Revenue Service disallowed the deduction, and Windsor, as executor, paid the deficiency.

Windsor then filed a suit for refund of the federal estate tax on the basis that Section 3 of the federal Defense of Marriage Act (DOMA) violates the Equal Protection Clause of the Fifth Amendment of the United States Constitution. Section 3 of DOMA specifically provides:

In determining the meaning of any Act of Congress, or of any ruling, regulation, or interpretation of the various administrative bureaus and agencies of the United States, the word “marriage” means only a legal union between one man and one woman as husband and wife. The word “spouse” refers only to a person of the opposite sex who is a husband or wife.

In February 2011, the Justice Department announced that it would no longer defend DOMA’s constitutionality because a heightened standard of scrutiny should apply to classifications based on sexual orientation and Section 3 is unconstitutional under that standard. As a result of the Justice Department’s decision, the Bipartisan Legal Advisory Group of the U.S. House of Representatives (BLAG) moved to intervene in this case to defend the constitutionality of the statute.

Windsor moved for summary judgment, arguing that DOMA is subject to strict constitutional scrutiny. Windsor contended that DOMA fails under that standard of constitutional review because the government is unable to establish that DOMA is narrowly tailored to serve a compelling or legitimate government interest. In the alternative, Windsor argued that DOMA has no rational basis. The district court granted the motion for summary judgment, finding that Section 3 of DOMA violated the Equal Protection Clause because it had no rational basis.

The 2nd Circuit Court of Appeals upheld the district court’s ruling, and the Supreme Court granted certiorari on Dec. 7, 2012.

In the 5–4 Windsor decision, the Supreme Court held Section 3 of the federal DOMA unconstitutional as a deprivation of the equal liberty of persons protected by the Fifth Amendment to the United States Constitution. That section of the law, which applied to all corners of the federal code, defined marriage as the union of one man and one woman only. For all federal purposes, including the estate tax marital deduction, this applied regardless of status of a relationship at the state level. The Supreme Court held that the federal government’s attempts at classification and regulation of marriage — as only existing between one man and one woman — would not stand.

Before Windsor, a same-sex couple living in a jurisdiction that allowed or recognized same-sex marriage was forced to live as married for the purpose of state law but as unmarried for the purpose of federal law. Going forward, the federal government will be required to respect all marriages from the states, including marriages of same-sex couples. And a couple living in a jurisdiction that allows or recognizes same-sex marriage will be married for state and federal law purposes.

Perry

In June 2008, the Supreme Court of California decided that marriages between same-sex couples would be recognized and equal to all other marriages performed in the state. Five months later in a ballot initiative known as Proposition 8, opponents of marriage equality successfully added a new provision to the California constitution whereby only a marriage between a man and a woman would be valid or recognized in the state.

Kristen Perry and her spouse, Sandra Stier, along with a gay couple, filed an action seeking to compel state officials and their respective county clerks to issue marriage licenses notwithstanding the language of Proposition 8. The plaintiffs claimed that the language added to the California constitution by Proposition 8 violated their rights guaranteed by the 14th Amendment to the U.S. Constitution and that they should be allowed to marry. The state officials refused to defend Proposition 8, and the district court allowed a group of individual citizens — the group that supported Proposition 8 — to defend the language added as a result of the ballot initiative.

The lower federal courts in California held that Proposition 8 was unconstitutional, and the state officials were ordered not to enforce Proposition 8. The state officials elected not to appeal the matter, but the individual citizens did appeal the decision to the 9th Circuit Court of Appeals. The 9th Circuit was unclear on whether the petitioners — the individual citizens who supported Proposition 8 — had standing to appeal. The federal appeals court certified the question to the California Supreme Court, which held that the proponents of the ballot initiative had standing under federal law to defend the constitutionality of the ballot initiative. The 9th Circuit heard the appeal and upheld the lower court on the merits.

The United States Supreme Court, however, did not reach the merits of the Perry decision. Rather, a five-judge majority determined that the opponents of marriage equality — the individual citizens — did not have standing to pursue the case. As a result, the decision of the lower courts stood. Proposition 8 was held to be unconstitutional, and the county clerks in California are authorized to issue marriage licenses to same-sex couples.

Federal Marriage Benefits Available

As of this writing, 13 states and the District of Columbia have recognized marriages between same-sex couples. Minnesota and Rhode Island, included in that count, have passed laws that take effect Aug. 1, 2013. In each of these jurisdictions, married same-sex couples now enjoy the same rights, and are eligible for the same benefits, as any other married couple.

As a result of the Windsor decision, the federal government is now obligated to respect a marriage that is validly recognized by a state. Specifically with respect to federal tax issues, same-sex couples may now:

  • file joint federal income tax returns;
  • elect to split gifts on a federal gift tax return;
  • claim the marital deduction for federal gift and estate tax purposes; and
  • elect portability of a deceased spouse’s unused applicable exclusion amount.

Other notable tax benefits of marriage include the nonrecognition of gain on assets transferred between spouses and the treatment of spouses as a single shareholder of an S corporation.

Qualified retirement accounts are another area that has a spousal preference, and the Windsor decision now extends that preference to same-sex married couples. If the surviving spouse of a same-sex couple is designated as the beneficiary under a qualified retirement account, the spouse is eligible for the preferential treatment of the “spousal rollover” of the account. The account may be eligible to be combined with that spouse’s other retirement accounts, and the distributions may be calculated using the surviving spouse’s life expectancy. For more on the impact of the decisions on qualified retirement accounts and other benefits issues, see this legal alert from the McGuireWoods LLP employee benefits team.

The IRS and U.S. Department of the Treasury have indicated that guidance will be forthcoming on treatment of these important issues.

Beyond tax issues, Windsor will have far-reaching effects for married same-sex couples on issues related to Social Security, Medicare and Medicaid benefits, federal financial aid programs, military and veteran’s benefits and even immigration status.

Same-sex couples should consult their tax and financial advisers to assess their planning in light of the new ruling.

  • Couples should evaluate the most appropriate filing status for federal income tax returns, and, where advisable, file amended returns for prior open years. Same-sex couples now have the opportunity to file a joint return, but they no longer may file as single taxpayers. If a married same-sex couple wishes to file separate returns, they must use the status married filing separately, which sometimes has harsh consequences for the taxpayer.
  • Couples should review the beneficiary designations on life insurance policies and qualified retirement accounts to determine the most effective and appropriate designations.
  • Couples should assess gift-planning strategies, including the election to treat gifts as split gifts, to take the maximum advantage of the unlimited marital deduction for gifts to a spouse and the annual exclusion from gift tax or the lifetime gift tax exemption for gifts to third parties.
  • Couples should review and revise estate planning documents to account for the unlimited marital deduction and planning possibilities that result.
  • Couples should examine any existing planning strategies to determine what, if any, adjustments can and should be made as a result of the ruling. Some same-sex couples may have implemented strategies that relied on the fact that the same-sex marriage was not recognized for federal tax purposes. Some of the “unwelcome” consequences of the Windsor ruling may include: the treatment of a same-sex spouse as a family member for purposes of Chapter 14 of the Internal Revenue Code; the disallowance of certain losses and exceptions to the stepped-up basis rules for property in the hands of a spouse; the attribution of stock ownership to a same-sex spouse; and the identification of a same-sex spouse as a disqualified person with respect to private foundations.

Any surviving spouse of a same-sex couple, including a surviving spouse whose partner died before the Windsor decision, should consult their legal and tax advisers about the possibility of filing a late or amended estate or gift tax return, either to qualify gifts to the surviving spouse for the marital deduction or to elect portability of the deceased spouse’s unused exclusion amount.

State Laws Complicated; New Cases on the Horizon

Thirty-seven states have yet to recognize the marriage of same-sex couples. Many states have passed state-DOMA statutes aimed at prohibiting such marriages or the recognition of marriages validly performed in another jurisdiction. And Windsor’s reach extends only to the federal government definition of marriage. Left untouched by the Supreme Court was Section 2 of DOMA, which provides that no state shall be required to give effect to any public act, record or proceeding of another state that recognizes a relationship between persons of the same sex as a marriage. And the decision in Perry confirms that, for now, decisions about marriage will be left to the states to decide.

This leaves open a number of issues for married same-sex couples. The federal system now will respect the state laws on marriage, and if a same-sex couple is validly married for state law purposes, they will be treated as such for federal law purposes. But some same-sex couples have been married in a jurisdiction that allows same-sex marriage but live in a jurisdiction that does not recognize, or explicitly prohibits, such a marriage. Their marital status, for both state and federal purposes, is complicated.

  • The federal government may recognize a joint federal income tax return, but some states may not recognize such a return.
  • Many state law benefits of marriage, including the elective share, the homestead exemption or related spousal privileges in the probate code, the creditor protection afforded by tenancy-by-the-entirety and retirement benefits governed by state law, may not be available to same-sex couples.
  • The exercise of powers of appointment in favor of a spouse may be complicated if a couple is validly married in one jurisdiction but the documents granting the power of appointment are governed by another that specifically does not recognize their union.

New cases are on the horizon, however. In the most recently reported decision, an Ohio federal district court ordered the Ohio registrar of death certificates to accept no death certificate for John Arthur, a resident of Ohio, that does not record his status as married and does not record James Obergefell as his surviving spouse. Obergefell v. Kasich, 2013 U.S. Dist. LEXIS 102077 (S.D. Ohio July 22, 2013).

Messers. Arthur and Obergefell have been in a committed relationship for 20 years and were recently married in Maryland. They are both Cleveland, Ohio, residents, and that state specifically has prohibited in the state code and state constitution the recognition of marriage between gay or lesbian couples. Mr. Arthur is suffering from ALS and is expected to die soon. The plaintiffs sought a preliminary injunction to prevent the Ohio registrar of death certificates from issuing a death certificate identifying Mr. Arthur as anything other than married to Mr. Obergefell at the time of this death. The district court found that the plaintiffs would suffer irreparable harm if Mr. Arthur’s death certificate did not recognize his marital status and, in light of the recent ruling in the Windsor case and the equal protection rulings from the U.S. Supreme Court, that the plaintiffs were likely to prevail on the merits of their case. The decision in Orbergefell is limited to the facts and circumstances in the case before that court, but it heralds the cases that are likely to arise in the coming months and years.

It is the first of what are likely to be many cases from the 37 states that still do not recognize the marriages of same-sex couples. Recent reports indicate that cases have been or are being filed in as many as 11 of the 37 states that do not recognize same-sex marriages. As these cases work through the district and appeals courts, and perhaps ultimately the U.S. Supreme Court, the eligibility of married same-sex couples across the country will be unsettled. Advisers should closely monitor the cases, and same-sex couples, or parents with children in same-sex relationships, should engage their advisers, to understand how the decisions impact their current financial planning and how that planning might change with new decisions to come.

As used in this paper, the references to ‘states’ include U.S. territories.