Supreme Court Ruling a Victory, but Questions Remain

07/30/2013

By Lillian Gonzalez, CPA, MST, CSEP, CSRP, ADPA

July 24, 2013

The Defense of Marriage Act (DOMA), a federal law enacted in 1996, contains two sections that since its inception have denied same sex married couples (SSMC’s) over 1000 federal benefits granted to their heterosexual counterparts.  Section 2 allows states to refuse to recognize same-sex marriages granted under the laws of other states, and section 3 defines marriages for federal purposes as a union between one man and one woman. On June 26, 2013, the Supreme Court struck down section 3 of DOMA, paving the way for SSMC’S to receive federally all the rights, obligations and protections granted to different sex married couples. 

The landmark case behind this ruling, United States v. Windsor (2013), was an estate tax case filed in New York by Edith Windsor in relation to her marriage to Thea Speyer.  Both Ms. Windsor and Ms. Speyer were NY residents who had married in Canada before same sex marriage was legalized in NY.  When Ms. Speyer passed away in 2009, Ms. Speyer’s estate owed $363,000 in taxes because section 3 of DOMA disallowed the unlimited spousal deduction to Ms. Windsor. In declaring section 3 of DOMA unconstitutional, the Supreme Court ruled that the Canadian marriage of Edith Windsor and Thea Speyer must be recognized under NY law.  Although this ruling is greeted as the victory it is, because of the benefits SSMC’S are now granted in areas such as estate taxes and gifts, health insurance, social security, retirement planning, banking, immigration, housing, hospital visitation, etc., in regards to income taxes, SSMC’S will also experience some disadvantages. 

The IRS is promising to move swiftly to provide revised guidance, however, due to the complexity of the issues, we are not quite sure how the IRS and other federal agencies will administer the decision, nor do we have any indications of when these issues will be resolved. Because the Windsor case resulted in a retroactive application of the law – Edith Windsor received her $363,000 – we believe that some aspects of the ruling should be applied retroactively, although these decisions are yet to be made. It would appear that SSMC’S will be able to prepare joint federal returns moving forward, at least in DC and the 13 marriage equality states. Once resolved, we believe it will also be possible that amended returns may be prepared for all years where the statute of limitations has not expired, or for which protective claims have already been filed.  If logic holds, this would mean that tax years 2010 – 2012 should be open to amendment, that the amendment of prior year tax returns in relation to the 2013 ruling would hopefully be voluntary, and that penalties would not be applied to any balances owed on amended returns. Additionally, my hope is that the IRS would allow SSMC’S to choose filing status for any tax returns currently on extension; however starting in 2013, SSMC’S would be required to use the appropriate filing status according to federal law.

In relation to retroactive amendments, we are also awaiting guidelines on adjusting for the past taxation of spousal health benefits.  It doesn’t appear feasible to require employers to prepare and issue corrected W-2’s for prior years; although this could result in a savings for the employer (Social Security and Medicare tax reductions); the work required could turn into a compliance nightmare. It may be possible that an individual could self-correct these amounts for the affected years and adjust on amended returns, but guidance is required to determine the appropriate process. 

Until the IRS provides guidance to reflect the Supreme Court ruling, uncertainty will abound.  We are already receiving word that the IRS is inconsistently deciding on filed protective claims, with some being allowed and some denied. It is yet to be determined how and when the denials can be appealed, or if a more streamline process may be available.

Section 2 of DOMA

Section 2 denies the portability of a marriage to any non-recognition state, however, in striking section 3 down, the federal government may well have to honor same sex marriages regardless of where the couple resides. Whereas the federal definition of marriage is no longer limited to gender, and since any couple married in DC or any of the 13 marriage equality states is now considered legally married, federal recognition of same sex marriage may soon be seen as portable, even to non-recognition states! Revenue ruling (58-66) alludes to the federal portability of any legal marriage performed in any state, although section 2 of DOMA trumps this only on the state level for non-recognition states.  Simply stated, since the same sex marriage is now recognized federally, it would follow that for federal tax filing purposes SSMC’S are considered married in the United States of America irrespective of whether SSMC’S live in a recognition or non-recognition state!

On July 11, 2013, John Arthur, who is in terminal stages of ALS, and his partner of more than 20 years, Jim Obergefell, flew from their home in Cincinnati, Ohio to Baltimore, Maryland, where they were legally wed in a ceremony officiated by John’s aunt. On their return to Cincinnati, Jim and John sued in federal court to have their marriage recognized in Ohio so that upon Jim’s death he would be able to be buried next to his beloved in the Arthur family plot, which is stipulated for direct descendants and their spouses. According to Ohio law, marriages performed in other states that may not be legally performed in Ohio are nonetheless recognized in Ohio, such as marriages between first cousins or marriages involving a minor. But in 2004, Ohio residents voted in a law to amend the state constitution to ban recognition of same sex marriages regardless of where they are performed. On July 22, US District Judge Timothy Black granted to Jim and John a temporary restraining order against the discriminatory 2004 law and ordered Ohio state officials to recognize the Maryland marriage of the two men. Jim can now officially be listed as John’s surviving spouse on his death certificate.

There remains much more work to do, such as repealing and gutting all of DOMA, which would entail honoring the full faith and credit clause of the US constitution, and making marriage throughout the United States portable both for federal and state purposes.

What This All Means for Our Clients

Since the Supreme Court ruling, I have been asked by my clients numerous questions about both the benefits and disadvantages for SSMC’S in relation to financial planning and tax preparation, now that section 3 of DOMA has been declared unconstitutional. What follows is a list of some important benefits of the ruling followed by the realities of filing jointly and considerations for filing amended returns:

Some Immediate Financial Benefits for SSMC’S Residing in DC and Marriage Equality States

• Married spouses may transfer unlimited amounts of money to each other without paying income tax or incurring gift tax, and gift splitting is now available.

• Titling of financial accounts is now simplified, as well as consolidation of those accounts.

• For Estate Planning purposes, married SSMC’s can use the unlimited marital deduction (US Citizen), and can elect portability, so at death, unused estate and gift tax exemptions can pass to the surviving spouse.

• Tax free employer health insurance benefits now cover both spouses equally, without additional imputing of income and tax payments.

•  Spousal health care expenses can be reimbursed from flexible spending accounts.

•  SSMC’S may now qualify for each other’s Social Security survivor and death benefits.

• Spousal provisions – such as IRA pay-ins for non-working spouses, annuities, rollover opportunities and other retirement accounts are now available to SSMC’s.

Realities of Filing Joint Income Tax Returns

• Filing jointly may produce less tax, especially if spouses have disparate income levels or there is a stay-at-home spouse.

• Conversely, higher income two-earner couples or those with children may have to pay more to the IRS.

• Filing joint returns may increase income and result in disallowance of certain deductions or losses that are limited by total income reported on the return (rental losses, IRA contributions, etc.).

• SSMC’S filing tax returns in multiple states may run into additional filing issues, particularly if income is earned in a non-recognition state.

Considerations for Filing Amended Income Tax Returns

• All the issues of filing jointly stated above apply.

• Keep in mind that when amending returns, the filing status must be either Married Filing Jointly (MFJ) or Married Filing Single (MFS), and all items must be corrected.  For example, returns cannot be adjusted only for imputed health benefits, per se, but must be adjusted for all applicable items.

• Couples who cross adopted their children and claimed a federal adoption credit would face recapture of that credit on a joint return.

• Transactions that may have been entered into by same sex spouses which were treated as “unrelated” transactions, due to attribution rules, may be disregarded, which could have significant adverse tax effects.

• When amending returns, carry-forwards (passive losses, capital losses) may be affected, which in turn affect tax liabilities in future years.  Even though penalties may be waived, it is not uncommon to get mired in correspondence with governmental agencies to waive the penalties.

• The IRS may require that all years subsequent to an amended year also be amended; alternating filing status may not be allowed.

• The cost to process the amendments versus the refund should be considered.

As a final note previously filed gift tax returns that reported marital transfers as gifts should be amended. The IRS may issue further guidance on how many years back we may be able to amend.

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