Tax Benefits for Married Same-Sex Couples

This week, legally married same-sex couples scored a victory when the U.S. Supreme Court struck down as unconstitutional Section 3 of the Defense of Marriage Act (DOMA), which defined marriage as between a man and a woman for federal law purposes. And they notched another win with the resumption of same-sex marriages in California.

There are many tax and benefit implications from the high court’s DOMA decision for same-sex couples who married in Washington, D.C., or in any of the 13 states that allow same-sex marriage: California, Connecticut, Delaware, Iowa, Maine, Maryland, Massachusetts, Minnesota, New Hampshire, New York, Rhode Island, Vermont and Washington. Over 1,000 federal statutes, including more than 100 tax laws, are affected. President Obama has ordered a review of all of the relevant laws and regulations, and the U.S. Attorney General has convened a working group with federal agencies to expeditiously implement the high court’s decision. It’s expected that in the coming weeks or months, the IRS, the Department of Labor and other federal agencies will begin issuing guidance.

We’ll take a look at some of the tax consequences below. But keep in mind that there are many other potential tax effects that are not discussed here.

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Same-sex married couples will be able to file joint tax returns, a tax saver for some and a tax burden for others. Joint filing generally produces less tax if the spouses have widely disparate income levels. On the other hand, because of the marriage penalty, many two-earner couples will discover to their chagrin that they will wind up paying more to the IRS come tax time, especially higher earners.

Estate planning will be simpler now that married same-sex couples can use the unlimited estate tax marital deduction when one spouse dies. Also, they can elect portability, so that on the death of one of the spouses, any unused estate and gift tax exemption ($5,250,000 for 2013) can pass to the surviving spouse.

Ditto for gift taxes. Married same-sex couples will be able to make gifts to each other without incurring gift tax. The recipient spouse will then generally take the donor spouse’s tax basis in the property received. And they’ll qualify for gift splitting, where each spouse is treated as gifting one-half of the property gifted by the other.

Employer-provided health coverage to spouses of same-sex married workers will now generally be tax free. Firms would no longer be required to impute as additional income to a worker the value of employer-subsidized health insurance provided for the employee’s same-sex spouse. Also, neither the worker nor the employer will be subject to FICA taxes on the imputed income. Companies will need to reprogram their payroll tax systems so they don’t continue to withhold income or FICA taxes on these benefits. Firms should also consider filing FICA refund claims for past years to seek refunds of payroll taxes paid on the value of same-sex spouses’ health care coverage if they haven’t already filed protective refund claims with the IRS.

Another health benefit implication from the high court ruling is that workers can get reimbursed from their health flexible spending accounts and their health reimbursement accounts for the medical costs of their same-sex spouses.

Retirement plans are also affected. Same-sex spouses of married employees will automatically qualify for survivor and death benefits under pension plans, 401(k)s and similar retirement plans. Hardship payouts from 401(k)s to cover medical costs or tuition of the same-sex spouse may qualify for an exemption from the 10% early withdrawal penalty.

Favorable withdrawal rules will apply to same-sex spouses who inherit plans or IRAs from their deceased spouses, so they’ll avoid having to tap the funds sooner under the nonspouse beneficiary rules. These spouses can roll the inherited funds into their own IRAs and delay taking required minimum distributions until the age of 70½. Nonspousal beneficiaries of inherited IRAs have to comply with more stringent rules: They generally must start taking payouts from the account by December 31 of the year after the IRA owner dies or must fully tap the account within five years of the owner’s death.

Also, working spouses can make contributions to spousal IRAs for nonworking same-sex spouses.

But the Supreme Court’s decision leaves a lot of open questions, not the least of which is how the Obama administration will apply the laws across state borders. For same-sex couples who move to states that don’t recognize their marriages, the consequences are murky. For example, the IRS has historically looked at the state of domicile in determining whether two people can file a joint return as a married couple. If the Service continues to follow this practice, that could be bad news for those who married in a state allowing same-sex marriage and who now live in a place where their marriage isn’t recognized. Likewise, it’s unclear whether the rules we noted on estate and gift taxes, health benefits, and retirement plans apply to couples who relocate.

Another big unknown is how the rules apply to an employee who is married and resides in a state allowing same-sex marriage but works in a state that doesn’t (for example, the worker lives in and married in Maryland but works in Virginia). It’s uncertain which state’s marriage laws will come into play when applying federal law.

And what about same-sex couples who are in domestic partnerships or civil unions? We don’t expect that these individuals will be covered by the court’s decision — for example, they’re likely unable to file joint tax returns. The Supreme Court’s ruling says that its opinion is confined to states that have legalized same-sex marriage.

The Service has a pile of protective refund claims for income and FICA taxes that were filed in anticipation of the decision, and many more claims will be filed. The hope is that the IRS will issue a streamlined procedure for claiming income and payroll tax refunds.

The IRS and federal agencies will be addressing these and other issues starting in the coming weeks. You can be sure that those of us at Kiplinger will continue to closely follow this and keep our readers abreast of any updates.