The Defense of Marriage Act (DOMA), as enacted, had two-prongs, namely:
- Section 2 of the Act provided and still provides that no state need recognize same-sex marriages legally consecrated under the laws of another state.
- Section 3 of the Act defined marriage for all purposes of federal law as being only “a legal union between one man and one woman;” and, that, “the word spouse refers only to a person of the opposite sex who is a husband or a wife.” This section has been struck down.
The highest court of our land on June 26, 2013 struck down Section 3 of DOMA in part, because:
- The court, with Justice Kennedy, writing the majority opinion found DOMA to be an overly broad invasion of terrain traditionally and constitutionally reserved to the states – domestic relations.
- The majority found that DOMA lacked a rational basis to support defining marriage to exclude legally married same-sex couples in the application of over 1,000 federal laws.
FACTS IN WINDSOR CASE
The facts of the case should be kept in mind in considering what this decision will mean for same-sex couples who are married or contemplate marrying:
- The couple, Edith Windsor and Thea Spyer were New York residents and long-term companions.
- They were legally and validly married in Canada while visiting in 2007.
- They returned to NY which at the time did not permit same-sex marriages but recognized those legally consecrated in jurisdictions that did permit them.
- Spyer died in 2009 and left her entire estate to Windsor.
- Windsor filed an estate tax return claiming the marital deduction allowed to surviving spouses.
- The IRS disallowed the deduction claimed based on DOMA Section 3 and assessed tax of $363,053.
- Windsor paid the tax and filed a claim for return which was denied by IRS.
- Windsor filed suit in U.S. District Court seeking her refund on equal protection grounds and won.
- The Second Circuit Court of Appeals affirmed the District Court’s ruling.
- Although the DOJ announced it would not defend DOMA in court, the IRS continued to enforce DOMA and would not issue Windsor’s refund check.
- The Supreme Court on certiorari shoved aside some jurisdictional objections and struck down DOMA as unconstitutional on equal protection, due process and reserved state’s rights grounds.
TAX IMPACT GOING FORWARD
The immediate tax impact of Windsor holds tax benefits, burdens and unanswered questions. For example:
- For couples married and living in a state that permits same-sex marriage or recognizes such marriage of other states (presently none):
- Joint returns can be filed for 2013 and later years. Benefits of joint filing can include:
- Rate splitting where one spouse earns significantly more income than the other spouse.
- For two earner couples, filing jointly often results in a higher tax than would have been due if both were able to file as single persons. But, the joint tax is almost always lower than if married filing separate returns are filed. Same-sex couples covered by Windsor will no longer be able to claim spousal privileges under state law but file federal tax returns as single persons. This could be costly for two-earner couples. Another joint return negative could be that two earners will have higher joint income for purposes of:
- The 3.8 tax on passive income.
- The phase out of the $25,000 cap on passive activity losses from rental activities in which a taxpayer materially participates.
- The phase out of personal exemptions and itemized deductions, and,
- Calculation of the Alternative Minimum Tax.
- Joint returns can be filed for 2013 and later years. Benefits of joint filing can include:
- Availability of Head of Household exemption for spouses with children living apart.
- Availability of a larger home sale exclusion of $500,000 instead of $250,000 where the home is owned by only one spouse. There was no pre-Windsor penalty for a jointly owned home because the two single exclusions before equaled the joint exclusion. Thus, joint owners now considered married will have no changed tax impact with regard to the exclusion.
- Availability of the alimony deduction for qualifying cash payments to or on behalf of a former spouse (Assuming same-sex couples will be able to divorce, if living in a state not permitting same-sex marriage).
- Availability of use of QDRO to split qualified plan benefits.
- Availability of innocent spouse relief under Section 6015 in appropriate cases.
- Employer health coverage for spouse will be tax-free. Presently the value of such coverage is treated as taxable compensation. Question: Will employers amend W-2s and file refund claims for workers who have been over-withheld for Social Security and Medicare taxes? With an amended W-2 the employee can include the tax paid on health care benefits in his or her refund claim for income taxes overpaid (This assumes the Windsor decision will be applied retroactively – see below). In any event, employees should ask employers to correct the current year and adjust withholding to recapture the overpaid tax paid to date.
- One will be able to add his or her spouse to flexible spending accounts if established by employers.
- As in Windsor, a same-sex surviving spouse will now be able to claim a marital deduction for inheritances from a deceased spouse. Note that this impact affects wealthy couples, for, even before Windsor, the first $5,250,000 (lifetime exemption) of a taxable estate could be passed without incurring U.S. estate taxes regardless of whether the beneficiary is a spouse. After Windsor, the amount that can be passed to a spouse tax free is doubled, however, due to portability of the unused lifetime exemption available to married couples.
- Gifts to a spouse will be eligible for the marital deduction and not use up part of the life-time exemption. Before Windsor, once the annual exclusion ($14,000 per done in 2013) was exceeded, the lifetime exemption was reduced dollar for dollar.
- Spouses will also be able to elect split gifts which expands use of annual exclusions when gifts are not made jointly.
- Spousal IRA beneficiaries will have available more liberal rules for stringing out distributions than are generally available for non-spouse beneficiaries.
Justice Kennedy was careful to point out that the holing of Windsor is limited to legally created marriages. The court did not state that its ruling would be applied retroactively, although most seem to believe that will be the case. IRS has traditionally defined marriage with respect to the laws of the state of residence, not the laws of the state where the spouses were joined. Moreover, Section 3 of DOMA is still on the books permitting states not recognizing same-sex marriage to ignore legal same-sex marriages of other states.
IRS has announced that it is working with the Department of Justice to promulgate rules and regulations to implement the Windsor decision. Hopefully, guidance will be forthcoming sooner than later because, questions abound:
- Will Section 3 of DOMA usurping full faith and credit to be afforded marriages of other states stand up to constitutional scrutiny when challenged, as undoubtedly it will be? This will be a difficult balancing act for a court that has based its decision in Windsor partly on states’ rights in the realm domestic relations. But, the court did make clear that state domestic relations laws while given a wide berth must pass constitutional muster; and, there is precedent in Loving v. Virginia, 388 U.S. 1 (1967), in which a state law restricting marriage between a man and woman of different races was struck down. As of today same-sex marriages are recognized in 13 states plus California as a result of the court also dismissing a case challenging a lower court holding striking down Proposition 8 which had banned same-sex couples from marrying. Thus, 36 states still have on the books versions of DOMA. (Same sex marriage is also legal in the District of Columbia).
- Will IRS continue to define marriage by the laws of the state of residence or issue regulations that accept as married for tax purposes all same-sex couples legally married in any state, regardless of residence?
- Even if IRS accepts all legal marriages, states with an income tax prohibiting same-sex marriage likely will not permit such spouses to file a joint state tax return.
- If IRS continues to use place of residence as the touchstone, couples legally married but living in states prohibiting same-sex marriage could still file as single taxpayers instead of having to choose between joint or married filing separately.
- Should same-sex married couples file amended returns if analysis reveals that they would be due a refund even if they live in a state not accepting same-sex marriages? I would say yes, even if IRS does not change its state of residence rule. Certainly, couples married and living in a legal state should do so. In either case, spouses should request from their employers amended W-2 Forms if health care benefits have been included in compensation.
- Are couples obligated to file amended returns if the return produces a higher tax? No, there is no obligation to amend a return; but, IRS may issue guidance waiving interest and penalties if couples do come forward voluntarily (assuming retroactive application of the decision).
- Will marriage benefits under federal law, apart from tax, e.g., Social Security survivor benefits, be extended to those joined in civil unions or comprehensive domestic partnerships?
- Will same-sex couples be able to obtain a divorce if living in a state that does not recognize same-sex marriage? The problem is a Catch 22: They cannot get a divorce where they live because the state of residence does not recognize their marriage; they cannot get a divorce where they were married because divorce filings have a residency requirement.
The Windsor decision marks a paradigm shift in the tax treatment of same-sex couples who have chosen or chose to formalize their relationship in marriage. Careful consideration of these changes on a couple by couple and agency by agency basis will be necessary for couples to adapt financial and tax planning to the new world.
© 2013 by Robert S. Steinberg, Esquire
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