Answers lingering questions for tax, estate planning
In a ruling lauded by tax and estate experts serving same-sex couples in the North Bay and beyond, the Internal Revenue Service said it would treat all same-sex spouses legally married in states like California as “married” for federal tax purposes — even if they are currently living in states where such marriages remain illegal.
It was the most pointed guidance yet following a duo of closely watched U.S. Supreme Court rulings regarding same-sex marriage in June, giving individuals and tax professionals clear direction that same-sex spouses should no longer file as “single” for federal tax purposes in California or elsewhere. Those rulings had found federal restrictions on same-sex marriage to be unconstitutional, and dismissed an appeal that would reinstate California’s former ban on same-sex marriage, Proposition 8.
Experts said the recent IRS guidance helped answer some significant questions involving the tax status of same-sex spouses throughout the United States. Yet the announcement stops short of fully resolving what has been a shifting patchwork of tax conditions for same-sex couples, a group that experts said often faces a higher burden of considerations than heterosexual spouses in issues like income taxes and estate planning.
“It’s a different conversation than if an opposite-sex couple comes into your office and says, ‘We were married on this date.’ Those rules are clearer,” said Naomi Metz, an adjunct professor at the Empire College School of Law and founder of a boutique law firm in Santa Rosa that specializes in legal issues concerning lesbian, gay, bisexual and transgender individuals.
It wasn’t long after the dust settled from the Supreme Court’s June 26 rulings that tax and financial professionals began to question what the decision would mean to the IRS.
In the first case, United States v. Windsor, plaintiff Edith Windsor, a resident of New York state, had sued for her right to the federal estate tax exemption as the beneficiary of her deceased wife’s estate. The court ruled in Ms. Windsor’s favor, deciding in a 5-4 vote that key parts of the 1996 Defense of Marriage Act were unconstitutional and requiring federal recognition of same-sex marriages throughout the United States.
Yet coupled with the Proposition 8 decision, the court declined a broader vote that could have affected the legality of same-sex marriage bans across the country. Individual state bans on same-sex marriage would remain intact, leaving tax planners to wonder if such marriages would only be recognized on a federal tax basis in the states where they are allowed.
The IRS delivered on its promise to issue new guidance on the subject in a joint announcement with the U.S. Department of the Treasury on Aug. 29.
“If a couple from North Carolina comes to California to get married — even though North Carolina doesn’t recognize their marriage for state purposes — the couple would be subject to obligations on the federal level,” she said.
Under the IRS ruling, same-sex spouses will be subject to all federal tax provisions where marriage is a factor. Those provisions include filing status, estate tax exemptions, personal and dependency exemptions, the standard marriage deduction, IRA contributions, earned income tax credits and employee benefits.
Spouses will generally be required to file as “married filing jointly” or “married filing separately” in their 2013 tax return. The ruling does not apply to other formal relationships recognized in individual states, such as registered domestic partnerships and civil unions.
Prior to the ruling, same-sex spouses were required to file as “single” in their federal return. When coupled with the various formal statuses recognized on a state-by-state basis, the medley of conditions was frequently enough to overwhelm the popular programs often used for tax preparation and create another layer of complexity for tax and estate planning, Ms. Metz said.
The IRS guidance would help some couples to streamline their tax and estate planning, but Ms. Metz and others cautioned that those with existing strategies may want to proceed carefully and revisit their documents in the new legal landscape.
Careful planning still needed
Though tax strategy is not always at the forefront in a decision to marry, potential spouses should consider that the related deductions are not an automatic guarantee of a lower tax bill, said Francine Vorhees, a partner heading the trust and estate practice for Moss Adams in its California Central Valley office.
Married couples filing jointly could find themselves in a higher tax bracket and subject to recently increased taxes on high-income earners, particularly if both spouses are contributing a significant amount of income, she said.
“The sense I’m getting out there is, ‘Good, I can file jointly and my taxes will go down.’ But they need to do a tax projection,” Ms. Vorhees said. “I think a lot of people may be surprised when their taxes go up while filing jointly.”
For those that do expect a tax windfall, Ms. Vorhees noted that the IRS will acknowledge amended filings for up to three years and, in cases like a protective claim, as many as four.
“The question was — do you have to? The IRS said, ‘If it reduces your tax, you can,’” she said.
Same-sex spouses will also be eligible for an estate and gift tax exemption that currently allows for more than $10.5 million in combined assets, a development Ms. Vorhees described as a “huge win” from a planning standpoint. Tax-exempt retirement accounts such as an IRA can be combined, and taxes paid for employer health insurance covering a same-sex spouse is now tax-deductible, she said.
Yet despite those benefits, same-sex spouses and couples with an existing tax and estate strategy may find it difficult to undo what are already longtime plans for asset management and income, said Jason Glazier, an independent financial planner with Ameriprise Financial in Santa Rosa and one of only a few accredited domestic partnership advisers in the United States.
Mr. Glazier and others noted that, even with the new IRS guidance, many have found accounting strategies that remain flexible regardless of residence or marital status. Even though mutual ownership of assets may be assumed on a tax or legal basis for same-sex spouses in California, for example, Mr. Glazier said that he continues to advise that ownership be carefully delineated.
“His, mine and ours — that’s where it traditionally has been,” he said. “People have to be very — I can’t say ‘very’ enough — specific as to who owns what assets.”
In the case of a long-term relationship that ended in divorce, a couple may have accumulated assets amid a number of legally recognized statuses over several decades. Accounting for separate ownership could be highly difficult without a plan, he said.
“The biggest risk is not planning for it,” he said.
Questions remain on several fronts in the new tax landscape for same-sex spouses, including whether or not Social Security and veteran’s benefits will be recognized in the same way as the IRS.
The IRS is also expected to issue further guidance for employers who wish to file refund claims for taxes paid on their contribution to employee benefits for same-sex spouses.
Still, experts said the recent rulings were a boon to planning and, in the very least, stood to reduce the time and money many same-sex couples needed to invest in financial planning.
“There may be some hiccups, but not so much that they shouldn’t marry the person they love,” Mr. Glazier said.
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