On June 26, 2013, the US Supreme Court ruled Section 3 of the Federal Defense of Marriage Act (DOMA) was unconstitutional as it violates the equal protection clause of the Fifth Amendment of the US Constitution as applied to persons of the same-sex who reside in states (and Countries or Provinces?) that recognize same-sex (or common-law marriages?) in Edith Windsor [111 AFTR 2d 2013-2385 (2013)]
This decision equalizes treatment for same-sex married couples to that of other married couples and possibly Canadian resident common-law couples with US tax filing obligations. It will have an impact on their income tax filing status, estate and gift tax planning, employee benefits, and ability to inherit, social security benefits, Etc.
In New York, the Department of Taxation and Finance issued a memorandum explaining the effect of the Windsor decision, offering equal treatment to estates of same-sex spouses for estates of individuals dying on or after 7/24/11 (legalization date of same-sex marriages in New York). Those affected by the Windsor decision can amend a previously filed estate tax return if the statute of limitations for claiming a refund is still open (usually three years from the date the original return was filed or two years since the tax was paid). Several other states may follow New York’s lead in the very near future.
U.S. States allowing same-sex marriages include: California, Connecticut, Delaware, Iowa, Maine, Maryland, Minnesota, New Hampshire, New York, Rhode Island, Vermont, and Washington, as well as the District of Columbia. Same-sex marriage is legal throughout all Provinces of Canada and has been since July 20, 2005. Canadian court decisions, starting in 2003, had already legalized same-sex marriage in eight out of ten Canadian provinces and one of three territories, whose residents comprised about 90% of Canada’s population. Most Canadian legal benefits commonly associated with marriage had been extended to cohabiting same-sex couples and also heterosexual common-law couples since 1999.
US Federal and State Income Tax Implications
Same-sex married couples who reside in a state that recognizes same sex marriage must now file their federal income tax return as either married filing joint or married filing separately for 2013. Prior to the ruling, same-sex married couples were denied the ability to file married filing jointly status on their U.S. Federal income tax return. Tax rate brackets, deductions, exemptions and phase-outs all are impacted by filing status.
Under DOMA, employers that allowed an employee to add his or her same-sex spouse to their health plan also had to include in taxable income the fair market value of the health coverage provided to the same-sex spouse. The Supreme Court’s decision opens the window for employees to apply for refunds of taxes paid by employees on income imputed to employees of same-sex married spouse and refunds of payroll taxes paid by employers on that income.
The ruling is effective as of June 26, 2013, Federal tax laws may consider same-sex couples married retroactively to the date of their marriage in accordance with their state law. Same-sex couples can now amend their previously filed returns claiming married filing jointly or married filing separately return status for open tax years. But are they required to amend prior year returns with joint status even if their taxes were lower overall under unmarried individuals? Further clarification and guidance from the IRS will be needed and is being worked on by the IRS.
A significant tax impact of the DOMA decision concerns income taxes. Gay and lesbian couples residing in states where their marriages are recognized can now file a joint federal income tax return, an option that can yield substantial income tax savings in some cases. One of the big benefits of filing jointly under the mostly progressive US Federal income tax code is the ability for couples to avoid higher tax brackets by splitting their income.
Another tax benefit for married same-sex couples is reduced paperwork. Before DOMA was struck down, same-sex couples in states where marriage was legal could file jointly a state income tax return, but had to file singly on the federal return. When deducting state income tax from the federal tax and vice versa, couples often resorted to drafting a fake federal return as if they were married, then used the fake return to determine state deductions. Likewise, they would develop a dummy single state return to determine their Federal tax deduction.
Now the process will be much easier. Couples can file either single or joint returns at both the Federal and state level. Married couples in recognition states should also be able to file amended returns for the 3 years preceding the DOMA decision to secure additional tax savings. But he questions whether the IRS would require amended returns, noting this could be an “administrative nightmare,” for both the couples and the IRS.
It is unclear how the attribution rules deeming family ownership will now apply to same-sex couples or on already completed transactions.
US Estate and Gift Tax
Prior to the repeal of DOMA, same-sex couples could not take advantage of the estate tax unlimited marital deduction and portability. DOMA also prevented same-sex spouses from the benefit of allowing spouses to make significant gifts to each other (above the annual exclusions) without filing Gift Tax returns. The unlimited marital deduction allows the decedent to transfer an unlimited amount of assets to his or surviving U.S. citizen spouse with no estate tax ramifications. Prior to the repeal, the surviving spouse of a same–sex couple would inherit the assets on an after-tax basis.
Portability also means that the estate of a surviving spouse can utilize the unused portion of the estate tax applicable exclusion amount of his or her predeceased spouse in something called a deceased spouse unused exemption (DSUE.) For 2013, the lifetime exclusion amount is $5,250,000 per person. If a spouse were to pass away without using his or her full lifetime exclusion, the unused portion may be transferred to the surviving spouse. Prior to the repeal of DOMA, only opposite-sex married couples could take advantage of portability as part of their estate planning. Under DOMA, only opposite-sex married couples were allowed to split gifts to take advantage of doubled annual gift tax exclusion ($28,000 for a married couple). In addition, transfers between spouses (where both are US citizens) were allowed an unlimited amount. With this repeal, same-sex couples considered married under state law are also afforded this benefit.
However, the estate tax exemption level at $5.25 million per individual and $10.5 million per couple for 2013. These exclusion amounts are sufficiently high as to render estate tax a moot issue for the overwhelming majority of same-sex couples and possibly most Canadian resident common-law couples with US tax issues.
Crossborder couples and dual citizens and residents have additional complications which could be explained in a consultation with an AG Tax Crossborder tax specialist.
Same-sex married couples who reside in states that recognize same-sex marriage should consult with their AG Tax LLP tax advisor to review their estate plan and on the need to or benefit of amending their income tax returns or just file differently going forward.
Even though President Obama has directed all Federal agencies, including the Treasury and the IRS, to revise their regulations to reflect the Supreme Court’s decision as soon as possible, it remains to be seen how quickly and how successfully the IRS and other Federal agencies will actually implement these changes.
Married same-sex couples are now supposedly legally recognized by the federal government in the same manner as married opposite-sex couples. However it all depends on which state or country the couple currently resides. U.S. Federal recognition does not necessarily mean state recognition. For instance, a married same-sex couple is able to file jointly under the federal IRS regulations but not necessarily under state law — unless the state legally recognizes this same-sex couple as married.
Key financial planning considerations for same-sex married couples can now include:
• Consider filing as married filing jointly beginning in 2013, or file an amendment for 2012.
• Consider applying for a tax refund going back three years.
• Take all deductions and exclusions as allowed for married opposite-sex couples.
• Take the 100% marital deduction for any property that passes from a deceased spouse, if applicable.
• Name your spouse as beneficiary of a qualified retirement plan.
Even though the verdict has been reached by the U.S. Supreme Court at the Federal level, the jury is still out in many of the 50 states and for US Taxpayers resident in foreign countries such as Canada. The bottom line is that you need to determine whether you are recognized as legally married in your domiciliary state, and if you move to another state, you may find yourself no longer being legally married.” Do Canadian Resident U.S. Taxpayers in common-law marriages for either heterosexual or same-sex couples now get treated as married couples for U.S Federal Tax purposes because in their place of residence they are considered married?
The decision, however, did not legalize same-sex marriage in all states. It left the decision to define marriage to each state. It is unclear whether a same-sex couple legally married in one state who now resides in a state that does not recognize same-sex marriage will be entitled to Federal benefits. In the past, most Federal agencies have defined marriage based on a couple’s residency and not where they were married.
There are more than one 1,000 US Federal laws and programs concerning married couples. Gays and lesbians living in states that recognize same-sex marriages will now, for example, be covered by Federal marriage provisions respecting Social Security, veterans/military benefits and immigration benefits, such as the ability for a foreigner to apply for legal residency when married to a U.S. citizen.
Federal Government employees will now also enjoy employment benefits for married couples. Among them: Federal health insurance for spouses; plus wages, worker’s comp, health insurance and retirement plan benefits for the surviving spouse of a deceased federal worker.
The Supreme Court decision will be of immediate benefit to gay and lesbian couples residing in the 13 states (plus the District of Columbia) that recognize same-sex marriage. But eligibility for federal marriage benefits is uncertain in cases where couples marry in a state that recognizes same-sex marriage, but reside in or move to a non-recognition state. The IRS and Social Security Administration, for example, make determinations based on where couples reside (the state of domicile) and not where they marry (the state of celebration).
The US Supreme Court ruling remains also largely a question mark for couples in marriage-equivalent relationships — those state-registered as domestic partnerships or civil unions — which 8 states currently recognize. Also Canadian residents who have signed Canadian Statutory Declarations of Common-law Union face uncertain US tax treatment.
This is general information, please contact one of our offices for more specific tax and other advice which is pertinent to your actual facts.
AG TAX LLP Can Help
If you have any other tax-related queries, and/or need assistance with tax planning/filing please contact AG Tax. Our tax professionals are highly-experienced with U.S. and Canadian tax laws and can provide you the right guidance to handle your tax situation.
Aylett Grant Tax LLP is a full service accounting firm with a dedicated team of experts, who are highly-qualified and experienced in handling situations related to U.S., Canada and other international tax laws.
We can assist with:
- Canadian Personal and corporate tax returns
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