On June 26, 2013, in United States v. Windsor,1 the U.S. Supreme Court struck down Section 3 of the federal Defense of Marriage Act (DOMA) as unconstitutional. In a related case, the Supreme Court also dismissed an appeal of the federal district court ruling that struck down California’s Proposition 8 (which overturned marriages of same-sex couples in California) as unconstitutional in Hollingsworth v. Perry,2 leaving intact the district court’s ruling that Proposition 8 is unconstitutional and can’t be enforced. What do these rulings mean for same-sex couples as we enter 2014? Married same-sex couples should consult with their advisors to take maximum advantage of the estate and income tax planning opportunities that result from the change in the law. Unmarried same-sex couples should now consider whether to marry. (For more information on these two rulings, see “Tax Law Update” by David A. Handler and Alison E. Lothes, in the August 2013 issue of Trusts & Estates, p. 10.)  

 

Implementation of Windsor

The Supreme Court’s ruling in Windsor requires the federal government to recognize legally performed marriages of same-sex couples. Note, however, that the Supreme Court limited the scope of its decision to “lawful marriages.” Therefore, the decision likely won’t be interpreted to require the federal government to recognize so-called “marriage equivalent” status that’s not actually “marriage” under state law (that is, civil unions, domestic partnerships and registered domestic partnerships). 

The District of Columbia and 15 states currently permit marriages of same-sex couples. Those states are California, Connecticut, Delaware, Hawaii, Iowa, Maine, Maryland, Massachusetts, Minnesota, New Hampshire, New Jersey, New York, Rhode Island, Vermont and Washington. Illinois will become the 16th state to permit marriages of same-sex couples, effective June 1, 2014.

Another issue left unresolved by Windsor is whether the Supreme Court’s decision applies to same-sex couples who lawfully married in a jurisdiction that permits marriages of same-sex couples (for example, New York), but who are domiciled or resident in a state that doesn’t permit or recognize such marriages (for example, Texas). Since the issuance of the decision, however, this issue has been addressed on a benefit-by-benefit basis.

On Aug. 29, 2013, the Treasury and the Internal Revenue Service issued Revenue Ruling 2013-17, holding that for purposes of administering all federal tax laws, including those pertaining to income, gift and estate taxes, same-sex couples that were lawfully married in any jurisdiction (domestic or international) will be treated as married, regardless of whether the jurisdictions in which such couples are resident and/or domiciled recognize the marriage. The ruling confirms, however, that neither the Treasury nor the IRS will recognize as married those same-sex couples that are in marriage equivalent legal relationships. 

As Treasury Secretary Jacob J. Lew stated in a press release, the ruling:

 

... provides certainty and clear, coherent tax filing guidance for all legally married same-sex couples nationwide. It provides access to benefits, responsibilities and protections under federal tax law that all Americans deserve.3

 

The ruling “also assures legally married same-sex couples that they can move freely throughout the country knowing that their federal filing status will not change.” It: 

 

. . . applies to all federal tax provisions where marriage is a factor, including filing status, claiming personal and dependency exemptions, taking the standard deduction, employee benefits, contributing to an IRA, and claiming the earned income tax credit or child tax credit.

 

As a result of the ruling, married same-sex couples, generally, will be required to file their 2013 federal income tax returns with a “married filing jointly” or ”married filing separately” filing status. In addition, same-sex couples who were married in prior years may, but aren’t required, to file original or amended tax returns within the statutory limitations period, which is ordinarily three years from the date the tax return was originally due or filed (if on extension) or two years from the date the tax was paid, whichever is later. Accordingly, married same-sex couples ordinarily may amend their returns for the years 2010, 2011 and 2012 and obtain a refund of any overpayment of taxes, if applicable. Taxpayers with special situations (for example, those that filed protective claims for refunds or that signed tolling agreements with the IRS) may be able to amend their returns for 2009 and/or prior years as well.

The ruling is a broad implementation of Windsor, though many specific tax-related issues remain to be addressed. For example, the Treasury and the IRS plan to issue future guidance regarding payroll taxes on health insurance and fringe benefits provided to same-sex spouses, as well as the treatment of same-sex spouses under tax-favored cafeteria plans and qualified retirement plans.

A handful of other federal agencies have issued their own guidance on various non-tax issues in the wake of Windsor, but have taken contrasting positions on whether they’ll follow the “place of celebration” rule (that is, by referring to the law of the jurisdiction where the marriage took place), as the Treasury and the IRS have done, or the “place of domicile” rule (that is, by referring to the law of the jurisdiction where the couple is resident and/or domiciled), in determining whether married same-sex couples should be treated as  “married” under federal law. Some agencies have indicated that they’ll follow the “place of celebration” rule, including the Office of Personnel and Management (spousal benefits for federal employees), the Department of Health and Human Services (Medicare eligibility for certain services) and the Department of Homeland Security (immigration visas). Other agencies have indicated that they’ll follow the “place of domicile” rule, including the Social Security Administration (spousal social security benefits) and the Department of Labor (family and medical leave). In accord with the Treasury and the IRS, none of the above agencies have indicated that they’ll recognize marriage equivalent relationships. More federal agencies are expected to issue their own guidance implementing Windsor. However, it’s too soon to predict which agencies will follow the “place of celebration” rule or the “place of domicile” rule or whether any will recognize marriage equivalent relationships for purposes of determining which same-sex couples will be entitled to the benefits, responsibilities and protections applicable to married opposite-sex couples under federal law.

 

Estate-Planning Opportunities 

Against that background, at minimum, married same-sex couples domiciled or resident in jurisdictions that permit and/or recognize marriages of same-sex couples likely will be entitled to the more than 1,000 benefits available to married opposite-sex couples under federal law. Some of those benefits present immediate estate-planning opportunities. Practitioners advising same-sex couples should take the following steps: 

 

1. Review estate-planning documents to ensure that the amounts and structures of any spousal bequests remain appropriate. Federal recognition of marriages of same-sex couples leads to the availability of the unlimited marital deduction from federal estate and gift taxes for transfers between same-sex spouses. Existing estate-planning documents may have been drafted with the assumption that any gift or bequest to a spouse of the same sex over and above the individual’s applicable exclusion amount from federal estate tax and/or federal gift tax (the applicable exclusion amount (AEA), currently $5.25 million, adjusted annually for inflation) would be subject to federal estate tax (currently at a maximum rate of 40 percent). However, that assumption is no longer true. Indeed, such gifts and bequests, if properly structured, are now entitled to the unlimited marital deduction. In addition, under the so-called “portability” provisions of federal gift and estate tax laws, under certain circumstances, a surviving spouse of the same sex will also be entitled to use any portion of the deceased spouse’s unused AEA (the deceased spousal unused exclusion (DSUE)), allowing the surviving spouse to make additional tax-free gifts and/or reduce the amount of estate taxes owed on the surviving spouse’s death. (Note, however, that DSUE doesn’t increase the surviving spouse’s applicable exemption from the federal generation-skipping transfer (GST) tax exemption. Accordingly, a married same-sex couple may wish to modify their estate-planning documents to provide that any assets included in their estates in excess of the AEAs will pass to the surviving spouse, either outright or in a properly structured marital trust for the spouse’s benefit, thus deferring all federal estate taxes until the death of the surviving spouse.)

Estate-planning documents may also be revised, if appropriate, to include a separate marital trust that’s designed to permit a spouse to use any of the individual’s unused GST tax exemption that remains after the individual’s death.

 

2. Review retirement account beneficiary designations and joint and survivor annuity elections to ensure that they remain appropriate. A surviving spouse is entitled to roll over a decedent spouse’s retirement account into the surviving spouse’s retirement account without being required to take minimum distributions or lump sum distributions until such time as the surviving spouse ordinarily would be required to take minimum distributions (usually on reaching age 70½). As a result of Windsor, this benefit is now available to married same-sex couples. Accordingly, married same-sex spouses should consider naming each other as the beneficiary of their retirement accounts to defer income tax on the rolled over retirement account as long as possible.

With regard to any retirement plans that are covered by the Employee Retirement Income Security Act of 1974 (ERISA), the spouse of a participant in such a plan may automatically be a beneficiary of the retirement plan as a result of Windsor. Accordingly, if a participant in an ERISA-covered plan (for example, a 401(k) plan) wishes to designate someone other than his spouse as a beneficiary, such participant will need to obtain the consent of his spouse to make that designation effective. Prior to Windsor, consent wasn’t needed from a spouse of the same sex. However, after Windsor, such consent is now required. Separately, if a participant previously made an election to waive joint and survivor annuity benefits after the date of the marriage, the participant may be able to make a new election at this time, and a new election may be required to be valid if the marriage is newly recognized under Windsor.

 

3. Consider replacing individual life insurance policies with survivor policies. Many same-sex spouses previously purchased individual life insurance policies of which the other spouse is the beneficiary (either directly via beneficiary designation or indirectly through a life insurance trust) to provide the surviving spouse with sufficient liquid assets that may be used to pay federal estate taxes due on the death of the first to die. With the unlimited marital deduction and DSUE now available to married same-sex couples, there may be little or no need for such liquidity on the death of the first spouse to die. Thus, a married same-sex couple should consider replacing such individual policies with so-called “survivor” or “second-to-die” policies that pay benefits only on the death of the surviving spouse. Such policies will still provide liquidity to children or other beneficiaries of the married same-sex couple and are generally less expensive than individual policies having the same death benefits.

 

4. Consider splitting gifts between spouses. Formerly, each spouse could make gifts only up to the AEA from federal gift tax and/or federal GST tax (the annual gift tax exclusion amount (gift AEA) and the annual GST exclusion amount (GST AEA), respectively—each currently $14,000) without using any portion of his AEA. Going forward, however, each spouse may now make gifts from his own assets and, with the other spouse’s consent, have such gifts deemed to have been made one-half by the other spouse for purposes of federal gift tax and GST tax laws. Both spouses acting together in this way currently may give up to $28,000 to any individual without using any portion of either spouse’s AEA (note that the annual GST exclusion amount doesn’t always apply to gifts made in trust).

 

5. Amend previously filed federal estate, gift and income tax returns and/or file protective claims as appropriate.

Gifts made to spouses. If one spouse previously made taxable gifts to the other spouse and reduced the donor’s AEA by the amount that the gift exceeded the annual gift tax exclusion amount and/or the donor’s federal GST tax exemption by the amount that the gift exceeded the gift AEA, it may be possible to amend the donor’s prior gift tax returns (subject to the limitations period discussed below) and retroactively claim the marital deduction for the gifts made in those years, thus increasing the donor’s AEA and/or reclaim the federal GST tax exemption used. By doing so, the donor may make additional tax-free gifts and reduce federal estate and GST taxes due on his death. Similarly, any gift taxes or GST taxes actually paid may be refundable.

Gifts made to third parties. To the extent that either spouse previously used a portion of his AEA and/or paid gift taxes or GST taxes by making gifts to third parties over and above his gift AEA and/or GST AEA, it may be possible to amend prior federal gift tax returns to retroactively split such gifts with the other spouse, thus increasing the donor’s AEA and/or federal GST tax exemption. Again, doing so will allow the donor to make additional tax-free gifts and reduce federal estate and GST taxes due on the donor’s death. Similarly, any gift or GST taxes actually paid may be refundable.

Inheritances from decedent spouses. In cases in which a decedent spouse’s estate paid federal estate taxes on assets that were inherited by a surviving spouse of the same sex, it may be possible to amend the decedent spouse’s federal estate tax return (subject to the limitations period discussed below) and retroactively claim a refund for the estate taxes paid. If the deceased spouse’s estate didn’t pay estate taxes and he died in 2010 or later, under the portability provisions of federal estate tax laws, the surviving spouse may be able to claim the deceased spouse’s DSUE, thus allowing the surviving spouse to make additional tax-free gifts and reduce the amount of estate taxes owed on the surviving spouse’s death (note, however, that DSUE doesn’t increase the surviving spouse’s federal GST tax exemption).

Income taxes. Both spouses may also amend prior year income tax returns to change their filing status from single to married filing jointly and obtain a refund if the amount of tax owed based on their married filing status is less than that owed based on their prior single status.

Retroactivity. The extent to which married same-sex couples will be allowed to amend prior tax returns depends on the extent to which Windsor is applied retroactively and whether the applicable limitations period has passed with regard to each tax return (that is, ordinarily three years from the date the tax return was originally due or filed (if on extension) or two years from the date the tax was paid, whichever is later). For example, it may no longer be possible to amend a 2009 individual income tax return due on April 15, 2010, which wasn’t put on extension, but individual income tax returns for 2010, 2011 and 2012 likely will be amended. That said, it’s conceivable that the IRS will permit amendments as far back as the year of the marriage on the basis that neither spouse lawfully could have amended his tax returns prior to the Windsor decision. In either case, it will take some time for the IRS to develop policies and procedures to implement Windsor, and amended returns should be filed in accordance with applicable published guidance from the IRS, if available. In any situation in which the limitations period is about to expire for a particular tax return, a married same-sex couple should consider filing a protective claim for a refund with the IRS to preserve the ability to obtain such a refund after the IRS has provided a means to amend the return.

 

6. Reside in a state that permits and/or recognizes marriages of same-sex couples. If a same-sex couple were lawfully married in a jurisdiction that permitted the marriage, but now reside in a state that doesn’t permit or recognize the marriage, that couple should consider moving to a state that either permits marriages of same-sex couples or recognizes such marriages lawfully performed in other states if they wish to be certain to enjoy the federal benefits now potentially accorded to married same-sex couples.

 

7. Non-citizen spouses should consider seeking permanent residency and/or becoming citizens. Until now, non-citizen spouses weren’t eligible for citizenship or permanent residency on the basis of their marriage to a spouse of the same sex who was a U.S. citizen. As a result of Windsor, however, non-citizens may be eligible for permanent residency and/or citizenship on that basis. Though there are many benefits to becoming a permanent resident or citizen, there are also numerous tax and non-tax consequences that should be carefully considered before making such an important decision.

 

Opportunities in California 

As a result of Perry, California will now be required to permit marriages of same-sex couples, but other states that don’t permit or recognize such marriages won’t be required to do so. California married same-sex couples will enjoy all of the benefits available to married couples under federal law; thus, they should consider the above recommendations, as well as the following tips:

 

1. Amend previously filed California income tax returns and/or file protective claims as appropriate. Married same-sex couples may be permitted to amend prior year California income tax returns to change their filing status and obtain a refund for any income taxes that were overpaid. Note that the limitations period for amending California returns expires four years after the original due date of the return (or the actual filing date if the return was put on extension) or one year from the date the tax was paid, whichever occurs later. If the limitations period for any particular tax return is about to expire, a married same-sex couple should consider filing a protective claim for a refund until such time as California provides appropriate guidance for amending prior returns. Note that, as discussed above with regard to the limitations period for federal tax returns, it’s conceivable that a married same-sex couple may be permitted to amend their returns through the first year of their marriage.

 

2. Amend previously filed tax returns and/or file protective claims with other states as appropriate. Married same-sex couples may also be entitled to amend prior gift tax and/or estate tax returns filed with other states that recognized marriage, but not marriage equivalents (for example, California registered domestic partnerships) at the time in question and receive a refund of taxes paid and/or reclaim any state gift tax and/or estate tax exemption. Again, the limitations period (if one applies) for amending such returns will vary by state. If the limitations period for any particular tax return is about to expire, a married same-sex couple should consider filing a protective claim for a refund until such time as the state provides appropriate guidance for amending prior returns.

 

Uncertain Future

For the time being, there are more questions than answers as to what has and hasn’t changed. It will take some time for the remaining questions to be resolved through litigation, legislation and/or regulation. How states will respond remains unclear.                

        

Endnotes

1. United States v. Windsor, 133 S.Ct. 2675 (2013).

2. Hollingsworth v. Perry, 133 S.Ct. 2652 (2013). 

3. U.S. Department of Treasury Press Release, dated Aug. 29, 2013 (www.treasury.gov/press-center/press-releases/Pages/jl2153.aspx).