For same-sex couples, the Supreme Court’s June 26, 2013, ruling invalidating Section 3 of the Defense of Marriage Act (DOMA), which barred the federal government from recognizing same-sex marriages legalized by the states, is likely to have far-reaching financial implications, particularly for taxes, benefits, and estate planning.
There are still some questions about how this landmark ruling will be implemented. However, the Internal Revenue Service has already begun the process of recognizing same-sex couples that are legally married. The U.S. Treasury Department and the Internal Revenue Service have also said their marriages will be treated as married for federal tax purposes, regardless of the rules in the jurisdiction in which the couple resides.
Currently, only 13 states, plus Washington, D.C., and five Native American tribes recognize same-sex marriages. Among the states that do are Massachusetts, New York, Connecticut, Iowa, Minnesota, Washington, Vermont, New Hampshire, Rhode Island, Delaware, Maine, Maryland and California. Of course, this list is subject to change at any time.
Other agencies, such as the Department of Labor (DOL) and Social Security Administration, are expected to follow the IRS guidelines.
The impact of the ruling means that same-sex couples can now move forward on defining their relationship as “married” for tax, benefits and estate planning purposes. For same-sex couples who married in one of the states mentioned above, or a foreign jurisdiction that permits same-sex marriage, the ruling means the following:
Joint filing. Same-sex married couples will be able to file their federal taxes jointly. Filing jointly will likely lower their tax preparation costs and should make filing simpler.
Some couples may have higher total tax liability under the new laws, however. “Filing jointly tends to be beneficial if one spouse earns most of the income,” says Mark Luscombe, principal federal tax analyst for CCH Incorporated, a Wolters Kluwer business. “But it may be detrimental if both spouses have roughly equal income.”
One reason: Married couples may lose eligibility for tax credits that phase out above specific income levels. For example, the child tax credit phases out above adjusted gross income of $75,000 for single filers, but above $110,000 for married couples—so if both partners earn $75,000, they could receive the credit filing singly, but not filing jointly. Similar rules govern credits for child and dependent care and adoption.
Couples in which both spouses earn a high income are especially at risk for higher taxes when they file jointly. Single tax filers hit the top 39.6% income tax bracket at $400,000 in income, meaning an unmarried couple could make up to $800,000 before reaching this highest tax tier. Married couples reach the top bracket at $450,000. So, filing jointly could mean an increase of close to $32,000 in federal taxes, based on 2013 tax rates.
Untaxed spousal health and dental benefits. Before the Supreme Court’s ruling, if an individual sought to cover his or her same-sex spouse under the employer’s health care plan, that coverage was taxed at the federal level as “imputed income.” In the post-DOMA world, a spouse’s coverage won’t be subject to federal taxation.
Government and workplace benefits
Social Security. When a member of a married couple retires, he or she can claim either his or her own Social Security payment or a spousal benefit that can be worth up to half the spouse’s benefit. And when one spouse dies, the survivor can claim the greater of the two spouses’ benefits. The larger the difference between spouses’ incomes, the more advantageous both the spousal and survivor benefits are likely to be.
The availability of spousal Social Security benefits opens the door for same-sex married couples to use claiming strategies long employed by opposite-sex couples. For example, many married couples take the lower-earning spouse’s benefit upon retirement, and delay the higher-earning spouse’s payments until he or she reaches age 70. This move seeks to maximize the size of the payments during the higher-earning spouse’s lifetime, and of any survivor benefit as well. (Read Viewpoints: “Social Security tips for couples.”)
Military benefits. Same-sex spouses of military members may be some of the greatest beneficiaries of the law change. Gay spouses now will be eligible for a wide range of military benefits, from pension survivor benefits to health care to housing. Defense Secretary Chuck Hagel recently announced that the Defense Department will start changing its policies immediately.
Income-based programs. A married couple’s combined income may disqualify either spouse from certain needs-based programs, even if one spouse’s income is low enough to qualify. For example, a social worker who is currently on an income-contingent plan to forgive a portion of his or her student loans may no longer qualify if the same-sex spouse’s income is combined with his or her income.
Employer retirement plans. An employee now take hardship distributions based on certain expenses (post-secondary educational, medical and funeral expenses) of a same-sex spouse, and the account can be split using a qualified domestic relations order (QDRO) in the case of divorce. On the other hand, a member of a same-sex married couple who wants to designate someone other than his or her spouse as the beneficiary of his or her 401(k) plans now may need to get the spouse’s written consent.
Employer reimbursement accounts. The expenses of either an employee or his or her same-sex spouse or the spouse's children now are eligible for reimbursement from a health savings account (HSA) or flexible spending account (FSA) tax free, provided they are used to pay for qualified medical expenses. There are also dependent-care FSAs that can be used for day care expenses of same-sex dependents.
Unlimited marital deduction. A married person can leave any amount of assets tax free to a legally recognized spouse. If the marriage is not recognized by the federal government—as had been the case with gay marriage to this point—assets above the $5.25 million federal lifetime gift and estate tax exclusion trigger federal estate tax. The threshold is even lower in states that have a separate state estate or inheritance tax. In fact, Edith Windsor from New York brought the case that led to the Supreme Court’s invalidation of Section 3 of DOMA after being taxed $363,000 on assets she inherited from her same-sex spouse.
Likewise, gay married couples now should be able to take advantage of portability—the ability for a surviving spouse to make use of a deceased spouse’s remaining unified exemption. “Having access to the unlimited marital deduction and portability may call for different estate planning strategies,” says Christin Haley, director of estate planning for Fidelity Investments. “Same-sex married couples should certainly review their existing documents with professionals in light of the Supreme Court decision, to see if any changes are necessary.”
Gift tax. Gifts of more than $14,000 per year to non-spouses eat into the giver’s $5.25 million lifetime gift and federal estate tax exclusion. Prior to the Supreme Court’s decision, gifts in excess of the annual exclusion from one gay spouse to the other required careful tracking, as it would be netted against the individual’s lifetime exclusion. For example, in general, adding a same-sex spouse as joint owner to the deed of a million-dollar house in 2013 would have reduced his or her exclusion by $486,000, the $500,000 gift less a $14,000 annual exclusion.
Same-sex spouses may now be able to take advantage of gift splitting, which allows a married couple to split the total value of the gift and have it treated as though each spouse contributed one-half of the amount.
Retirement plan rollovers. Generally, a non-spouse inheriting an IRA has to either:
- Start taking minimum required distributions no later than December 31 of the year after the IRA owner died, or
- Withdraw the entire balance within five years of the IRA owner’s death.
An inheriting spouse can roll over inherited assets to his or her own IRA and defer minimum required distributions until he or she is 70½ years old.
The changes to these and other laws make this an opportune time for same-sex married couples to consider reviewing their financial plans with an adviser, tax professional, attorney, and any other relevant professionals, following the issuance of additional interpretative guidance from the federal agencies.