The June 26, 2013 Supreme Court ruling to strike down the Defense of Marriage Act (DOMA) comes as an immense win for same-sex married couples who will now be able to take advantage of many federal rights and benefits that are linked to marriage. Social Security survivor benefits, immigration rights, family leave, pension rights, creditor protection and doctor-patient confidentiality for same-sex married couples will all be affected. However, the biggest changes for these couples may be federal taxation.
Going forward, and possibly retroactively, many same-sex couples will be able to reduce their federal income, payroll and estate tax liabilities. Previously, Section 3 of DOMA limited the federal definition of marriage as between a man and a woman, effectively preventing same-sex couples who are legally married under state laws from being treated as married for federal tax purposes. This prohibited couples from filing joint federal returns, which prevented them from claiming certain credits and taking advantage of certain preferential gift and estate tax laws afforded to opposite-sex married couples.
As a result of the court’s ruling, there will be no distinction between homosexual and heterosexual married couples for federal tax purposes. Couples who file jointly will now be able to take advantage of the marital deduction, portability of the estate exclusion, the netting of losses of one partner with the income of the other and decreased FICA taxes, among other things. However, with all of these beneficial changes, same-sex couples should still be asking questions: Who exactly is affected by the Supreme Court’s decision? What tax benefits are available to me/us? Are there any pitfalls to be aware of? When can I begin to take advantage of these provisions, and is this ruling retroactive back to when we first were married?
Fortunately, the Tax Warriors at Drucker & Scaccetti have the answers to all of these questions and more!
Who is Affected?
The ruling affects more than 100,000 homosexuals who are legally married under state laws. Before today, 12 states and the District of Columbia allowed same-sex marriages. Those states are: Massachusetts, Connecticut, Iowa, Vermont, New Hampshire, New York, Washington, Maine, Maryland, Delaware (effective 7/1/13), Rhode Island (effective 8/1/13) and Minnesota (effective 8/1/13). However, the Supreme Court’s ruling today on Hollingsworth v. Perry, which effectively shot down California’s Proposition 8, also adds California to the list of states allowing same-sex marriage with the new law taking effect immediately. Same-sex couples that are legally married and living in these states will be treated as married for federal purposes and will be able to file joint tax returns. Additionally, same-sex couples that were legally married before today’s ruling may be able to retroactively take advantage of the federal benefits now available to them for taxes paid in prior years in which they were legally married under state laws. This is discussed more below.
The federal status of same-sex couples that have legally entered into civil unions, domestic partnerships, or other unions that grant rights similar to marriage has not changed due to the Supreme Court’s ruling today. Currently, six states, including New Jersey, allow such unions. Only marriages recognized by state law are recognized as marriages by the federal government.
Additionally, same-sex couples living in states that do not recognize same-sex marriages or civil unions, such as Pennsylvania, remain unaffected. Unfortunately, it is not yet clear whether legally married same-sex couples living in states that do not allow same-sex marriages will be afforded the federal benefits of marriage. However, the ruling provides more incentive for couples in both civil union and non civil-union states to change domicile and marry in states that allow same-sex marriage, as these couples will now receive both state and federal tax benefits as opposed to just state benefits.
Lastly, same-sex couples who live in community property states where same-sex marriage is not legal may also be able to take advantage of certain federal benefits and rights, including the ability to file joint tax returns. This issue is not yet clear, and will be addressed in future posts. Currently, nine states, including Alabama, Colorado, Kansas, Rhode Island, South Carolina, Iowa, Montana, Oklahoma and Texas, and the District of Columbia--recognize common-law marriages. In addition, 5 states including Georgia, Idaho, Ohio, Oklahoma and Pennsylvania have "grandfathered" common-law marriage, allowing those established before a certain date to be recognized. (Source: National Conference of State Legislatures)
Specifically What Federal Tax Benefits Are Available to Married Same-Sex Couples? Is There Any Downside?
In 2003 the Government Accountability Office found more than 1,100 provisions in federal laws that listed marital status as a factor in determining benefits, rights, and privileges. The bulk of these provisions are related to payroll taxes, income taxes, and estate and gift taxes. Most prominent is the ability for same-sex married couples to file joint income tax returns. This allows couples to net the gains of one spouse with the losses of the other, something that was previously unavailable when spouses had to file separately. As losses can often be suspended or limited once they exceed income, couples where one partner had large gains and the other had large losses often had to forego the benefit of the offsetting losses. Additionally, benefits such as employer health insurance, HSA, and flex spending arrangement plans, which are generally excludable from compensation when covering a spouse, are no longer required to be treated as taxable compensation for same-sex couples, subject to income and employment taxes.
Married same-sex couples are also now entitled to the unlimited marital deduction for estate tax purposes, reducing many of the gift tax consequences married same-sex couples previously had to plan and watch out for. Additionally, portability of the estate exclusion is also available and should reduce the burden of tactical asset titling that married same-sex couples had to do before.
In addition to these benefits, there are countless more that can help reduce your tax liability. However, there are also hazards that same-sex couples need be aware of that may increase their liability. Couples that file jointly will not be able to deduct up to $25,000 of rental real estate losses for each partner, but will be limited to $25,000 of losses in total. Additionally, federal income tax rates may not be as favorable for joint return filers, as one spouse’s income may be exposed to higher tax rates. Additionally, it is important to plan accordingly where different income thresholds kick in. Deductions allowed for medical expenses and miscellaneous itemized deductions, as well as the 0.9% Medicare Surtax on Earned Income, the 3.8% Surtax on Investment Income and the phase-out of itemized deductions are all functions of a taxpayer’s AGI and will different based on filing status. Click here for a quick reference chart summarizing tax rates for single and married individuals between 2012 and 2014.
The list of potential benefits and drawbacks goes on and on. It is crucial for married same-sex couples to consult with their tax advisors to determine how the Supreme Court’s ruling will affect them specifically. Each couple’s situation is different and needs to be analyzed individually in order to determine the how the couple will be impacted and to develop the best tax plan going forward.
When Do These Changes Take Effect?
Going forward, married same-sex couples will be able to file joint returns and take advantage of the other federal tax benefits afforded opposite-sex married couples. Additionally, same-sex married couples that previously had to file separately, now have the option to amend prior tax returns and file jointly. This is not mandatory, but is available recourse to those couples that paid more tax in prior years due to DOMA. However, the IRS has a statute of limitations that prevents couples from amending returns after a certain length of time has passed since they were filed. Generally, the IRS allows taxpayers to amend returns for up to three years after the filing deadline or up to two years after the taxes are paid. Couples that filed protective refund claims for previous tax years may have more time. However, the option to file jointly and file amended returns should be carefully considered by a professional tax advisor as there are potential hazards that may offset the benefits and actually increase taxes. Additionally, employers that paid and withheld FICA taxes on employee benefits for same-sex spouses are also eligible for a refund.
How D&S Can Help?
The TaxWarriors at Drucker & Scaccetti are experts in federal taxation and are highly specialized in family tax planning. We can help examine your individual tax situation, determine the impact this ruling will have on you and your family, and develop a tailored plan for your future. This ruling gives married same-sex couples the opportunity to be treated equally under the law and affords them many tax benefits that were previously denied, but it also requires that previous financial and tax planning strategies be assessed, wills and trust documents be reviewed and likely revised, and possibly prior year amended returns to be filed.
We would love to hear what questions you may have on how the recent DOMA ruling may affect your taxes! Please post any questions or comments below and we will do our best to address them in future blog posts. If you want to be sure you receive future posts about the tax impact of the June 26, 2013 Supreme Court ruling to strike down DOMA, subscribe to the Tax Warrior Chronicles by using the box in the upper left corner of this page.
At 7pm on Monday July 1, 2013, there will be an event at Giovanni’s Room (a LGBT bookstore in Philadelphia) focusing on the particulars of the DOMA ruling. Rosalind Sutch, CPA, MT, a D&S shareholder, will be there to discuss the tax implications and answer questions. Please feel free to stop by!