Marital Status after DOMA: Exploring the Practical Tax Implications
By Mason, Richard | |
Proquest LLC |
For most taxpayers filing a return, marital status is one of the few straightforward determinations in complying with the tax code; however, the recent history of the Defense of Marriage Act of 1996 (DOMA) highlights the ambiguity that sometimes accompanies the determination of marital status for federal tax purposes. This ambiguity, which can also affect couples in a common law marriage, has practical tax implications; thus, tax professionals should understand the consequences when marital status appears to be flexible.
A Changing Landscape
When signed into law, DOMA defined marriage as a legal union between one man and one woman for federal purposes (DOMA section 3) and did not require states to recognize same-sex marriages from other states. The basic implication was that same-sex couples legally married in their state were treated as single taxpayers for federal tax purposes. They would file their federal income tax return as single or head of household and submit a joint return for state income tax purposes if residing in a state where same-sex marriage was legal.
But in
After careful consideration, including a review of my recommendation, the President has concluded that given a number of factors, including a documented history of discrimination, classifications based on sexual orientation should be subject to a more heightened standard of scrutiny. The President has also concluded that section 3 of DOMA, as applied to legally married same-sex couples, fails to meet that standard and is therefore unconstitutional. Given that conclusion, the President has instructed the Department not to defend the statute in such cases. (Statement of the Attorney General on Litigation Involving the Defense of Marriage Act,
In
The other case, Hollingsworth v. Perry, involved the legality of Proposition 8, a constitutional amendment prohibiting same-sex marriage, in
We have never before upheld the standing of a private party to defend the constitutionality of a state statute when state officials have chosen not to. We decline to do so for the first time here.
Background
Currently, 13 states (
On
Thus, there appears to be little ambiguity going forward for legally married same-sex couples; however, for same sex couples who previously filed as single under DOMA or have not yet filed prior-year returns, flexibility still exists with respect to marital status on the federal tax return. Furthermore, in states that recognize common law marriages, marital status for federal tax purposes is not always straightforward. Although these states have several requirements that must be met in order to qualify as a common law marriage, the couple must ultimately "represent themselves to others as being married" (Texas Family Code section 2.401 [2]), something that the couple could choose to do, depending upon the tax consequences of the action. Same-sex common law marriages present an even greyer area for determining marital status. Finally, even unmarried couples contemplating marriage should consider the tax consequences and benefits of legally marrying.
Being treated as a married couple for federal tax purposes is not necessarily more beneficial for all taxpayers; thus, a couple with an ambiguous marital status should carefully consider the consequences of being treated as married versus being treated as single. The following sections discuss federal tax areas where marital status is significant.
Tax Rates, Brackets, and Deductions
The most visible difference between married and single taxpayers is their filing status. Married taxpayers file jointly (MFJ) or separately (MFS). Individual taxpayers file as single or as head of household. Although the brackets and standard deduction are higher for MFJ, a couple with children that has an ambiguous marital status is likely better off filing separate, nonmarried returns because of the higher bracket thresholds for heads of households. As shown in Exhibit 1, if both spouses have comparable income, filing a pair of nonmarried returns subjects less income to the higher tax brackets and will result in a significantly higher standard deduction than filing a joint return.
Related to filing status are various limitations and phaseouts. For example, the child tax credit is phased out at
The choice between filing a joint return and filing with a nonmarried status is also impacted by other deductions. For example, the dependent care credit for a disabled spouse (Internal Revenue Code [IRC] section 21 [b][l][C]), deductions related to qualified tuition and student loan interest (IRC sections 221 and 222), and deductions related to medical expenses (IRC section 213[a]) might be lost if the spouse who incurs these expenses has no taxable income and separate nonmarried returns are filed. In this case, MFJ allows the spouse with taxable income to claim as deductions the costs incurred by the low- or no-income spouse.
In the case of employee benefits, it can be beneficial to be married or to file as single, depending upon a couple's specific circumstances. For example, spousal contributions to individual retirement accounts (IRA) count toward the contribution limitation, and if the spouse participates in an employer-sponsored plan, the deductible amount to traditional IRAs is phased out at a certain income level, as shown in Exhibit 2 (IRC section 219[g][l]). On the other hand, spouses qualify for many employee benefits, such as employer-provided healthcare (as in Golinski v.
In addition, if federally unmarried spouses receive health insurance benefits, the transfer of these benefits may be subject to gift taxes. But the authors believe that benefits will rarely exceed the annual gift tax exclusion amount (
One interesting aspect is the tax treatment of alimony and separate maintenance payments. Alimony payments are deductible to the payer and considered income to the payee. Property settlements, in the context of a divorce, are not deductible or subject to tax. The issue of alimony payments and property settlements between divorced same-sex couples is a relatively new area. The IRC defines alimony and separate maintenance payments as transfers made under a divorce or separation instrument (IRC section 71[b]). But, under DOMA, same-sex spouses were not considered spouses. Traditionally, separation agreements and divorce decrees are a state issue. It remains unclear whether the
So do same-sex couples include alimony as income and get a deduction for it? The authors are unaware of any cases in which the
Earned Income Tax Credit
The earned income tax credit is designed to provide refundable credits to lowerincome individuals as an incentive to work (IRC section 32). The credit is generally largest (as high as
Related-Party Issues
Many IRC provisions deal with related-party issues, mostly due to the fear that related parties can distort transactions in order to avoid taxation-for example, losses on sales between related parties are not deductible. Consider a case in which Jamie sells Jessie a business asset for
Spouses are also considered family for purposes of the family attribution rules on stock redemptions (IRC section 318) and for purposes of determining the 100-shareholder limitation for S corporations (IRC section 1361[b][l][A]). Thus, in the case of the former (IRC section 318 attribution rules), taxpayers would benefit by not being treated as spouses because they would not constructively own each other's shares, increasing the likelihood of a redemption being treated as a sale instead of the less favorable dividend treatment. (Note that this distinction would become more important if the preferential treatment of dividends were eliminated.) In the latter instance (S corporation owner limit), being considered a spouse increases the effective number of individuals that can be shareholders of S corporation stock.
Estate and Gift Tax Issues
For purposes of estate and gift taxes, filing as a married couple is almost always more beneficial; transactions between spouses and gifts made while married are eligible for special tax treatment. Although estate tax and gift tax returns are never filed jointly, several mies apply exclusively to spouses. Wealth transfers between spouses during lifetime and at death are always tax free (IRC sections 2523[a] and 2056[a], respectively). Spouses also have the option to gift split, whereby they treat gifts made to third parties as made half by each spouse. The advantage of this is that the annual exclusion amount (
Under current estate tax law (as amended in the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 and made permanent in the American Taxpayer Relief Act of 2012 [
One spouse can create a qualified terminable interest property trust for the other, which enables that spouse to maintain control over how the assets are distributed after the surviving spouse dies. The transfer to the surviving spouse is considered a taxfree transfer between spouses. This transfer would not be tax free to a nonspouse- it would be subject to the gift tax-so this transfer vehicle is attractive only to couples that file as married.
Insights for Tax Planning
Numerous potential tax issues may arise due to the recent changes at the federal and state level, both by statute and in the courts, with regard to the status of same-sex marriages. After the
Moreover, both heterosexual and samesex common law couples (in states that recognize this arrangement) that have not yet represented themselves as married face some ambiguity (and perhaps flexibility) in determining their marital status for federal tax purposes. Being treated as married or unmarried has significant tax consequences. CPAs should be sensitive to the needs of different individuals in these situations, while continuing to provide frank and realistic tax advice. ?
Copyright: | (c) 2013 New York State Society of Certified Public Accountants |
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