The recent U.S. Supreme Court decision inUnited States v. Windsor overturning Section 3 of the Defense of Marriage Act (DOMA) raised several questions regarding the federal tax treatment of same-sex couples. (See Holland & Knight Private Wealth Services alert, "United States v. Windsor: A New Direction in Planning for Same-Sex Couples," July 9, 2013.) A chief concern under the text of the decision was whether same-sex couples who were legally married in a domestic or foreign jurisdiction would be recognized as married for federal tax purposes — even if they subsequently moved to a state that did not recognize their union. In addition, the Windsor decision applied only to marriage — it did not address civil unions or domestic partnerships, leaving uncertainty as to the federal recognition of these relationships. On August 29, 2013, the Department of Treasury issued guidance on these questions and provided practical direction for same-sex couples filing tax returns.
Marital Status Will Be Uniform, Regardless of State of Residence
As part of that guidance, Revenue Ruling 2013-17 confirmed that same sex-marriages validly entered into in a domestic or foreign jurisdiction will be recognized for federal tax purposes. Relying on a 1958 ruling that recognized common law marriage if valid where formed, the Internal Revenue Service cited the need for uniform nationwide rules as "essential for efficient and fair tax administration" for federal tax purposes. The IRS stated that a rule in which a couple's marital status could change depending on their state of residence would be unduly difficult to follow. Accordingly, wherever the terms "husband and wife," "husband" and "wife" appear in the Internal Revenue Code, they will be construed in a gender neutral manner to refer to "spouse." As a result, a same-sex marriage that was validly entered into will be recognized for federal tax purposes, regardless of the couple's place of domicile.
The Revenue Ruling affirmatively answers an important question for couples who reside in a state that does not recognize their marriage: for federal tax purposes, their marriage will continue to be recognized. While some of the implications of the ruling may be obvious — i.e., couples may file joint income tax returns, take advantage of the unlimited marital deduction for gift and estate tax purposes, and avail themselves of estate planning techniques that are limited to "married" couples — others are more subtle. For example, there is no longer a generation-skipping transfer tax imposed on a gift to a significantly younger spouse or to the spouse of a child. This result will hold true regardless of where the donor resides.
Alternative Arrangements Not Recognized
The Windsor decision did not, however, grant recognition to alternative arrangements to marriage, such as civil unions or domestic partnerships, even if the state legislation provides that such designation confers all benefits of marriage. The Revenue Ruling confirmed that couples joined in a legal relationship that is not "denominated as a marriage under the laws of that state" will not be treated as married for federal tax purposes.
Treasury's Release Addresses Practical Issues
In addition to the ruling, Treasury Secretary Lew also issued a release addressing certain practical issues concerning tax filing obligations of same-sex married couples and the ability to amend previously filed returns:
- Married couples must file as such, either jointly or separately, beginning with calendar year 2013.
- Couples may, but need not, file original or amended returns for one or more prior years that are open under the statute of limitations. For the purpose of determining whether a return may be amended or a refund collected, the three-year statute of limitations will apply, unless an individual taxpayer had an agreement with the IRS to keep an earlier return open. Couples should consult their tax preparers to assess whether they would benefit from amending any prior returns. By providing that couples may amend returns for "one or more" prior open years, the release appears to allow couples to amend for those years in which they would enjoy a tax benefit, and to leave other returns as originally filed.
- Employees who purchased health insurance for a spouse on an after-tax basis may treat the premium cost as a pre-tax amount, excludable from income. Further guidance for employers seeking refunds relating to benefits programs will be forthcoming.
Many Complex Questions Remain Unanswered
The release augments the ruling with clear direction to taxpayers seeking to avail themselves of potential tax benefits under the Windsor decision. Nonetheless, the IRS acknowledged in the ruling that the application of Windsor will likely require further guidance, and that other federal agencies will need to address programs they administer. Some of the remaining open questions include:
In states that do not recognize the marriage of their resident same-sex couples:
- Will the state permit couples to file joint state income tax returns, or will these couples file jointly for federal purposes and singly for state purposes? The state of Arizona, for example, has advised couples that they will not be permitted to file jointly for state purposes.
- Will the same result hold in all states, or will it be limited to states that do not require the same filing status as the federal return?1
- Will the IRS permit a deduction for a larger state income tax obligation based on the single filing status?
- Favorable federal income tax treatment will be permitted for alimony payments and property settlement on divorce. Couples who had previously separated but not divorced — including couples living in states that do not recognize their marriage and therefore refuse to grant divorce — now have reason to legally sever their relationships. Will states require adjustments to the tax treatment of these alimony and property settlement payments?
- The guidance issued by the IRS is not binding on other federal agencies. A number of federal programs are either administered by the states (i.e., Medicaid) or look to state law in determining marital status (i.e., Social Security).2 Must the states acknowledge federal recognition of a marriage in these cases? Will there be a distinction between being married for purposes of federal law as opposed to state law?
How will federal recognition impact the gift and estate tax liability of couples who live in a state that does not recognize their marriage?
- Can state estate taxes be paid from a QTIP Marital Trust without jeopardizing the federal marital deduction? Assuming payment of tax from the QTIP Marital Trust would jeopardize the marital deduction, the overall tax would be increased: any tax paid would be ineligible for the marital deduction, thus further increasing the taxable amount and creating a tax on the tax. The result is an interrelated calculation that significantly increases the tax due. This issue applies both to couples who live in a state that does not recognize their marriage, as well as those who own real estate in such a state.
- Irrevocable trusts that have the spouse as a beneficiary will be treated as "grantor trusts" for federal income tax purposes. If the state of residence does not recognize the marriage, will the trust be treated as a non-grantor trust for state income tax purposes?
- Federal tax laws permit favorable disclaimer provisions for a surviving spouse, but disclaimers will be scrutinized under state law as well. Will the state rules recognize the marriage?
- Further guidance has yet to be released regarding rollover of retirement plan balances by a surviving spouse and other elections governed by the ERISA rules.
While this initial guidance clarifies the main questions following Windsor, a host of complex issues remain. Many of the states that recognize same-sex marriage are also high-tax jurisdictions, both with respect to income and estate taxes. On the other hand, many of the low-tax jurisdictions do not recognize same-sex marriage. This presents additional complications for couples who may want (or need) to change their domicile. As a result, many couples will continue to grapple with uncertainty or inconsistent recognition of their relationships.