Supreme Court Ruling Changes Federal Tax Treatment of Same-Sex Couples

Edith Windsor and Thea Spyer entered a long-term relationship in the mid-1960s and made their home in the state of New York. In 2007, the couple was married in Toronto, Ontario, Canada. In 2009, Thea passed away, leaving an inheritance of around $4.3 million to her spouse Edith.

Under the unlimited marital deduction for married couples, there would be no federal estate tax. However, Thea’s estate owed a $363,000 tax because their union, as a same-sex marriage, was disqualified under the 1996 Defense of Marriage Act (DOMA). As her executor and beneficiary, Edith paid the tax and sued for a refund. Her case went all the way to the U.S. Supreme Court, which just this week on June 26, 2013 ruled in her favor by declaring Section 3 of DOMA unconstitutional.

Section 3 of DOMA is short, but also quite broad in scope:

“In determining the meaning of any Act of Congress, or of any ruling, regulation, or interpretation of the various administrative bureaus and agencies of the United States, the word ‘marriage’ means only a legal union between one man and one woman as husband and wife, and the word ‘spouse’ refers only to a person of the opposite sex who is a husband or a wife.”

The invalidation of Section 3 opens up a number of tax planning possibilities for married same-sex couples, and a number of possibilities for tax refund claims. And it’s not just taxes – federal rules from immigration status to social security benefits are affected. President Barack Obama has ordered all federal agencies to “review all relevant federal statutes to ensure this decision, including its implications for Federal benefits and obligations, is implemented swiftly and smoothly.”

Here are some of the planning possibilities now available to gift planners working with married same-sex donors.

1. Property can be transferred to a same-sex spouse at death free of federal estate tax.
2. Tax-free gifts to a same-sex spouse during lifetime are no longer subject to a $14,000 (indexed to CPI) annual limit.
3. Transfers from one same-sex spouse to the other no longer reduce the $5.25 million (indexed to CPI) exemption amount that can be passed to others free of federal gift and estate tax.
4. Portable $5.25 million (indexed to CPI) unused exclusion amount is now available from deceased same-sex spouses.
5. QTIP and other marital trusts long used in planning for married couples can now be used by married same-sex couples.
6. Two-life planned gifts providing income to married same-sex couples will now be free of federal gift and estate taxes.
7. Same-sex spouses can both contribute to a single Charitable Remainder Trust without risk of disqualification.
8. Joint/community property ownership by same-sex couples recognized under state law will also be recognized under federal tax law.
9. Property transfers to same-sex spouses more than 37.5 years younger will no longer be considered generation skips subject to the generation skipping tax.
10. Married same-sex couples will now file federal income tax as married filing jointly or married filing separately rather than as single or head of household.

Note that to get the unlimited marital deduction, the spouse must still be a U.S. citizen, although it now may be easier for a foreign-born same-sex spouse to become a U.S. citizen. Also, the married filing jointly status can be a double-edged sword, due to the marriage penalty whereby some married couples end up paying more filing jointly than they would if each were allowed to file separately as single.

What about refunds for federal taxes already paid? For example, same-sex marriage became legal here in Massachusetts back in 2004. That means there are 9 years of potential estate, gift, or income tax refund claims. Many same-sex couples already have tax refund claims pending for past years. For those who don’t, amended tax returns on Form 1040X can be filed, at least for tax years that are still open, generally 3 years from the due date including extensions, or if later, 2 years from when the tax was paid.

That means tax refunds can be claimed for 2012, 2011, and 2010. New refund claims are now barred under the statute of limitations for 2009 tax returns due April 15, 2010 as 3 years have elapsed, but would still be open for 2009 tax returns filed on extension in late June 2010 through October 15, 2010 or in some cases later. Refunds can also be claimed for 2009 and earlier tax years if and to the extent payment of the tax was made within 2 years of the refund claim, which would leave open years for which taxes were paid in late June 2011 or later.

What about refund claims for tax years that are now closed? While U.S. v. Windsor does not extend the statute of limitations for filing tax refund claims, there could be pressure on Congress to grant an extension or for the IRS to do that administratively. Again, many same-sex couples were advised by their tax advisors to file protective tax refund claims within the original 3 year statutory period, and those claims should still be open.

What about same-sex couples who got married in one of the 13 states plus DC or a foreign country that recognizes same-sex marriage but now reside in one of the 37 states that do not? Those couples still face ongoing questions over the tax planning challenges listed above. While U.S. v. Windsor does not grant a right to same-sex marriage in those others states, it is worth noting that Thea Spyer died 2 years before New York passed its Marriage Equality Act recognizing same-sex marriages performed in New York, but it was held that New York courts in 2009 would have recognized same-sex marriages performed in other jurisdictions. The IRS or the courts may likewise grant refunds for married same-sex couples in states they find to be in the same gray area as New York was in 2009. In any case, protective tax refund claims could be made in the hope of being validated by future legal developments.

Same-sex couples still face a number of issues that may vary from state to state. The new recognition for federal taxes does not necessarily extend to state taxes. Many states have written provisions similar to Section 3 of DOMA into their state constitutions. It can be expected that litigation and legislation over these issues will continue for many more years. Getting tax and legal advice specific to situation and state remains of paramount importance for same-sex couples.

Added on July 2, 2013:

For further information on issues faced by unmarried couples including unmarried same-sex couples and same-sex couples in states that do not recognize same-sex marriage, see Wendy S. Goffe and J. William (Bill) Zook Jr., Estate and Charitable Gift Planning for Unmarried Couples, Journal of Gift Planning (2006).

Added on September 16, 2013:

The IRS has announced it will recognize same-sex marriages based on place of celebration. Same-sex marriages will be recognized for federal tax purposes if legal in the state or foreign country where the marriage was performed, even if not recognized in the state of residence. Civil unions and domestic partnerships will continue to not be recognized as marriage for federal tax purposes. The IRS has also provided guidance on refund claims. For more information, see Revenue Ruling 2013-17, Frequently Asked Questions for same-sex couples, and FAQs for registered domestic partners and individuals in civil unions.

Added on September 24, 2013:

The IRS has issued Notice 2013-61 with special administrative procedures for refunds and adjustments of social security and Medicare taxes and Federal income tax withholding for employees who are in a same-sex marriage. For example, an employee may have had taxes taken out for the cost of covering a same-sex spouse under an employer-provided health plan which is not taxable for married same-sex couples under Revenue Ruling 2013-17. This guidance enables same-sex couples and their employers to get back taxes overpaid in 2013 and earlier years on a streamlined basis.