In our last report (Vol. 8, No. 3, September 2013), we told you about the recent Windsor case, in which the Supreme Court held unconstitutional Section 3 of the Defense of Marriage Act, which precluded the Federal government from recognizing a marriage between a same-sex couple that was recognized by the state where the couple resided. This ruling of the Court will have far-reaching ramifications for a variety of federal taxes, including income, estate, and gift taxes. There are over 200 places in the Internal Revenue Code where a person’s marital status is relevant to a particular tax treatment.
In order to clarify these tax ramifications, on August 29, 2013, the IRS issued Rev. Rul. 2013-17, which by its terms is effective as of September 16, 2013. Taxpayers who were validly married under state law in prior years may also rely on the ruling to amend returns for those prior years that are still open under the applicable statute of limitations, but they are not required to do so.
The ruling clarifies two issues that were uncertain from the Court’s opinion in Windsor. First, a same-sex couple will be treated as married for Federal tax purposes if their marriage was valid in the state or foreign jurisdiction where it took place, even if the couple is currently domiciled or residing in a state that does not recognize same-sex marriage. This is an important clarification, as same-sex marriage is recognized in only about one-third of the states.
This is the position of the Internal Revenue Service for all tax purposes; however, other federal agencies are not bound to follow this approach and indeed may choose the domicile approach to determine the validity of a same-sex marriage. Thus far, the Social Security Administration and the Department of Labor have indicated they will follow the domicile approach.
The second clarification is that the recognition of marriage for a same- sex couple does not extend to registered domestic partnerships or other civil unions. A same-sex couple who desires to be treated as married for Federal tax purposes will have to actually become married under the law of a state that permits same-sex marriage.
Income tax consequences. Beginning with the 2013 tax year, a same-sex married couple will be required to file their Federal income tax return(s) either as married filing jointly or married filing separately. Filing as an unmarried individual will no longer be allowed, although filing as unmarried may still be mandatory in the state where the couple resides if that state does not recognize same-sex marriage. Married filing separately will usually result in higher taxes than filing as an unmarried individual. Married filing jointly may result in lower taxes if only one of the spouses has significant income, but will usually result in higher taxes if both spouses have significant income compared to filing as an unmarried individual.
If the couple did not file their 2012 Federal income tax returns before September 16, 2013, then they will also have to file their 2012 returns as either married filing jointly or married filing separately. Spouses who were legally married under state law in prior years may amend prior year filings if they determine doing so will reduce their income tax in the prior year and the statute of limitations is still open for the prior year. At this time, income tax returns for 2010, 2011, and 2012 can still be amended. In order to determine whether amending a return from a prior year to file it as a joint return will be beneficial, it will be necessary to have your accountant re-compute your tax for that year under the filing jointly classification.
The IRS ruling points out that if one of the spouses had a pre-tax salary reduction for health coverage under a cafeteria plan, but paid into the plan on an after-tax basis for his or her same-sex spouse, he or she may amend the return and treat the contribution for the spouse on a pre-tax basis as well.
Same-sex couples who separated or divorced in tax years before 2013 were not able to avail themselves of the benefits of IRC Section 1041, which allows spouses to transfer appreciated property to each other without recognizing the tax gain inherent in the property. If a couple made such a transfer and one of the spouses paid tax on the gain, it may be advantageous to amend that return if the statute of limitations is still open.
Estate and Gift Taxes. In the estate and gift tax arena, being treated as married may offer substantial benefits to a same-sex couple. It makes available the unlimited marital deduction for both estate and gift taxes, provides for portability of the estate tax exemption, and also allows the couple to treat gifts they make jointly as being made one-half by each spouse. Most couples should amend their estate planning documents to incorporate traditional marital deduction planning, at least if they intend to leave significant amounts to each other. Various beneficiary designations should also be reviewed to see if they are still appropriate in light of the couple now being treated as married. The IRS said that further guidance will be forthcoming regarding employee benefit plans and arrangements.
Estate and gift tax returns involving a same-sex spouse that were filed for prior tax years should be reviewed to see if amending to claim a marital deduction will be advantageous, provided the statute of limitations has not expired on the tax year. In almost all cases, it will be beneficial to claim a marital deduction where available.
We will continue to update you as further guidance is issued.