Some clients have inquired as to the tax treatment of same-sex spouses now that the Supreme Court has struck down the provision of the Defense of Marriage Act that treated same-sex spouses as unmarried under federal law. This newsletter briefly explains the impact of that landmark decision.
Following up on the Supreme Court’s decision, the IRS announced that it will treat same-sex spouses legally married in a jurisdiction that permits same-sex marriage as married for federal tax purposes, even if they now live in a jurisdiction that doesn’t recognize same-sex marriages. This change is effective as of September 16, 2013. Therefore, starting with tax year 2013, same-sex spouses must generally file their tax returns as married. In addition, for 2012 and earlier years, same-sex spouses who file an original return on or after September 16, 2013, generally must file as married.
The tax consequences of this change are significant, since almost 200 provisions of the Internal Revenue Code treat marital status as a factor for receiving a benefit or being subject to a limitation. The following are some of the most important tax consequences.
Same-sex spouses must now file their taxes as married spouses. Filing as a married couple versus filing as two single individuals may increase taxes for the two spouses or may reduce them, depending on the income of each. In any event, filing as spouses is mandatory for 2013. But same sex-spouses have a choice of filing jointly (married filing jointly) or separately (married filing separately). Joint filing is generally more advantageous, since filing as married filing separately usually results in higher tax liability.
It’s important to note that although same-sex spouses can now file jointly for federal tax purposes, they may still need to file as single for state tax purposes. The changed status for federal tax purposes may allow reduced withholding or estimated tax payments for those who will owe less total taxes as a married couple than they would have owed as two single individuals. Those who will owe more may want to increase withholding or estimated taxes.
Same-sex spouses filing jointly, same as opposite-sex spouses filing jointly, must choose as a marital unit to either itemize deductions or take the standard deduction. Itemized deductions are subject to an overall limitation. If the adjusted gross income (AGI) of an individual exceeds an applicable amount, the amount of itemized deductions otherwise allowed is reduced by the lesser of 3% of the excess of AGI over the applicable amount, or 80% of the amount of itemized deductions otherwise allowable. Since filing as married may result in increased combined income, itemized deductions may be reduced as a result of the overall limitation. Same-sex spouses can now take certain deductions for expenses incurred for their spouse. For example, same-sex spouses can deduct payments made for their spouses’ medical expenses.
Many tax credits are structured so that the amount of the credit is gradually phased out when income reaches a certain threshold. Since filing as married may result in increased combined income, a credit amount may be reduced (or eliminated completely), resulting in a greater tax liability. Examples of credits that are subject to income limitations are: the earned income tax credit, the child and dependent care credit, the child tax credit, the education tax credits, and the adoption credit. In addition, a same-sex spouse can’t claim the adoption credit for expenses incurred in adopting his or her spouse’s child.
A same-sex married employee who is covered by an employer-sponsored health insurance plan can now exclude from gross income the amount of the premium paid by the employer for coverage of his or her same-sex spouse. Before the Supreme Court’s decision, if a plan covered the non-employee spouse, the employee spouse was taxed on the estimated value of the coverage. Further, an employee spouse can now pay health coverage premiums for his or her same-sex spouse on a pre-tax basis under an employer-sponsored cafeteria plan.
Additionally, a same-sex spouse non-employee can now obtain continuation of health coverage under the Consolidated Omnibus Budget Reconciliation Act of 1985, known as “COBRA coverage,” if the same-sex spouse employee’s coverage ends due to a qualifying event such as termination of employment.
A less favorable consequence of the decision is that same-sex spouses will now be subject to a combined contribution limit for certain health savings accounts or flexible spending accounts that used to apply to each spouse on an individual basis. For example, before the decision, each same-sex spouse could individually contribute the maximum contribution amount to a dependent care flexible spending account. After the decision, the maximum contribution amount applies to the combined contributions of the same-sex spouses.
Same-sex spouses now have the rights of married spouses with respect to retirement plans. This is the case even for a qualified retirement plan maintained by an employer that operates in a state that doesn’t recognize same-sex marriage. Thus, spousal consent must be obtained before certain actions can be taken with respect to a retirement account, such as changing the plan beneficiary to a nonspousal beneficiary.
In case of divorce, a qualified domestic relations order can be obtained that gives one spouse the right to share the pension benefits of the other. After a spouse’s death, the surviving spouse can stretch out distributions from a qualified retirement plan or individual retirement account under more favorable rules than apply to nonspousal beneficiaries.
Estate and Gift Taxes
There are a number of favorable estate and gift tax provisions available to married couples that are now available to same-sex spouses. For example, either spouse can utilize the marital deduction to transfer unlimited amounts during life to the other spouse, free of gift tax. The spouses can also “split” their gifts, meaning that gifts to others are treated as if made one-half by each spouse. Further, the estate of the first spouse to die gets a marital deduction for amounts transferred to the surviving spouse and can transfer the deceased spouse’s unused exclusion amount to the surviving spouse.
We recommend that same-sex spouses review and amend their estate plans to take advantage of these provisions.
Actions to Consider
Same-sex spouses should consider filing amended tax returns for open tax years if filing as married would decrease their tax liability.
Same-sex spouses should also consider filing amended estate tax and gift tax returns to claim the tax benefits discussed above, as well as reviewing and amending their estate plans.
Same-sex spouse employees who paid employment taxes (social security and Medicare) on gross income attributable to health coverage for their same-sex spouses should consider seeking an adjustment or reimbursement from their employer.
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