Massachusetts cpa Erica Nadeau reached out to some of her married gay clients almost immediately after the U.S. Supreme Court declared Section 3 of the Defense of Marriage Act (DOMA) unconstitutional. Among other things, the June 26 decision means married gays in states recognizing same-sex marriage can amend federal income tax returns filed as far back as three years ago and change their filing status from “single” or “head of household” to “married.” For those who filed their ’09 return in the summer or fall of 2010 under an extension, as Nadeau’s clients did, time is running out to get a refund from the change.
“We contacted the clients because we wanted to be proactive,” says Nadeau, a tax principal at DiCicco, Gulman & Company LLP in Woburn, Mass. “Our main concern right now is amending 2009 tax returns for clients who extended their returns.”
From the financial advisor’s chair, the DOMA ruling presents an opportunity to add value to relationships with gay clients and reach out to gay prospects. However, the Supreme Court’s ruling ostensibly affects only gays in states that respect their marriages. The impact elsewhere is debatable, according to Miami-based attorney Diana Zeydel, chair of Greenberg Traurig’s national trusts and estates department.
Taxpayers’ marital status under state law dictates their federal tax status, and the high court was silent about whether the states that don’t sanction gay marriage must recognize unions performed elsewhere. As a result, Zeydel says, “It isn’t clear what the marital status is for federal tax purposes for clients in certain situations.”
Falling in the gray zone are gay couples who wed outside their home state when it does not allow same-sex marriage, as well as those who married and lived in a gay-marriage state but then subsequently relocated to one that isn’t, Zeydel says. The treatment of clients in civil unions and domestic partnerships is murky as well.
Frankly, practitioners also have a lot of questions about filing amended tax returns. Fortunately, the Internal Revenue Service has said it will provide guidance related to the court ruling “in the near future,” without specifying which issues might be addressed first.
Clients who can still amend ’09 income tax returns before the three-year clock runs out should just do it, rather than wait for IRS guidance, says CPA Robert Keebler, co-founder of Keebler & Associates LLP in Green Bay, Wis. But he recommends waiting to amend returns for 2010 and subsequent years until the agency speaks on the subject.
How To Advise
Clients able to take advantage of the court’s ruling need education. In practical terms, the court’s decision in United States v. Windsor immediately switched the federal tax status of gay couples from “single” to “married” in the states where their marriages are honored. Nadeau says advisors should explain to those clients what the federal tax rules are.
If that seems like the script for a dull consultation, remember that joint returns put each spouse on the hook for taxes owed by the other. That will get the clients’ attention. (If that puts an unwanted burden on somebody, then there’s a little comfort in the fact that innocent-spouse relief is now available in same-sex divorces, according to divorce-planning attorney Mary Schmidt, founder of Schmidt & Federico in Boston.)
Another unpleasant discovery such couples will make is that, beginning with 2013 returns, gay couples affected by the DOMA ruling must file their 1040s as married, and some couples will pay more in federal income tax than they did filing singly. Two high earners typically fall in this camp.
For instance, when each partner in a married couple earns $175,000 in taxable income for 2013, they will end up paying over $7,000 more than what the two would pay together if they were single. This figure does not take into account the reduction in itemized deductions and personal exemptions that high-income taxpayers face this year, or the new 0.9% additional Medicare tax on earned income or 3.8% Medicare surtax on investment income.
If they are married, the couple’s $350,000 household earnings would potentially subject them to all of these wrinkles targeting the affluent, depending on the composition of their income and deductions. In contrast, a single person earning $175,000 isn’t subject to any of these things.
Filing federally as married for 2013 may not have been part of the tax plan that gay clients mapped out with their accountant last spring, Nadeau says. “Be sure they are paying enough in estimated taxes or having enough withheld,” she urges.
For single gays in same-sex-marriage states who are contemplating nuptials, “You should crunch the numbers and see what the impact for them would be before they run out and get married,” says attorney Marshal S. Grant at Pierce Atwood in Portsmouth, N.H.
Gift And Estate Tax Implications
Gay couples who are now deemed married under federal tax rules need their estate plans reviewed. “A lot of same-sex couples have plans that don’t quite do what an estate plan for a heterosexual couple could do when it comes to avoiding tax at the first death,” Grant says. “But those objectives are easy to accomplish now that their partner will be a surviving spouse.”
Prior to the ruling, partners were considered unrelated adults.
That had some advantages. Before the Windsor case, “same-sex couples were able to use certain highly leveraged estate-planning techniques the IRS disallows between family members,” Grant says. “Now they can’t.”
Gift tax returns filed by married gays in the last three years also warrant review, he adds. In the past, gay couples often faced gift-tax consequences for common transactions, say when they purchased property jointly or used funds in a joint financial account that they contributed to unequally. When the amount involved in such transactions exceeded the annual gift-tax exclusion, it consumed a piece of one partner’s $5.25 million lifetime gift-and-estate-tax exemption or triggered gift tax.
“With the change in marital status for federal purposes, the marital deduction for gifts would now apply,” he says. Recasting the transfers as tax-free exchanges between spouses on an amended gift-tax return erases their previous transfer-tax consequence.
Survivors of deceased gay spouses may be able to take advantage of the estate tax marital deduction by amending their spouses’ estate tax returns if these were filed within the last three years. This assumes that the couple was legally married under state law when the first spouse passed away, Grant says.
Cases involving married gays who died after 2010 present another opportunity for amending estate tax returns, according to Keebler, the Green Bay CPA. Because these individuals would have been considered single at death for federal purposes, there was no surviving spouse to benefit from so-called spousal portability, which allows a spouse to pass his or her unused lifetime gift-and-estate tax exemption to the survivor. Today there is, Keebler says.
No conversation about marriage is complete without talk of divorce, even if there is some data suggesting that gay marriages are less likely to dissolve than heterosexual ones. For advisors to gays in same-sex-marriage states, divorce planning is easier now that the federal tax rules apply the same way to homosexuals and heterosexuals alike, says Schmidt, the Boston attorney.
For example, alimony payments to a former spouse in a gay marriage can now be taken as an above-the-line deduction on Form 1040. And property transfers in a same-sex divorce are now “inter-spousal” for federal purposes, rendering them non-taxable, Schmidt says. When prior law treated the partners as unrelated adults, property divisions among divorcing gays were federally taxable.
In situations where gay divorce settlements reflect a tax treatment that no longer applies, some divorced individuals may seek—and conversely, others will have to defend against—a reallocation of marital assets or alimony renegotiation, Schmidt predicts.
Additional planning strategies are bound to emerge in time. Experts have only begun to comb the more than one thousand laws touched by the DOMA’s annulment. Regulations, court cases and private letter rulings will further flesh out the implications of the Supreme Court’s decision. It all portends greater opportunity to advise clients about taxes, both the good and the bad.