An Evolving Legal Landscape: Planning for Same-Sex Couples

First Republic Investment Management

June 17, 2015

The U.S. Supreme Court ruled in June 2013 that portions of the Defense of Marriage Act (DOMA) were unconstitutional, allowing same-sex couples who were married in states where they can legally marry to qualify for federal tax benefits. This landmark decision gave these couples access to a number of new benefits, including the ability to file a joint federal income tax return, roll over retirement programs to a surviving same-sex spouse and to gift or bequeath assets to a same-sex spouse without being subject to federal transfer taxes, such as gift and estate taxes (United States v. Windsor, U.S., No.12-307, 6/26/13).

Although the Windsor decision stated that Section 3 of DOMA—which defined marriage as being between a man and woman—was unconstitutional because it violated the Equal Protection Clause (the 14th Amendment) of the U.S. Constitution, it did not reach the same conclusion about Section 2 of the Act—which left it to the individual states to decide whether they would allow same-sex couples to be legally married.

As a result, while the definition of marriage now entitles same-sex couples to benefits under federal law, for state law purposes they will only be entitled to the same benefits as married heterosexual couples in those states that recognize same-sex marriage.  This issue is now being litigated in a majority of the states where same-sex marriage is banned. As of May 2015, the results of these lawsuits led to 37 states plus the District of Columbia allowing same-sex marriage (13 states still ban same-sex marriages). Several of the banned states are pending an upcoming Supreme Court decision expected later this term.

The ruling in Windsor allowed for all of the federal tax benefits that historically had been available to married heterosexual couples to apply to same-sex couples.

 Those benefits included the following:
1. Married filing jointly and household filing statuses for federal income tax
2. Dependent exemptions (the ability to claim one’s partner/spouse as a dependent)
3. Medical expenses
4. Child, earned income and dependent care credits
5. Education credits
6. Taxation of health care benefits provided to non-employee spouses 
7. Capital gains and loss limitations
8. Retirement plan benefits
9. Unlimited estate and gift tax marital deductions and portability
10. Spousal gift splitting

In October 2013, the IRS adopted the “State of Celebration Rule” for recognizing same-sex marriages. The State of Celebration Rule states “that a same-sex couple that was legally married in a domestic (i.e., New York, Connecticut, Massachusetts) or foreign (i.e., United Kingdom) jurisdiction that recognizes their marriage will be treated as married for federal tax purposes, regardless of what state they currently reside in.” For example, if you live in Florida (a state that does not recognize same-sex marriage), but are married in Illinois (a state that does recognize same-sex marriage), for federal tax purposes you are considered married. However, for state tax purpose you are not considered to be married and would not receive any marriage benefits under Florida law. 

Federal Transfer Tax Benefits

The biggest tax benefit for same-sex couples resulting from Windsor was in the area of estate, gift and generation-skipping taxation. Previously, same-sex couples could not take advantage of the unlimited marital deduction against federal estate taxes or federal gift taxes that had been available only to married heterosexual couples. The decision enables both spouses in a same-sex marriage to take advantage of the unlimited marital deduction and to take advantage of the lifetime gifting exclusion amount/estate tax exemption amount, which is $5.43 million per individual in 2015. Same-sex spouses also may make split gifts, which means that one spouse can make a gift of $50,000 to a beneficiary but claim on their Federal Gift Tax Return (Form 709) that each spouse gifted $25,000 to that beneficiary.

The table that follows illustrates the changes in federal tax benefits for same-sex spouses pre-Windsor and post-Windsor:


In 2012, A and B were a same-sex married couple living in Connecticut, a state that allowed same-sex marriage. A and B had an estate valued at $7 million. All assets were owned in A’s name; B owned nothing in her name. A died in 2012 and left her entire $7 million estate to B as her spouse. What happened? Although A and B were married under Connecticut law, they were not considered to be married under federal law and were not entitled to take advantage of the unlimited marital deduction available to married heterosexual couples. The estate exemption amount in 2012 was $5.12 million, and the top federal estate tax rate was 35%. Therefore, A’s taxable estate would equal $7 million – $5.12 million = $1.88 million. A’s estate would owe $1.88 million x .35 = $658,000 federal estate tax.

Fast-forward to 2014: Post-Windsor, A and B are considered to be married under federal law as well as state law. If A left her entire $7 million estate to B, her estate would qualify for the unlimited marital deduction, and no federal estate tax would be owed by A’s estate at her death, a savings of $658,000. In addition, B could claim A’s $5.34 million estate tax exemption as her own through a portability clause in her Will or Revocable Living Trust, on A’s Federal Estate Tax Return (Form 706) and be able to pass up to $10.68 million to her heirs at her future death.

The Supreme Court decision in Windsor has opened up new possibilities when it comes to planning for same-sex couples in all areas of federal taxation, but specifically for those couples who need to do planning for their estates. Whereas planners and clients had to think outside the box prior to this decision, it now allows them to look at more conventional ways of planning going forward. 

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