Supreme Court Decisions Mean Financial Benefits for Same Sex Married CouplesAugust 2013
As was widely reported, on June 26, 2013, the United States Supreme Court issued two decisions that greatly affect the lives of same sex couples, both those who are married and those who are considering marriage. Briefly, in United States v. Windsor, the Supreme Court ruled that the federal law defining marriage as solely between a man and a woman was unconstitutional. In Hollingsworth et al v Perry et al, the Court reinstated a lower court’s ruling that California’s Proposition 8 defining marriage as “a union between a man and a woman” was also unconstitutional.
The purpose of this article is not to detail the facts and reasoning behind both decisions but instead to answer a question that may be in the back of your mind: in addition to the emotional victory, what exactly does this mean for same sex married couples financially?
Tax Benefits of the Supreme Court Decisions
These Decisions affect the financial lives of same-sex married couples in many ways, both apparent and not so apparent. Numerous statutes and federal regulations now apply to and financially benefit same sex married couples in California and in all other states that recognize same sex marriage. The list below outlines some of these benefits.
- Joint Filing of Income Tax Returns: Prior to these decisions, same sex married couples in California had to file joint California income tax returns and individual federal income tax returns. The complication and expense of doing so could be burdensome as couples had to prepare a complete joint federal tax return solely for the purpose of completing their California joint tax return, and they then had to prepare individual federal tax returns for filing. Couples may now file joint income tax returns for both California and federal tax purposes.
- Marital Gifts: The federal gift tax marital deduction allows spouses to give assets to each other tax free. Similarly, the federal estate tax marital deduction allows spouses to leave their property to each other at death and thereby defer any estate tax owed on that property until the death of the second spouse. Prior to the Supreme Court’s decisions, same sex couples could not transfer property between themselves without either depleting their exemption amounts or incurring gift or estate tax. In fact, this was the main issue in the Windsor case: Thea Spyer left all of her assets at her death to her spouse, Edith Windsor, and Ms. Windsor was required by federal law to pay estate taxes on those assets. Now, when that same situation occurs, no federal estate tax will be imposed.
- Double Step-Up in Basis for Community Property: The general rule is that a deceased spouse’s income tax basis in his or her property receives a “step-up” to its fair market value at the time of death. However, with community property the entire asset receives a step-up in basis, not just the deceases spouse’s half interest in the community property. This can be a tremendous benefit for substantially appreciated assets. Prior to the recent decisions, California allowed this benefit for same sex spouses and registered domestic partners, but the federal government did not. Now, community property assets of the same sex married couple will receive a full step-up in basis for federal purposes as well. As a result, if the surviving spouse sells the asset after the death of the first spouse, the surviving spouse will pay capital gain taxes only on any appreciation after the first spouse’s death.
- Charitable Deductions: Due to limitations in the federal income tax laws, in order to receive the full benefit of a charitable deduction, a donor has to earn income at least double the donated amount. Married couples may use both spouses’ income to determine how much of the charitable deduction can be deducted for federal income tax. Same sex married couples can now take advantage of this benefit.
- Spousal IRA: Generally, to open an individual retirement account (IRA), the contributing individual must have compensation equal to the amount he or she wishes to contribute to an IRA. Because this requirement would pose a problem for a non-working spouse, the federal government allows an exemption for married couples. It provides that if only one spouse works, that spouse’s earned income can be imputed to the non-working spouse, thus allowing that spouse to contribute to an IRA.
- Rollover Benefits: Federal law provides several tax benefits to a surviving spouse who is the beneficiary of his or her deceased spouse’s retirement plan or IRA. For example, the surviving spouse can do a tax-free rollover to his or her own retirement account or IRA and postpone income tax by deferring distributions from the account or IRA. Now that same sex marriage is recognized for federal purposes, a surviving same sex spouse can enjoy these same benefits.
- Gift Splitting: Same sex married couples may now choose to “split” gifts. Making a split gift allows a spouse to take advantage of both his or her own annual exclusion or lifetime gift tax exemption and his or her spouse’s annual exclusion or lifetime gift tax exemption for a gift that is made entirely from the gifting spouse’s assets. For example, an individual can gift $14,000 to one person this year using his or her annual exclusion. If a same sex married spouse gives $28,000 to a person, then the entire gift can be sheltered from gift tax by choosing to split the gift with the other spouse. In this way, since both annual exclusions are used, no gift tax will be due and there will not be a reduction in the gifting spouse’s $5,250,000 lifetime estate tax exemption amount.
- Health Care Costs: Prior to these decisions, the value of health care benefits provided by employers for same sex spouses were taxed as compensation to the employee spouse. This raised the cost of health care for same sex couples because the employer had to withhold taxes on the value of those benefits and the employee spouse had to pay income taxes on the value of that imputed compensation. Now, an employee spouse can provide benefits for his or her same sex spouse without negative income tax consequences.
New Estate Planning Options To Consider
Since a same sex spouse can now leave assets at death to a surviving spouse free of estate tax, new planning options exist. Two of these options are portability and marital deduction trusts.
- Portability: In our March Quarterly Insights for Clients, we detailed the pros and cons of designing estate plans using portability, an option that became permanent under the American Taxpayer Relief Act of 2012. Under portability, a deceased same sex spouse’s estate can elect to pass any unused gift and estate tax exemption (currently $5,250,000) to the surviving spouse without creating a Bypass/Credit Shelter Trust for the survivor. Whether to create a simplified portability estate plan is a complex decision, but is one worth exploring.
- Marital Deduction Trusts: A deceased same sex spouse can also now leave assets to his or her spouse through a Marital Deduction Trust. No estate tax will be owing at the first death on any assets left to a Marital Deduction Trust. Unlike with portability however, the deceased spouse may control who will receive the trust assets after the death of the surviving spouse. This option can be combined with portability or with the traditional Bypass/Credit Shelter Trust to round out a same sex married couple’s estate plan.
The tax benefits now available to same sex married couples provide an abundance of opportunities and options. The items mentioned above are only a few of many examples.