This article focuses on the income, gift and estate tax implications of outright and split-interest charitable gifts made by same-sex couples before 2013.
Background. The Treasury and the Internal Revenue Service rule that same-sex couples legally married in jurisdictions that recognize their marriages will be treated as married for federal tax purposes. The ruling applies whether or not the couple lives in a jurisdiction that recognizes same-sex marriages.
• For 2013 and future years, same-sex couples will be treated as married for all federal tax purposes, including income, gift and estate taxes.
• The ruling 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, claiming the earned income tax credit or child tax credit and claiming gift and estate tax marital deductions.
• Any same-sex marriage legally entered into in one of the 50 states, the District of Columbia, a U.S. territory or a foreign country is covered by the ruling. The ruling doesn’t apply to registered domestic partnerships, civil unions or similar formal relationships recognized under state law.
• Legally-married same-sex couples generally must file their 2013 federal income tax return using either the married filing jointly or married filing separately filing status. (So they may be subject to the “marriage tax penalty” as is the case for opposite-sex couples.)
• For years before 2013, individuals who were in same-sex marriages may, but aren't required to, file original or amended returns choosing to be treated as married for federal tax purposes for one or more tax years still open under the statute of limitations (open years).
• For whom the statute tolls. Generally, the statute of limitations for filing a refund claim is three years from the date the return was filed or two years from the date the tax was paid, whichever is later. As a result, refund claims can still be filed for tax years 2010, 2011 and 2012. Some taxpayers may have special circumstances, such as signing an agreement with the IRS to keep the statute of limitations open, that permit them to file refund claims for tax years 2009 and earlier.
For more details: See Revenue Ruling 2013-17, 2013-38 IRB 201 (9/16/13) and IR-2013-72.
Income Tax Charitable Deductions
Charitable contribution carryover to 2013 and later years. The rules for same-sex couples are now the same as for opposite-sex couples who file joint returns or married filing separately returns. The issue here is how the charitable-deduction carryover for gifts made before 2013 will be treated on a same-sex couple’s joint tax return for this and following years. For opposite-sex couples, the carryover contributions are aggregated. So, for example, if Alan and Beth were single last year and either or both made charitable gifts last year and had carryover contributions to this year and file a joint return this year, their carryovers are aggregated. Same now for same-sex couples. The usual complications continue for the varying types of carryovers (20 percent, 30 percent, 50 percent type gifts) apply.
Gift Tax Marital Deductions for Charitable Remainder Unitrusts and Annuity Trusts Created Before 2013
The below rules can now (with amended or new tax returns) apply to same-sex couples who were married in years before 2013.
One-life unitrust or annuity trust for beneficiary other than the donor. A donor who creates a charitable remainder unitrust or annuity trust calling for payments to another (for example, a spouse or child) for life, with the principal to be delivered to charity on the life beneficiary's death, makes two reportable gifts: one to the beneficiary (the value of his life interest) and one to charity (the value of its remainder interest). The charitable remainder interest is reportable, regardless of size, because it's a future interest. Then it's deductible as a charitable contribution, resulting in a wash.
Life beneficiary's interest when the beneficiary isn't the donor's spouse. The donor makes a gift to the life beneficiary of the beneficiary's life interest. The life interest has—over the years—been treated as a present interest and qualifies for the annual exclusion.1 If the value of the interest exceeds the annual exclusion and the gift isn't offset by the donor’s unified gift and estate tax exemption,2 gift tax will be due.
Life beneficiary's interest when the beneficiary is the donor's spouse. A citizen-spouse's life interest qualifies for the unlimited gift tax marital deduction. The gifts to a non-citizen spouse should qualify for the non-citizen spouse’s (alien spouse’s) annual exclusion.3
Two-life unitrust or annuity trust funded with the donor's separate property and the donor is the first beneficiary. A donor who creates a unitrust or annuity trust using his own property that pays income to the donor for life and then to a survivor beneficiary for life makes two reportable gifts: one to charity (the remainder interest) and one to the survivor beneficiary (the right to receive payments if he survives the donor). The charitable remainder interest is reportable, regardless of size, because it's a future interest. Then it's deductible as a charitable contribution, resulting in a wash.
Second life beneficiary's interest when the beneficiary isn't the donor's citizen-spouse. The donor makes a gift to the beneficiary of the value of the survivorship life interest. The gift is of a future interest, so it doesn't qualify for the annual exclusion or the annual exclusion for a non-citizen spouse. If the gift isn't offset by the donor’s unified gift and estate tax exemption, gift tax will be due.
Pointer: The donor can avoid making a gift to the survivor by retaining the right exercisable only by will to revoke the survivor's life interest. If the donor exercises that right, the trust terminates on the donor's death. The trust principal is then delivered to charity. The donor need not actually exercise the right, but retention of the right avoids the donor's making a completed gift to the survivor beneficiary.
Second life beneficiary's interest when the beneficiary is the donor's citizen-spouse. A citizen-spouse's future interest qualifies for the gift tax marital deduction. Alternatively, gift tax concerns can be avoided if the donor reserves the right to revoke the surviving spouse's life interest by will.
Two-life unitrust or annuity trust funded with joint, tenancy in common or community property and the donors are spouses. The charitable remainder interest is reportable, regardless of size, because it's a future interest. Then it's deductible as a charitable contribution, resulting in a wash. The actuarially older spouse makes a gift to the actuarially younger spouse of the difference in value of their survivorship interests. However, the gift qualifies for the gift tax marital deduction if the actuarially younger spouse is a U.S. citizen.
Alternatively, the spouses can each reserve the right—exercisable only by will—to revoke the other spouse's survivorship interest in one half of the life-income gift. That right need not be exercised. Non-citizen spouses should each reserve that right to avoid gift tax concerns.
Spousal right of election. The IRS ruled in 2005 that inter vivos charitable remainder unitrusts and annuity trusts were disqualified if a spousal right of election existed under state law (Rev. Proc. 2005-24, 2005-1 CB 909). The IRS provided safe harbor procedures for avoiding disqualification by obtaining a waiver of the right of election. For trusts created before June 28, 2005, the IRS ruled it would disregard the right of election, even without a waiver, but only if the spouse didn't exercise the right of election. However, Rev. Proc. 2005-24 created many practical problems for donors, trustees, advisors and charities. In IRS Notice 2006-15, 2006-8 IRB 501, the IRS stated that, until further notice, a spousal waiver of a right of election is no longer needed for charitable remainder unitrust and annuity trust qualification. The IRS extended the June 28, 2005 grandfather date indefinitely. Therefore, a spouse’s right of election, even without a waiver, will be disregarded, but only if the surviving spouse doesn’t exercise that right.
Pointer: Despite the IRS’s “until further notice” pronouncement, I believe that it's prudent to obtain a waiver of a spouse’s right of election.
Pooled Income Funds
One-life pooled income fund gift for donor's life. The value of the charitable remainder interest is not subject to gift tax. However, the donor must report the remainder gift, regardless of size, because it's a future interest. The donor then takes an offsetting gift tax charitable deduction, resulting in a wash.
One-life pooled income fund gift for beneficiary other than donor. A donor who creates a pooled income fund gift for another individual makes two reportable gifts: one to the income beneficiary (the value of the life interest) and one to the charity (the value of the remainder interest). The charitable remainder interest is reportable, regardless of size, because it's a future interest. Then it's deductible as a charitable contribution, resulting in a wash.
Life beneficiary's interest when the beneficiary isn't the donor's spouse. The donor makes a gift to the life beneficiary of the value of the life interest. The life interest is a present interest; thus, it qualifies for the annual exclusion. If the value of the interest exceeds the annual exclusion and the gift is not offset by the unified gift and estate tax exemption, gift tax will be due.
Life beneficiary's interest when the beneficiary is the donor's citizen-spouse. If a qualified terminable interest property (QTIP) election isn't made, the rules are the same as in the preceding paragraph. But, if a QTIP election is made, the entire amount transferred by the donor to the pooled income fund—not just the spouse's life interest—is eligible for the unlimited gift tax marital deduction. If the donor elects to treat the gift on a gift tax return as a qualified terminable interest, the full value of the assets in the fund (attributable to the beneficiary's units) on the surviving spouse's death will then be included in the survivor's gross estate. But, the surviving spouse's estate will be entitled to an offsetting charitable deduction, resulting in a wash. If the spouse is a non-citizen, the gift should qualify for the non-citizen spouse annual exclusion.
Two-life pooled income fund gift made with the donor's separate property when the donor is the first beneficiary. A donor who uses his own property to make a pooled income fund gift—paying income to the donor for life and then to a successor for life—makes two reportable gifts: one to charity (the remainder interest) and one to the successor beneficiary (the right to receive payments if he or she survives the donor). The charitable remainder interest is reportable, regardless of size, because it's a future interest. Then it's deductible as a charitable contribution, resulting in a wash.
Second beneficiary's interest when the beneficiary isn't the donor's spouse. The donor makes a gift to the beneficiary (the value of the survivorship life interest). Because the gift is a future interest, it doesn't qualify for the annual exclusion. If the gift isn't offset by the unified gift and estate tax exemption, gift tax will be due.
Pointer: A donor can avoid making a gift to the survivor by providing that the donor retains the right—exercisable only by will—to revoke the survivor's life interest. Should the donor exercise that right, payments will terminate not on the death of the survivor and the second beneficiary, but on the donor's death. The donor need not actually exercise the right, but the retention of the right avoids the donor's making a completed gift to the survivor beneficiary.
Second life beneficiary's interest when the second beneficiary is the donor's spouse. A citizen-spouse's future interest in a pooled income fund gift can't qualify for the gift tax marital deduction as a QTIP because the spouse's life interest starts in the future. But, gift tax concerns can be avoided if the donor reserves the right to revoke the surviving spouse's life interest by will as described in the preceding paragraph. The right to revoke should also be retained when the survivor beneficiary is a non-citizen spouse.
Two-life pooled fund gift funded with joint, tenancy in common or community property when donors are citizen spouses. The charitable remainder interest is reportable, regardless of size, because it's a future interest. Then it's deductible as a charitable contribution, resulting in a wash. The actuarially older spouse makes a gift to the actuarially younger spouse of the difference in value of their survivorship interests. The spouses’ survivorship interests can't qualify for the marital deduction as a QTIP. But, gift tax concerns can be avoided by each spouse reserving the right—exercisable only by will—to revoke the other spouse's survivorship interest in one-half of the life-income gift. That right need not be exercised. That right should also be retained for non-citizen spouses.
Charitable Gift Annuities
One-life annuity for donor. The value of the charitable gift element of a gift annuity is deemed a present interest. The donor must, nevertheless, report the gift if it exceeds the annual exclusion. The donor then takes an offsetting gift tax charitable deduction.
One-life gift annuity for annuitant other than donor. A donor who creates a gift annuity with payments to another (for example, a spouse or child) makes two gifts: one to the annuitant (the actuarial value of the annuity) and one to the charity (the gift element). The charity's gift is a present interest gift and is reportable if it exceeds the annual exclusion. It's then deductible, resulting in a wash.
Annuitant's interest when annuitant isn't the donor's citizen-spouse. The gift to the annuitant may qualify for the annual exclusion. If it exceeds the annual exclusion and the gift is not offset by the unified gift and estate tax exemption, gift tax will be due. It may qualify for the annual exclusion for a non-citizen spouse. The word “may” is used because there isn’t authority on this point.
Annuitant's interest when annuitant is the donor's spouse. A one-life gift annuity when a citizen spouse is the annuitant automatically qualifies for the unlimited gift tax QTIP marital deduction. You have to "elect out" if you don't want it. The gift tax marital deduction isn't available for non-citizen spouses. But, the gift tax annual exclusion for a non-citizen spouse, as stated above, may be available.
Two-life gift annuity funded with donor's separate property when the donor is the first annuitant. A donor who uses his own property to create a gift annuity that pays an annuity to the donor for life and then to a survivor annuitant makes two gifts: one to the charity (which is reportable if it exceeds the annual exclusion, and then deductible resulting in a wash), and one to the survivor annuitant (the right to receive annuity payments if he or she survives the donor). The gift to the survivor annuitant is a future interest; thus, it doesn't qualify for the annual exclusion. For the same reason, it doesn't qualify for a gift tax marital deduction.
Pointer: The donor can avoid making a gift to the survivor annuitant by retaining the right to revoke the survivor's life interest. Should the donor exercise that right, the payments will terminate, not on the death of the survivor and the second beneficiary, but on the donor's death. The donor need not actually exercise the right, but retaining the right avoids making a completed taxable gift to the survivor annuitant. Unlike charitable remainder trusts, a gift-annuity donor can retain the right to revoke during life, by will or both, without disqualifying the gift annuity. I believe that it's best, however, to keep the right to revoke only by will to avoid possible income tax issues.
Two-life gift annuity funded with joint, tenancy in common or community property when donors are spouses and are the annuitants and payments are made to them jointly and then to the survivor. Citizen-spouses' interests qualify for QTIP marital deductions. Alternatively, each spouse can reserve the power to revoke the survivor's interest in the payments from his half share of the joint, tenancy in common or community property. Joint and survivor annuities automatically qualify for the unlimited gift tax QTIP marital deduction. You have to "elect out" if you don't want it. The gift tax marital deduction isn’t available for non-citizen spouses.
Caution. It isn’t clear that the QTIP marital deduction is available for gift annuities that make consecutive payments—first to one spouse and then to the survivor for life—as opposed to paying the spouses jointly for life and then the survivor for life. Presumably, it can qualify. But to be safe, the donors should reserve the right to terminate the surviving spouse's annuity. Unlike charitable remainder unitrusts, annuity trusts and pooled income fund gifts where the right to revoke can only be by will, a charitable gift annuity donor can keep the right to revoke during life, by will or both, without disqualifying the gift annuity. I believe that it's best, however, to keep the right to revoke only by will to avoid possible income tax issues.
Deferred Payment Gift Annuities
One-life deferred payment gift annuity for donor. The value of the charitable gift element of a deferred payment gift annuity is deemed a present interest. However, the donor must report the gift if it exceeds the annual exclusion. The donor then takes an offsetting gift tax charitable deduction.
One-life deferred payment gift annuity for annuitant other than donor. A donor who creates a deferred payment gift annuity with payments to another (for example, a spouse or child) makes two gifts: one to the annuitant (the actuarial value of the annuity) and one to the charity (the gift element). The charity's gift is a present interest gift and is reportable if it exceeds the annual exclusion. It's then deductible, resulting in a wash.
Annuitant's interest when annuitant isn't the spouse. It's unclear whether the gift to the annuitant qualifies for the annual exclusion.
Annuitant's interest when annuitant is the spouse. The gift tax marital deduction is not available for one-life deferred payment gift annuities created for a spouse because the spouse has no immediate right to income. If a donor during his life wishes to provide a one-life deferred payment gift annuity for a spouse, he should consider making an outright gift to the citizen spouse. That qualifies for the unlimited gift tax marital deduction. The spouse may then use the gift to establish a one-life deferred payment gift annuity for himself. The income tax charitable deduction is then taken by the spouses on their joint income tax return. This end run gives them income tax benefits and wipes out gift tax concerns. For deferred annuities for non-citizen spouses, consider a gift of up to the annual exclusion for a non-citizen spouse to the non-citizen spouse. Then, the non-citizen spouse creates his own deferred payment gift annuity.
Two-life deferred payment gift annuity funded with donor's separate property when the donor is the first annuitant. A donor who uses his own property to create a deferred payment gift annuity that pays an annuity to the donor for life and then to a survivor annuitant makes two reportable gifts: one to the charity (which is reportable if it exceeds the annual exclusion, and is then deductible, resulting in a wash), and one to the survivor annuitant (the right to receive annuity payments if he survives the donor). The gift to the survivor annuitant is a future interest and doesn't qualify for the annual exclusion or the gift tax marital deduction.
Pointer: The donor can avoid making a gift to the survivor annuitant by retaining the right to revoke the survivor's life interest. Should the donor exercise that right, the payments won't terminate on the death of the survivor and the second beneficiary, but on the donor's death. The donor needn’t actually exercise the right; retaining the right avoids making a completed taxable gift to the survivor annuitant. Unlike charitable remainder trusts, a deferred payment gift annuity donor can retain the right to revoke during life, by will or both, without disqualifying the annuity. I believe that it's best, however, to keep the right only by will to avoid possible income tax issues.
Two-life deferred payment gift annuity funded with joint, tenancy in common or community property when donors are spouses and are the annuitants and payments are made to them jointly and then to the survivor. The gift tax marital deduction is not available for joint and survivor deferred payment gift annuities created for a spouse because the spouse has no immediate right to income. To avoid adverse gift tax implications, each annuitant should reserve the right to revoke the other annuitant's interest. If that right were exercised, the charity would only have to pay half of the payments to the survivor annuitant for his life. The gift to the charity—the gift element—is a present interest gift and is reportable if it exceeds the annual exclusion. It's then deductible, resulting in a wash.
Charitable Remainder Interests in Personal Residences and Farms
Gift of a charitable remainder interest with life estate reserved for donor's life. The value of the charitable remainder interest is not subject to federal gift tax. However, the donor must report the remainder gift, regardless of size, because it's a future interest. The donor then takes an offsetting gift tax charitable deduction.
Gift of charitable remainder interest with life estate reserved for beneficiary other than the donor. A donor who gives a charitable remainder in a personal residence or farm, creating a life estate in another who is not a spouse (for example, a child) makes two reportable gifts: one to the life beneficiary (the value of his life interest) and one to the charity (the value of its remainder interest). The charitable remainder interest is reportable, regardless of size, because it's a future interest. It's then deductible as a charitable contribution, resulting in a wash. The donor makes a gift to the life tenant of the value of his life interest. The life interest is a present interest and qualifies for the annual exclusion. If the value of the interest exceeds the annual exclusion and the gift is not offset by the unified gift and estate tax exemption, gift tax will be due.
Gift of charitable remainder interest with life estate reserved for spouse. If the donor's spouse is a citizen, the entire value of the property (not just the spouse's life interest) is eligible for the unlimited gift tax marital deduction if the donor elects to have the transfer treated as a gift of a QTIP. If the donor elects to treat a life interest in a personal residence or farm as a qualified terminable interest, the property will be includable in the spouse's estate on his subsequent death. Property included in the surviving spouse's estate will be treated as passing from the spouse to the charity. Thus, the surviving spouse's estate will be entitled to a charitable deduction for the property passing to charity, resulting in a wash. A gift of a life estate to a non-citizen spouse should qualify for the special non-citizen-spouse annual gift tax exclusion.
Gift of charitable remainder interest with life estate retained for two lives. A donor who makes a gift of a remainder interest using his own property—reserving a life estate for the donor's life and then for the life of another—makes two reportable gifts: one to the charity (the remainder interest) and one to the successor beneficiary (his life interest if he survives the donor). The charitable remainder interest is reportable, regardless of size, because it's a future interest. Then it's deductible as a charitable contribution, resulting in a wash.
Second life tenant's interest when the tenant isn't the donor's spouse. The donor makes a gift to the second life tenant of the value of his or survivorship life interest. Because the gift is of a future interest, it doesn't qualify for the annual exclusion.
Pointer: The donor can avoid making a completed gift to the survivor by providing in the deed of transfer that he reserves the right to revoke the survivor's life interest. Unlike charitable remainder unitrusts and annuity trusts, the right to revoke a survivor's life interest in a personal residence or farm needn't be exercisable only by will. The donor need not actually exercise the right to revoke, but retaining the right avoids the donor's making a completed gift for gift tax purposes to the survivor beneficiary.
Second life tenant's interest when the tenant is the donor's spouse. A citizen-spouse's future life estate doesn’t qualify for the gift tax marital deduction as a QTIP because the spouse's life interest starts in the future. Gift tax concerns can be avoided by having the donor reserve the right in the deed to revoke the surviving spouse's interest. Also reserve that right when the spouse is a non-citizen.
Gift of charitable remainder interest in joint, tenancy in common or community property when donors are spouses. The charitable remainder interest is reportable, regardless of size, because it's a future interest. It's then deductible as a charitable contribution, resulting in a wash. The actuarially older spouse makes a gift to the actuarially younger spouse of the difference in value of their survivorship interests. But, a citizen-spouse’s survivorship interest doesn't qualify for the QTIP marital deduction. To avoid gift tax concerns, each spouse can reserve the right to revoke the other's survivorship interest. It can be a testamentary right or a lifetime right. Also reserve that right when a spouse is a non-citizen.
Estate Tax Marital Deductions for Split-Interest Charitable Gifts
• Testamentary charitable remainder unitrusts and annuity trusts—2013 and earlier years. A donor’s will creates a CRUT or CRAT for a surviving citizen spouse. The charitable remainder qualifies for the estate tax charitable deduction and the spouse’s life interest qualifies for the marital deduction. The two deductions equal the trust’s value. Thus, no amount is taxable.
The estate of a deceased spouse of a same-sex couple should file an amended return for an estate tax return for an open year before 2013 and claim the estate tax marital deduction. The couple must have been married in the year of the deceased spouse’s death.
Caveats: An estate tax marital deduction is allowable for the spouse’s life interest only if he is the sole beneficiary. For a non-citizen spouse, an estate tax marital deduction is allowable only if the CRUT or CRAT is drawn to qualify as a Qualified Domestic Trust (QDOT).
• Testamentary gift annuity purchased by donor’s estate under direction in donor’s will. An estate tax charitable deduction is allowable for the difference between the amount transferred to the charity and the actuarial value of the annuity (computed the same way as an inter vivos annuity). A citizen spouse’s interest in a gift annuity created by will qualifies for the QTIP election. Property passing to a QDOT for a non-citizen spouse qualifies for the marital deduction if the gift otherwise qualifies for the estate tax marital deduction.
• Pooled income fund gift created by donor’s will for benefit of spouse. If a QTIP election isn’t made, the estate gets a charitable deduction for value of the charitable remainder interest. If a donor’s estate elects to treat the transfer as a qualified terminable interest, the full value of assets transferred qualifies for the marital deduction—assuming the spouse is a U.S. citizen. Although the value of the assets will be includable in the surviving spouse’s gross estate, that estate will be entitled to an offsetting charitable deduction. The income interest of an alien spouse can qualify as a QDOT.
• Gift of remainder interest by will in a personal residence or farm, reserving life estate for donor’s spouse. If the QTIP election isn’t made, the estate gets a charitable deduction for the value of the charitable remainder interest. However, if a donor’s estate elects to treat the transfer as qualified terminable interest property for a U.S. citizen spouse, the full value of the residence or farm is deductible as a marital deduction. Although the value of the property at the time of the surviving spouse’s death will be includable in his gross estate, that estate will be entitled to an offsetting charitable deduction. For an alien spouse, a life estate in a personal residence can qualify as a QDOT.
Query: Can a timely QTIP election for gift and estate tax purposes be made by a same-sex spouse on an amended or new gift or estate tax return filed for 2012 or earlier years? Presumably yes, but just asking.
And that’s the news from Lake Taxbegone.
Endnotes
1. The exclusion, now $14,000, was $13,000 in 2012 and recent earlier years.
2. For 2013, it's $5.25 million; for 2012, it was $5.12 million; for 2011, it was $5 million; and for 2010, the rules varied depending on an estate’s election.
3. For 2013, it's $143,000; it was $139,000 in 2012; and $136,000 in 2011.