When it comes to legal matters, it's been a huge year for the LGBT community. In June, the U.S. Supreme Court ruled in the Perry and Windsor cases to restore same-sex marriage in California and extend the federal rights of marriage to validly married same-sex couples across the nation, respectively. In September, the IRS made it clear that for federal tax purposes, a married couple's domicile is irrelevant. A couple that was validly married in the state in which their marriage was celebrated has the federal tax rights and responsibilities that come with marriage �" regardless of whether or not their marriage is recognized in the state in which they currently live.
What this has meant for same-sex couples is that there are more choices than ever before �" (i) the choice to get married, a status which conveys both federal and state rights and responsibilities in states that recognize same-sex marriage; (ii) the choice to enter into a marriage equivalent status such as registered domestic partnership, which results in state but not federal rights and responsibilities; and (iii) the choice to stay single.
Marriage or registration as domestic partners (which is still available to same-sex couples in California) changes the way in which a couple is required to file its tax returns. Married couples living in California must file as "married filing jointly" or "married filing separately" for both state and federal purposes. Registered domestic partners must file "married filing jointly" or "married filing separately" for state purposes, but must file as single taxpayers for federal purposes. Status is determined on the last day of the year, so a couple who marries at a New Year's Eve party (before the ball drops) will be considered married for tax purposes for all of 2013.
Anyone who runs the numbers will see that marital status can make a big difference when it comes to how much tax is owed. Because the rates that apply to married taxpayers are not double the rates that apply to single taxpayers, some married couples experience a "marriage penalty" �" they pay more tax filing as a married couple than they would pay as two single people. This marriage penalty generally applies to couples where both spouses earn fairly equal amounts of income; and there is actually a "marriage benefit" for some couples with disparate incomes �" they pay less tax filing as a married couple than they would filing as single taxpayers.
When evaluating whether marriage is going to cost money on the tax side, it's important to consider more than tax rates. For income tax purposes, married couples can combine one spouse's capital losses with the other's capital gains, one spouse's passive activity losses with the other's passive income, and one spouse's net operating or business loss with the other's overall income �" all of which can result in income tax savings. In addition, for gift tax purposes, married couples can utilize "gift splitting," which allows one spouse to make gifts from his or her own funds but to "split" these gifts with his or her spouse by utilizing both of their remaining gift tax exemptions. For example, the generous uncle who wants to fund his nieces' and nephews' 529 plans is not limited to making a $14,000 contribution to each, which is the current annual exclusion gift amount; he can contribute $28,000 per year to each plan without utilizing any of his lifetime gift tax exemption by splitting the gifts with his husband. In addition, contributions to a 529 plan may be "front-loaded" and funded now with five year's worth of annual exclusions, or $140,000 for a married couple.
Another wrinkle is that the effect of filing jointly as married may not be the same for federal and state purposes. Some couples are finding that filing as married for federal purposes will result in more tax being due, while filing as married for state purposes will result in a lower tax bill �" which makes registered domestic partnership a more appealing alternative than marriage �" assuming all one cares about is income tax. It's important of course to consider the non-tax benefits of marriage, as well as other tax benefits, including the ability for a surviving spouse to roll over his or her deceased spouse's retirement account into his or her own IRA �" and continue tax deferral until reaching age 70 and a half, instead of being required to begin taking distributions the year following the spouse's death.
While same-sex married couples can now freely transfer property to each other without those gifts being considered taxable, because of the gift tax marital deduction, couples who have not chosen to marry do not have that freedom. For couples with disparate wealth, it makes great sense for the wealthier partner to make annual exclusion gifts to the less wealthy partner each year �" and it's use it or lose it, so 2013 gifts should be made soon.
Couples who were married prior to the Supreme Court's decisions in the Windsor and Perry cases should consider amending prior year's tax returns if doing so would result in a tax savings. The IRS has specifically allowed amendment during the statute of limitations period �" generally three years from when a return was filed. Once the statute has run, the IRS says it won't accept the amended return, which may or may not be constitutional. It's best to play it safe, however, and get those amended returns in as soon as possible. Another reason to file an amended return is to recoup tax paid on welfare benefits provided to a same-sex spouse, as well as employment tax on those amounts.
Married couples who previously filed gift or estate tax returns (Forms 709 and 706) that reported gifts or inheritance to a spouse should consider amending those returns in order to claim the marital deduction if the transfer occurred during the marriage. Again, the IRS says amendment is permissible during the three-year period following the filing of the return.
Of course there is a lot more to marriage than taxes. But as we come to the close of 2013 and anticipate the 2014 tax season, it is a good time to focus on the benefits and costs of the various legal status options now available to same-sex couples �" as unromantic as that may be �" and to take advantage of annual gift tax exclusions that disappear if unused with that last glass of champagne on December 31.
Susan von Herrmann is a partner in the Private Clients, Trusts and Estates Group at Schiff Hardin LLP in San Francisco. She can be reached at [email protected], or via the firm's website at http://www.schiffhardin.com.