In 2013, the Supreme Court invalidated Section 3 of the Defense of Marriage Act (DOMA), which had barred the federal government from recognizing same-sex marriages for purposes of federal law. As a follow up to the decision, the Internal Revenue Service announced that it would apply a “state of celebration” rule for purposes of determining whether a couple is married. Same-sex couples legally married in jurisdictions that recognize their marriages will be treated as married for federal tax purposes, regardless of the rules in the jurisdiction in which the couple resides.
Meanwhile, the number of states that recognize same-sex marriage has grown to 19 plus Washington, D.C. Those states are currently California, Connecticut, Delaware, Hawaii, Illinois, Iowa, Maine, Maryland, Massachusetts, Minnesota, New Hampshire, New Jersey, New Mexico, New York, Oregon, Pennsylvania, Rhode Island, Vermont, and Washington. Keep in mind that the list is constantly changing.
While other federal agencies are still wrestling with how they’ll implement the ruling, and there are still open issues regarding, for example, retirement benefits, there’s no doubt that the Supreme Court’s decision has had far-reaching financial effects. Here is how the ruling has affected same-sex couples who married in one of the states mentioned above, or in a foreign jurisdiction that permits same-sex marriage:
Joint filing. Same-sex married couples can now file their federal taxes jointly. Filing jointly will likely lower their tax preparation costs and should make filing simpler.
However, same-sex couples should understand the consequences of filing jointly. Many couples have encountered higher total tax liability under the new laws. “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 in most cases. 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 $406,751 in income, meaning an unmarried couple with equal earnings could make up to $813,502 before reaching this highest tax tier. Married couples reach the top bracket at $457,601. So, filing jointly could result in a significant tax increase based on 2014 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.” Now a spouse’s coverage won’t be subject to federal taxation. Further, if an employer provided health coverage for an employee’s same-sex spouse prior to the June 2013 Supreme Court ruling, the employee may claim a refund of any income taxes paid on the value of coverage that would have been excluded from income had the employee’s spouse been recognized as the employee’s legal spouse for tax purposes.
“Same-sex couples may seek to amend their prior years’ income tax returns, in order to change marital and filing status, declaration of dependents, deductions, tax credits, or other information that could alter the tax calculations and potentially result in a lower tax liability,” says Christine Finn, regional vice president and wealth planning consultant for Fidelity Investments’ Private Client Group. “However, careful consideration must be given to each situation, and the advice of tax and legal professionals should be sought in order to gain an understanding of the potential ramifications, prior to filing any amendments.”
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. Same-sex spouses are now eligible for a wide range of military benefits (PDF), from pension survivor benefits to health care to housing.
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 can 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 may now 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 are now 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 same-sex marriage to this point—assets above the $5.34 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 more than $360,000 on assets she inherited from her same-sex spouse.
Likewise, same-sex married couples should now 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 Finn. “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 annually to non-spouses eat into the giver’s $5.34 million lifetime federal gift and estate tax exclusion. Prior to the Supreme Court’s decision, gifts in excess of the annual exclusion from one same-sex spouse to the other required careful tracking, as it would be netted against the individual’s lifetime exclusion. For example, before the ruling, adding a same-sex spouse as joint owner to the deed of a million-dollar house 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.
There have been many changes in the application of federal law since the Supreme Court ruling in June 2013, as federal agencies struggle to afford legally married same-sex couples the same federal benefits and obligations as afforded legally married heterosexual couples. These changes, as well as the evolving landscape regarding same-sex marriage, make this an opportune time for same-sex couples to review their financial plans with an advisor, tax professional, attorney, or any other relevant professionals.
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