2014 Year-End Planning for Lesbian, Gay, Bisexual and Transgender (LGBT) Taxpayers
By Janis Cowhey - Partner, Tax & Business Services and Portia Rose - Mahanger, Tax & Business Services
The year following the landmark Supreme Court Decision in US v. Windsor has seen an exponential growth in the number of states recognizing same sex marriage. Last year at this time, there were only 16 recognition states, plus the District of Columbia. Today that number now stands at 35 states plus DC. State bans have been ruled unconstitutional in several of the remaining states, where they are being challenged in the local courts. The recent Supreme Court decisions not to review the state bans paves the way for same-sex marriage to be recognized not just in those states, but in states governed by the same circuit courts. At the same time, a contrary ruling by the Sixth Circuit Court, which upheld samesex marriage bans in four states, adds confusion and inconsistency to the issue. It is likely this decision will be appealed.
On top of all this, the government is still working on reviewing and updating the myriad inconsistencies across federal agencies. States are playing catching up, too. What does all of this mean to tax and estate planning as you approach the end of 2014? For LGBT married couples living in one of the 35 recognition states, federal and state year-end tax planning may seem relatively simple as compared to past years. For those living in the other 15 states, year-end tax planning will remain as complicated as ever. Whatever state you are living in and whatever states you may be filing in, it is important to consult your tax advisor about ways that current tax laws may benefit you. Following are some of the key considerations to keep in mind looking ahead to year-end 2014 and into 2015.
Place of Celebration
On August 29, 2013, the IRS released Revenue Ruling 2013-17 clarifying that where a couple was married (place of celebration) rather than where a couple resides (place of domicile) determines a same-sex couple’s marital status for federal tax purposes. A tremendous benefit of this decision is that married same-sex couples can travel freely across state lines and be considered married in each state for federal tax purposes. The ruling applies to same-sex marriages legally entered into in a U.S. state, the District of Columbia, a U.S. Territory or a foreign country. The ruling does not apply to civil unions, registered domestic partnerships or similar relationships that might be recognized under state law but do not necessarily guarantee the same protections as marriage.
Some federal agencies, such as the Social Security Administration, only recognize marriages that are valid in the state of domicile for the purpose of granting federal benefits. This means that if you’re in a same-sex marriage but you live in a non-recognition state at the time of your application, you aren’t eligible for Social Security benefits on your spouse’s work record. If you live in one of the states or Washington, DC, where same-sex marriage is recognized, you will qualify for benefits. Additionally, if you apply for benefits and then move to a non-recognition state, you can still collect the benefits. This rule also applies to Medicaid and Supplemental Security Income, bankruptcy filings and benefits under the Family Medical Leave Act.
Because the IRS now recognizes all same-sex marriages regardless of what state you live in, a same-sex married couple is now able (and required) to file a married federal income tax return (either jointly or separately) and is afforded many of the benefits of filing jointly, including but not limited to: less time and expense in filing one return as opposed to two separate returns; a potentially lower combined income tax bracket, if two spouses have substantially different levels of income; and others. On the other hand, you may find that you and your spouse are now subject to the so-called “marriage penalty.”
For a married couple, annual tax filings may become more complicated on both the federal and state tax levels as income and expenses are combined. On the federal level, the filing options available are married filing jointly or married filing separately. On your state return, if you are living or filing in a state that doesn’t recognize your marriage, you will most likely have to file as single. If you are living in a state that recognizes your marriage but you receive income from a non-recognition state, you would have to file a joint return.
As part of your year-end planning, married same-sex couples should review the filing statuses available for years that are open under the statute of limitations. The statute of limitations is open for three years from the date a return is filed or two years from the date the tax is paid, whichever is later. Couples should review their prior years’ returns to see if a married filing jointly or married filing separately status would provide a benefit. Taxpayers are under no obligation to file amended returns, but a review is worthwhile to determine whether a different filing status may result in a refund of taxes paid.
The Marriage Penalty
Same-sex married couples now have all of the same benefits (and penalties) as heterosexual married couples at the federal level. One of the drawbacks is the so-called “marriage penalty” tax. Couples who recently married may be in for a bit of a shock when filing their taxes under their new status this year.
The marriage penalty refers to the higher income tax liability a married couple faces as compared to two individuals with exactly the same income. This is because of our progressive federal tax-rate structure, which means that you will pay a higher income tax rate on the last dollar you earn than the first. (This is true for same-sex as well as heterosexual married couples). Thus, combining incomes for purposes of filing a joint return carries a higher tax burden. The marriage penalty generally has the biggest effect on couples at the very bottom and very top of the income scale, especially couples with disparate incomes.
Estate and Gift Taxes
Married couples benefit from the federal exemption from both estate and gift taxes for bequests or gifts of property to a spouse. Spouses can combine their personal estate tax exemptions as well – this is referred to as “portability.” The second spouse to die can leave property worth up to $10,680,000 (2014 exemption, indexed for inflation) free from federal estate taxes if the first spouse to pass away did not utilize all of his or her exemption amount. Unmarried couples do not get portability, so the second partner to die is restricted to leaving half that amount, or $5,340,000, tax-free.
On the flip side of the estate planning coin, you cannot “disinherit” your spouse. Your spouse has the right of election against your estate and has the first right to serve as your estate Executor. A prenuptial agreement can address these aspects of your estate planning.
If you die in a state that does not recognize same-sex marriage, your spouse will not automatically inherit under state spousal rights statutes. If a couple intends to inherit from each other, a will or living trust is essential.
Spouses have priority if a conservator needs to be appointed by the court; so you are the one making the financial and/or medical decisions on your spouse’s behalf.
Estate planning, particularly if children are involved, should be an important part of year-end planning. Review and update your will and estate documents (including insurance and retirement beneficiary designations) to be sure they reflect your current wishes as well as ensure you are taking advantage of any benefits available to you. Additionally, if you are planning to marry, a prenuptial agreement can address certain aspects of your asset protection and estate and income tax planning.
Prior to 2013, benefits provided to a same-sex spouse were paid with after-tax dollars, and the benefit was included in the employee’s taxable income. Now, employees are able to pay for these benefits with pre-tax dollars. The IRS has provided guidance on how an employee should treat amounts wrongfully included in W-2 income for the premiums paid by the employer for a same-sex spouse’s benefits. The IRS advises the employee to request a corrected W-2 or, if that fails, to take specified steps to report a corrected amount of taxable income when filing your tax return. Additionally, employers who paid payroll taxes based on previously taxed health insurance and other benefits can also file amended returns.
An employee’s gross wages do not include contributions that the employer makes to an accident or health plan (through insurance or otherwise) for personal injuries or sickness incurred by the employee, the employee’s spouse or dependents, and certain other individuals. The value of the coverage isn’t taxable. The IRS concluded that the employer-paid portion of health coverage for a same-sex spouse is excludable from the employee’s gross income. If the employer offers the health coverage through a cafeteria plan that permits employees to pay the employee portion of the cost of coverage through pre-tax salary reduction, and if the taxpayer paid for the cost of their own health coverage on a pre-tax basis, then any amounts paid on an after-tax basis for spousal coverage would also be excludable from the taxpayer’s income.
The IRS states that a taxpayer may be entitled to a refund of federal employment taxes (social security and Medicare) paid on the value of excludable spousal health coverage provided that the spouse is the taxpayer’s legal spouse under state law. Taxpayers in this situation might wish to contact their employers to determine if the employer will seek a refund of these amounts on the taxpayer’s behalf. If the employer will not seek a refund, the taxpayer may file for a refund of the taxes paid.
Employees in a same-sex marriage should:
- Consider amending their tax returns if they were paying for employer-provided benefits for their spouse.
- Meet with their HR department to review the benefits provided to married couples to make sure they are taking full advantage all benefits.
- Provide their HR department with a copy of their marriage license and confirm that the spouse’s insurance coverage is no longer included in taxable income.
Employers should ensure that their benefits packages are in compliance with the provisions of the new laws as they relate to same-sex couples.
Federal recognition of marriage is a tremendous benefit for the LGBT community. This is a time to be proactive in understanding the impact of your tax filing status on both federal and state levels and to consider updating or modifying your existing financial plan.
Marcum’s dedicated LGBT Practice group constantly reviews and updates the almost daily changes that come from federal, state and local agencies. Check Marcum’s website for our interactive online map (produced in association with CNN) depicting the current status of same-sex marriage in the United States, as well as our Top 10 Estate Planning Tips, Top 10 Tax Planning Tips for Legally Married Same-Sex Couples, and The Financial I Do’s and Don’ts for Same-Sex Married Couples.
Marcum LLP is the thought leader in the specialty area of tax compliance and consulting services within the LGBT community. Our professionals have more than 20 years of experience in dealing with the complex tax and financial rules faced by LGBT couples and families, state-by-state and around the country. Our forward thinking professionals grasp the subtleties and differences in these rules and, today, have the tool box to help economically mitigate the differences for clients in need.