The Supreme Court ruling against the Defense of Marriage Act and recent IRS interpretation of the ruling presents new opportunities and traps for same sex couples. Financial advisors can help their clients by being aware of the effects of this decision on:
- Income taxes
- Estate & gift taxes
- Employee benefits
The Supreme Court ruled in United States v. Windsor that Section 3 of the Defense of Marriage Act is unconstitutional. Therefore, the federal government now recognizes the marriages of same-sex couples who reside in Washington D.C. or one of the 13 states (including all 6 New England states) where same-sex marriage is permitted. The IRS recently announced that it will recognize those marriages regardless of where the couple resides, but will not recognize civil unions. This ruling and the IRS reaction to it has far-reaching effects for same-sex couples, businesses, and the government.
The ruling in Windsor grants to same-sex married couples the same rights and responsibilities that all married couples have under federal law. This means access to over 1,000 federal benefits, including those related to Social Security, housing, criminal sanctions, family leave rights, copyrights, veterans’ benefits, and immigration. As a financial advisor, you are able to assist your clients by increasing awareness of the effect of the ruling in these areas.
The ruling means a great deal of change for income tax purposes. Same-sex spouses will be required to use “married” filing status, whether joint or separate, for all original tax returns filed on or after September 16, 2013 (even if for prior years). For some couples, this may mean a lower tax burden. However, higher income same-sex couples may now face the marriage penalty. Thresholds for certain deductions and credits change for married couples, which can result in lower income tax deductions and credits. Same sex-couples may be unable to claim as much of the student loan interest deduction as they previously could and lower-income couples may now be ineligible for the earned-income credit.
Because of the Court’s ruling, same-sex couples should consider amending their tax returns for the prior three years. Significant tax savings are possible for those who take the time to examine their situation. The IRS has ruled that same-sex couples may amend returns filed prior to September 16, 2013 and still within the statute of limitations, but they are not required to. Filing a new W-4 with an employer to adjust tax withholding from wages should also be considered, since the tax burden for same-sex couples will undoubtedly change.
ESTATE & GIFT TAXES
Same-sex spouses will now avoid (or defer) paying estate and gift taxes when they transfer money and property to each other. This issue was at the heart of the Windsor case. Edith Windsor married her partner in 2007, and inherited her estate when she died in 2009. The federal estate tax on that inheritance was $363,000. Now that Section 3 of DOMA is unconstitutional, she can expect a refund of the entire tax.
Same-sex spouses will now benefit from “portability.” Starting in 2013, if a spouse dies, their federal exclusion amount is $5,250,000. By law, this exclusion amount is “portable” between spouses (as long as the estate’s executor makes the election on the estate tax return). The surviving spouse can use the deceased spouse’s unused exclusion amount. This means a surviving spouse could potentially transfer up to $10,500,000 free of the estate tax upon his or her death.
Gifts made between spouses are not taxable for gift tax purposes. Previously, same-sex couples could not transfer property to one another without paying gift tax on amounts in excess of the annual gift tax exclusion amount or the unified credit. Now they can transfer an unlimited amount.
High net-worth same-sex couples should update their estate and gift plans to take full advantage of these new opportunities.
Windsor affects employee benefits in a variety of ways. Federal workers can now add their spouse to their health plan. Same-sex couples no longer have to pay federal taxes on the value of their spouse’s health insurance coverage, and will be allowed to pay for their spouses coverage with pre-tax dollars. Workers with a Flexible Spending Account (FSA) will be able to add their same-sex spouse. Same-sex widows and widowers are now entitled to survivor benefits from a pension covered by ERISA. The Family and Medical Leave Act will now require larger employers to provide up to 12 weeks of unpaid leave and health benefits to same-sex couples for birth or adoption of a child, spousal illness, and illness of a parent or child.
This information presented is only of a general nature, may omit many details and special rules, is current only as of its published date, and accordingly cannot be regarded as legal or tax advice. Any tax advice contained in this communication is not intended or written to be used and cannot be used by any taxpayer for the purpose of avoiding tax penalties. Please contact our office (603-627-3838) for more information on this subject and how it pertains to your specific tax or financial situation. Howe, Riley & Howe, PLLC would be happy to answer your tax and financial questions regarding these issues or other matters that may be of interest to you or your business.