A long engagement: Married same-sex couples finally receive post-DOMA access to federal tax and estate planning benefits

by Saul Ewing Arnstein & Lehr LLP
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Summary

The U.S. Supreme Court’s ruling in United States v. Windsor will forever change many facets of the lives of same-sex couples. One of the most important changes is that same-sex couples will now be able to engage in estate planning – an area of the law in which married couples receive numerous advantages over unmarried individuals and to which same-sex spouses were previously only granted limited access.

In United States v. Windsor, the U.S. Supreme Court struck down §3 of the Defense of Marriage Act (DOMA) which, among other things, defined marriage federally as between only one man and one woman. In requiring the federal government to permit states to define marriage as they see fit, the Court opened the door for married same-sex couples to obtain over 1,000 federal rights that attend marriage, including employment benefits, estate and gift tax exclusions and rate breaks, rules affecting immigration and access to federal civilian and military benefits.

Despite the monumental changes that will occur based on the Supreme Court’s ruling in Windsor, there are still a significant number of questions that remain unanswered. It may take weeks, months, or even years for all of the legal ramifications of the Windsor decision to fully play out. For example, it is unclear whether same-sex couples with a marriage certificate granted by a state that recognizes same-sex marriage, but who currently reside in a state that does not, will be recognized as married by the federal government. The Windsor opinion itself reasons that citizens of a state should not be treated simultaneously as married and unmarried by the two governments that operate on them: state and federal. This cuts against the idea that the government would recognize two people as married when their domicile state would not. Additionally, different governmental agencies rely on different tests for the validity of a marriage – with some, like the IRS, looking to the state of residence, while others, like the Department of Defense, looking to the state of celebration.

Until statutes and regulations are re-written to “catch up” with the outcome of the Windsor decision, same-sex couples will live with some level of uncertainty in their attempt to understand how the ramifications of the decision will impact their lives. However, there are several legal changes that we can currently forecast with a fair amount of certainty. Several of these predictable changes will have enormous consequences on same-sex spouses from an estate or financial planning perspective. For example, Windsor will allow same-sex spouses the opportunity to:

  • File joint tax returns. Like all married couples, same-sex spouses will now be given the option of filing joint federal tax returns. In some instances this will be a financial benefit to the couple as spouses in different tax brackets often pay a lower overall amount when filing jointly. However, depending on their income levels, filing jointly may also place a marriage penalty on the couple by raising the combined tax obligation of the couple. It is important that couples closely examine the ramifications of filing jointly or continuing to file separately before deciding how to file for the 2013 tax year.
  • Amend previous returns. If filing a joint 2013 federal return is preferable, same-sex spouses who were married prior to 2013 may wish to re-examine their previous returns. Taxpayers are permitted (but not required) in most circumstances to amend previously filed tax returns for the last three years. Same-sex spouses who should have received a marriage bonus in those years may now have an opportunity to file an amended return to claim the bonus they were previously denied.
  • Utilize the unlimited marital gift and estate tax deductions. Prior to Windsor, most transfers of property between same-sex couples, regardless of whether the transfer was made during one’s life or following one’s death, resulted in gift and estate tax consequences. Often these consequences were unnoticed by the transferring parties due to the use of the annual exclusion (currently $14,000). However, transfers between same-sex spouses that exceeded or did not qualify for an exclusion were forced either to utilize some of the taxpayer’s lifetime estate and gift tax credit, or caused the taxpayer to incur a tax on the amount transferred. Now all transfers between same-sex spouses can pass tax-free as they will qualify for the marital estate and gift deductions. This change opens a world of planning opportunities for wealth that same-sex spouses were previously denied, such as QTIP, QDOT, A/B or credit shelter trusts, to reduce or defer the payment of the federal estate tax.
  • Rely on portability and exclude GST. Married couples that do not engage in pre-death planning to maximize their use of the marriage deduction may instead turn to portability, which allows a surviving spouse to add the unused estate tax exclusion of their deceased spouse to their own remaining exclusion. Although relying on portability requires some additional administrative services to be performed after the death of the first spouse, this will permit many same-sex couples that did not maximize federal exemptions under their wills a second opportunity to do so. Additionally, same-sex spouses will also be given an opportunity to plan to maximize their use of any unused generation skipping tax.
  • Split gifts. Spouses are permitted to combine their annual exclusions, which is typically referred to as “splitting gifts” in order to double the amount the couple can transfer to a single beneficiary and still qualify for the annual exclusion amount. Same-sex spouses will now be able to split gifts and essentially double the amount they can gift to others and still qualify for the annual exclusion.
  • Receive tax benefits on the sale of a personal residence. An unmarried taxpayer may exclude up to $250,000 of gain realized on the sale of a personal residence while married taxpayers may exclude, on a joint return, the first $500,000 of gain. Same-sex couples will now be permitted to receive equal benefits, which will be of particular importance where only one taxpayer owns the residence. In many jurisdictions same-sex spouses may also receive additional benefits by now being permitted to hold property as tenants by the entirety, rather than only as tenants in common or as joint tenants with rights of survivorship.
  • Optimize retirement benefits. Same-sex spouses widows and widowers will now be eligible for spousal Social Security, meaning that when one spouse dies, the survivor is permitted to switch to the deceased spouse’s benefits (if those benefits are higher). Also, specifically pertaining to IRAs and qualified plans, if anyone other than a spouse is named as the fund’s beneficiary, that recipient is forced to begin making withdrawals by December 31 of the year following the account owner’s death. However, spouses, which now includes same-sex spouses, are permitted to roll the assets into their own IRAs and delay the required minimum distributions until the year after they turn 70.5.

Although estate planners and their clients may face a slight delay in fully understanding how same-sex spousal rights will be recognized in all areas of the law, from an estate planning perspective there are already a number of planning techniques that same-sex couples can utilize to take advantage of the legal changes that will result from this historic ruling. For more information about this important development, please feel free to contact the attorneys in Saul Ewing’s Personal Wealth, Estates and Trusts practice.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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