Same-Sex Spouses Should Examine Estate Planning
Recent monumental court decisions open new planning opportunities for same-sex married couples.
Regardless of whether the federal estate and generation-skipping transfer tax is repealed this year, estate planning for same-sex couples has been positively changed for the foreseeable future. The United States Supreme Court’s 2015 decision in Obergefell v. Hodges determined that legally married same-sex couples must receive equal treatment under the law, thereby recognizing same- sex marriages in all 50 states. The Court’s earlier 2013 decision in United States v. Windsor declared a portion of the Defense of Marriage Act unconstitutional. These monumental decisions leveled the playing field and opened new planning opportunities for same-sex married couples looking to transfer their assets to each other and their families.
In the wake of these decisions, the IRS announced that it will recognize all same-sex marriages that were legal in the place that the marriage was performed. This initial recognition has been further expanded in the past year-and-a-half as the IRS has issued new rulings and notices clarifying the equal status of same-sex marriage and techniques used to address same- sex spouses adversely affected by the prior Defense of Marriage Act. These recent notices and determinations suggest that now may be the time for married same-sex couples and the surviving spouses of deceased same-sex married couples to review the administration of their estates or their estate plans with a competent advisor.
1. FINALIZED IRS REGULATION: TRANSFER OF UNLIMITED ASSETS
At the end of 2015, the IRS issued temporary regulations expressly stating that, for tax purposes, the definition of husband and wife would include any legally married couple regardless of gender. The IRS finalized these regulations at the end of 2016, thereby ensuring that married same-sex couples receive the same treatment under the tax code as opposite-sex couples.
While there was some concern that the Trump Administration might choose to rescind these rules in its review of the regulations enacted by President Obama, this has not come to pass and seems unlikely in the foreseeable future. The effect of this policy for planning purposes is profound, since same-sex couples are now guaranteed the ability to transfer unlimited amounts of assets between spouses during lifetime as well as at death. The ability to transfer unlimited amounts of assets to a spouse via gifting remains an important planning tool for all married couples, regardless of whether the federal estate tax is repealed, since it seems unlikely that the federal gift tax will also be repealed. Further, if the federal estate tax is not repealed, same-sex married couples with assets over the threshold for the federal estate tax ($5.49 million per individual in 2017 and $5.6 million per individual in 2018) will also be able to transfer any remaining unused exemption amount to their surviving spouses (“portability”).
Combining the ability to transfer unlimited amounts to your spouse without incurring a tax with the current federal exemption amount and the ability to transfer any used exemption to the survivor, a married couple can effectively transfer $10.98 million in 2017 or $11.2 million in 2018 without incurring a federal estate tax. In addition, couples living in states retaining an estate tax without the ability to transfer their unused exemption amount (for example, New York State), the ability to transfer assets to a spouse will remain an important means by which to equalize the value of the assets in each spouse’s estate.
2. NOTICE 2017-15: RECALCULATION OF LIFETIME ESTATE, GIFT, AND GENERATION-SKIPPING TRANSFER TAX EXEMPTIONS
In addition to the finalization of the regulations recognizing same sex marriage, in 2017 the IRS expressly created new procedures to enable same-sex spouses and the estates of deceased same-sex spouses to seek a recalculation of their lifetime estate and gift tax exemption amounts (and generation-skipping transfer tax exemption) retroactively. Prior to the Windsor decision’s nullification of the Defense of Marriage Act, the first deceased spouse of a same-sex marriage leaving an estate to the surviving spouse or members of the surviving spouse’s family was required to use his or her lifetime estate and gift tax exemption amounts or lifetime generation- skipping transfer tax exemption amount, since the federal definition of marriage did not permit such a transfer to qualify for the marital deduction or the spousal generation- skipping transfer tax assignment. As both the statute and the federal regulations have changed, the IRS has now provided a procedure for taxpayers or their estates who were adversely affected by the prior law to file amended estate and gift tax returns seeking to retroactively have their lifetime estate, gift, and generation-skipping transfer tax exemptions recalculated, taking into account their marriage to a same-sex spouse. The notice also provides that estates or spouses can seek a refund or a credit for overpayment of taxes, provided that the period of limitations has not expired.
While these procedures were previously envisioned, the IRS has now provided a procedure for taxpayers adversely affected by prior non-recognition of their marriage to seek redress under the new rules. Personal representatives of the estates of deceased individuals or individuals whose same-sex marriage were not recognized prior to the Windsor opinion should consider filing amended returns seeking a recalculation or a refund or credit, if applicable.
3. REV. PROC. 2017-34: LATE ESTATE TAX RETURNS
In addition to the above procedures for same-sex married couples, the IRS has provided an additional procedure that can benefit married couples with estates that are not subject to the estate tax. The IRS will permit the estates of deceased spouses which are not subject to the estate tax to file a late estate tax return for the purpose of transferring the deceased spouse’s unused estate and gift tax exemption amount to a surviving spouse. This procedure is limited to the later of the second anniversary of the deceased spouse’s date of death or January 2, 2018. While this relief procedure is only valid for a limited time and is for all married couples, it is clear that the surviving spouses and personal representatives of recently deceased spouses in same-sex marriages should consider this procedure if estate tax returns need to be filed for the purposes of electing portability of the deceased spouse’s unused estate and gift tax exemption amount.
4. REV. PROC. 2016-49: QTIP TRUSTS
For estates not subject to estate tax, the IRS further explained when a trust electing to use the deceased spouse’s marital deduction but terminating on the death of the second spouse (a so-called qualified terminable interest property trust, or QTIP trust) will be respected or disregarded if such election is not necessary to reduce estate or gift taxes. In order for assets in QTIP trusts to not be taxed in the first spouse’s estate but rather to be taxed in the surviving spouse’s estate for federal tax purposes, an election must be made on the decedent’s estate tax return. While generally a QTIP election is made to defer estate taxes until the surviving spouse’s death, there can be other important reasons (both tax and non-tax) to include the property in the surviving spouse’s estate (such as to increase the cost basis of the property). Prior to its recent announcement, the IRS’s position was that all QTIP elections not used to reduce the estate tax would be disregarded. The IRS has now provided that it will only disregard QTIP elections when a request is made and procedures are followed to do so, and certain criteria are met.
As marriage equality is now recognized by the IRS for tax purposes, the recent procedure regarding QTIP recognition has opened up the use of this transfer technique for all same-sex married couples, whether their estates are subject to estate tax or not. The use of a QTIP trust can be essential for married couples in second marriages and married individuals who might otherwise be subject to state estate taxes. QTIP trusts can be created during lifetime and also at death.
While much uncertainty still surrounds the future of the estate tax and its impact upon same sex- married couples in the year ahead, the recent IRS determinations and procedures have provided some measure of assurance for the estates of recently deceased same-sex spouses and for same-sex married couples seeking to plan their estates. All personal representatives of deceased same- sex spouses and same-sex couples should consider examining their respective estate administration and estate planning with a tax advisor or estate planner, to see if any of the above determinations apply.