Tax Issues of the Supreme Court Ruling that DOMA is Unconstitutional

Today I had the good fortune of speaking with Nanette Lee Miller, CPA, who is the National Leader of Marcum LLP's LGBT & Non-Traditional Family Practice Group. She shared with me her thoughts on the tax implications of the Supreme Court's decision in United States v. Windsor that section 3 of the Defense of Marriage Act is unconstitutional.

The Supreme Court ruling impacts "same-sex married couples if they live in California or in a state with legally recognized marriages for same-sex couples," Miller said. Such couples can now file joint or separate returns married and amend previously filed returns to change their filing status and recalculate their federal income tax.

"What if a same-sex married couple now resides in state that doesn't allow for gay marriage? In the past, the IRS has a policy guideline where state where the couple is a resident trumps the state where the marriage license was granted. This is an area that will need to be re-addressed by the IRS," Miller said.

Tax Planning Issues for Same-Sex Spouses

For gay and lesbian couples "tax planning around marriage is nothing new, it's just like planning for traditional married couples," Miller said. Issues to consider in tax planning for married couples often looks at tax-free employee benefits (such as health insurance) for both spouses, and considering estate and gift tax issues around transferring assets between spouses. Miller recommends, "Same-sex married couples may want to revisit their estate plan to take into consideration the unlimited marital deduction, even if the estate plan was looked at recently."

"Gay marriage is not a moral issue, it's an economic issue," Miller points out. Some of the tax-related financial issues that gay married couples may want to consider include:

Employer-provided health insurance coverage. Under the Defense of Marriage Act, health insurance benefits provided to a same-sex spouse of an employee was added to that spouse's W-2 income for federal income tax. Those benefits are pre-tax now that same-sex marriages are recognized at the federal level.

Inherited Individual Retirement Accounts. Under the Defense of Marriage Act, when a person who is not a spouse inherits an IRA, that the funds in that IRA must be distributed over a set period of time, usually five years. However if a spouse inherits an IRA from his or her same-sex spouse can now treat the inherited IRA as his or her own and rollover the funds into his or her own IRA. This changes the timing of when and over what duration funds must be distributed from the IRA.

Estate tax. Same-sex married couples now enjoy an unlimited marital deduction against the federal estate tax. When one spouse inherits assets from a deceased spouse, those assets are not included when calculating the taxable portion of the deceased spouse's estate.

Gift tax. Same-sex married spouses are permitted to give an unlimited amount of assets between each other without gift tax consequences. Previously, same-sex spouses had to consider the annual gift tax limitations for transferring assets between themselves.

Social Security Benefits. Same-sex spouses may now be eligible for higher Social Security benefits. It may take "Social Security two or three months to figure out" how to address this issue, Miller said.

Procedural Issues

Miller recommends that we "wait and see" on a variety of procedural issues. She expects the IRS to come up with procedures to address issues around filing returns and amending returns to take into account all the tax changes impacting same-sex married couples.

There's already one procedural issue that we could think of. Same-sex spouses in community property states had to split the net income between both spouses if one spouse had self-employment income on a Schedule C. Both spouses reported half the total Schedule C income and each spouse had to pay the self-employment tax on that income. Now that same-sex spouses are recognized as married for federal tax purposes, "the self-employment tax on Schedule C issue goes away for same-sex married couples in community property states." Same-sex spouses would now be eligible to file jointly or separately, and with the self-employment tax applied only to the spouse who actually earned the Schedule C income. This could change the annual Social Security earnings of both spouses, which in turn could impact future Social Security benefits. They may also be a change in the self-employment tax liability if the Schedule C income was over the annual wage base for calculating the Social Security tax.

Miller imagines that the IRS will allow same-sex spouses to voluntarily revise previous tax returns, and that will be "mandatory going forward" to file as married. She expects that "within 6 months this will be sorted out."

Issues for Registered Domestic Partners and Civil Unions

The Supreme Court ruling does not impact Registered Domestic Partners and Civil Unions. For these taxpayers it's "business as usual," Miller said. Registered Domestic Partners and Civil Unions are still considered unmarried for federal tax purposes and may need to allocate income and deductions if their state has community property laws.

Miller alerted me that CCH has released its Tax Briefing, "Supreme Court Strikes Down DOMA" [pdf]. Her firm, Marcum LLP, has published a map showing which states recognize same-sex marriages. That map is located at www.marcumllp.com/LGBT-Unions.

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Post-DOMA Tax Issues for New York Same-Sex Married Couples

I had the good fortune of speaking this afternoon with Ms. Jane Bernardini, CPA, a tax partner at Anchin Block & Anchin LLP in New York City. We discussed some of the tax implications for New York gay and lesbian couples of the Supreme Court's ruling in United States v. Windsor that section 3 of the Defense of Marriage Act was unconstitutional.

Ms. Bernardini said, "New York passed the law two years ago allowing same-sex couples to marry." On June 24, 2011, the NY State Legislature passed and Governor Cuomo signed into law the Marriage Equality Act. Since then, same-sex spouses have been able to file jointly with New York State, but had to file as single on their federal tax returns.

For gay and lesbian spouses in New York, "the next step is to file amended tax returns," with the IRS, "as they are now able to file jointly," Bernardini said.?? "New York State did allow joint filing," for state tax returns, so couple's state tax returns probably don't need to be changed. Similarly, New York City taxes follows the same rules as the state, so changes aren't anticipated with city taxes.

New York also allows for couples to enter into domestic partnerships. "We do have domestic partnerships, and heterosexual couples were? using the partnership agreement ?to obtain health benefits for one of the partners," Bernardini said. "But it's kind of gone aside as now employers claim the ?gay couple can get married." She related a story of one client who said that "not until the federal government accepts us will we get married." So there may be an uptick in people getting married.

Federal Tax Implications

"This is going to take time," Bernardini cautioned, "it will take the federal government I don't know how long to straighten out." Some of the "big issues" at the federal level include Social Security benefits, pension plans and survivor benefits, and taxable fringe benefits. "Language has to be changed," Bernardini said, from terms like 'husband and wife' to more neutral terms like 'spouse 1 and spouse 2.' Language will have to be changed not just in the laws, but in plan documents. "Be a little patient until everyone catches up with the law," Bernardini reiterated.

Fringe benefits, such as for health insurance coverage, is a key issue. For New York same-sex couples where one spouse was covering his or her spouse through their employer's group plan, " the federal government was not recognizing the marriage and the insurance premiums for the other spouse was taxable fringe benefits," Bernardini said. Couples in this situation can "amend their federal returns to get a refund" on the taxable fringe benefits that really should have been tax-free. Bernardini explained that the employee would have been "informed by their employer what the amount was, there would have been another line on the W-2 for taxable fringe benefits," Bernardini said.

On the topic of retirement benefits, Bernardini mentioned that same-sex spouses may have taken an annuity from private or government retirement plans, but the plan did not allow the surviving same-sex spouse? to continue distributions as a spouse. Surviving spouses may want to take another look at their deceased spouse's annuity to make sure they "got the benefits they were entitled to," for example they may be eligible for different benefits as a spousal beneficiary.

Similarly, persons may want to take another look at the employer-provided death benefits. Especially at government jobs, the employer might not have paid death benefits to the surviving spouse as their marriage was not recognized at the federal level. Bernardini mentioned the case of "a woman in the army who died, and the government denied the death benefits to her wife." There may be an opportunity to go back and receive those benefits. The Defense of Marriage Act "went into effect in 1996," Bernardini reflected, and so we may need to go back and look at what benefits might be available over that period of time.

Estate and Gift Tax Issues

"Any couple that is living in a state that recognizes same-sex marriage should revisit their wills to provide for? the full marital deduction" against the estate tax.

Also, for persons whose same-sex spouse has died, they may want "to file for refund on estate tax."

Similarly for the gift tax, "living expenses were considered a gift to the other spouse," and one spouse may have filed gift tax returns to report the value of the living expenses given to the other spouse. Now that their marriage is recognized for federal tax purposes, they may want to "amend gift tax returns to remove the value of imputed gifts," as spouses are allowed to transfer an unlimited amount of assets between themselves without gift tax consequences. There's a possibility here to correct a person's lifetime estate and gift tax exclusion and/or gift tax calculations.

Bernardini also cautioned that some same-sex couples have set up Grantor Retained Income Trusts (GRIT). "GRITs are a way of giving assets to their partner while retaining the income, but you can only create these trusts with a non-relative. Now that the partner is considered a spouse, if they had set up a GRIT, they will need to wait for guidance from the IRS. It is not certain as to whether? the IRS will determine the trust remainder to be a taxable gift."

Moving to Other States

What happens when a same-sex couple gets married in one state and moves to another state which does not recognize their marriage? Bernardini mentioned the story of one couple who are "about to get married in New York and then move to Florida, where same-sex marriage is banned. We really have to plan for non-recognition states."

Wait and See

"We're waiting ?for the IRS to come out with a lot of different regulations," Bernardini said, "there's a lot of uncertainty." Bernardini anticipates the IRS to provide guidance on how the three-year statute of limitations on refunds will apply to same-sex married couples. The IRS "may make an exception or they may not," she said.

What is clear is that "if they were married within the last three years, definitely look at amending federal tax returns. Similarly, if their spouse passed away? within the last 3 years, file an ?amended estate returns."

IRS Releases Statement on the Supreme Court Case

The Internal Revenue Service today issued the following statement:

"We are reviewing the important June 26 Supreme Court decision on the Defense of Marriage Act. We will be working with the Department of Treasury and Department of Justice, and we will move swiftly to provide revised guidance in the near future."

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