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Preparing for Marriage Equality: Inheritance, Social Security and Taxes after DOMA

June 26, 2013
Personal Finance
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DOMA and Proposition 8 are no more, so LGBT couples now finally have equal financial standing in the following states: CT, DC, DE, IA, ME, MA, MD, MN, NH, NY, RI, VT and WA.

This shift is monumental not only for its symbolic import but also its effect on same-sex couples’ coffers. So, with this issue in mind, before the Supreme Court’s decision was released, NerdWallet asked financial advisors: What could the Supreme Court’s ruling mean for the marital finances of LGBT couples? FAs helped us answer the four questions we pose below.

1) Will couples be able to reclaim financial assets lost under DOMA?

With DOMA overturned, a number of questions still need to be answered, namely: Will same-sex couples have the right to re-claim financial assets denied them under DOMA?

In the case of the inheritance tax, DOMA imposed the following costs on the surviving member of a same-sex couple:

      • An estate tax, which applies to estates larger than $5.25 million. Surviving spouses in federally recognized marriages are forgiven any tax.
      • An inheritance, in states that didn’t recognize same-sex unions and marriages. In those states, an inheritance may have gone to the biological family, not the surviving spouse. With DOMA’s repeal, the following question is on the table: Does the spouse have the right to sue?

A word from the experts, on the inheritance tax under DOMA:

“[Under DOMA], if LGBT married couples [owned] property together, the surviving spouse could [have been] left with a large inheritance tax or [been] subject to lawsuits from family members challenging will or trust provisions intended to leave assets to the survivor. […] Some of these legal arrangements will need to be unwound [after DOMA’s repeal] to take advantage of the default protections you receive through marriage.”

David Flowers, a financial advisor based in Berkeley, CA

With DOMA no more, gay couples may be able to regain assets denied them earlier:

“For instance, a gay couple was married in 2010, and in 2012 moved to a state where gay marriage is illegal. […] One of the spouses died at the beginning of 2013 without a will, and the biological family of the deceased spouse inherited all of the assets. [Since DOMA has been] struck down, will the surviving spouse be able to sue, as a surviving spouse, to recover the inheritance?  If estate tax was paid because the estate was larger than $5 million, can the surviving spouse recover the estate tax?”

James Dowd, a financial advisor based in San Francisco

2) Will spouses be eligible for social insurance in case of their partner’s death?

Federally recognized couples are afforded some security if one half dies or falls ill. With DOMA’s repeal, surviving spouses of an LGBT marriage will also be able to claim benefits for:

      • Social Security. If the deceased earned more than the surviving spouse, the survivor stands to see an increase in Social Security benefits. He or she can either claim their own Social Security benefits, based on their own employment history, or claim 50% of the deceased’s full Social Security benefits.
      • Medicare. If one half of the couple dies, the surviving half stands to see the full amount that the deceased claimed under Medicare. The surviving spouse need be 65 or older and the marriage must have lasted longer than 9 months.

A word from the experts, on the rules and regulations of Social Security benefits:

“In the typical married couple setting if spouse A receives more social security benefits than spouse B and spouse A dies before B, spouse B gets an increase in social security benefits to match what spouse A was receiving. […] This could also come into account if a couple has been married for many years and spouse A has an earnings history and spouse B does not for whatever reason. When spouse A starts claiming social security, spouse B is able to receive marital benefits, up to 50% of what spouse A is receiving. In both of these situations where heterosexual married couples [could] take advantage of these benefits, LGBT couples [could not].”

— Karl Schwartz, a consultant at Hewins Financial Advisors

3) Would filing tax returns be less complicated?

Under former law, it was immensely complicated simply to file a tax return. Even if their marriage was recognized by the state, LGBT couples had to file their federal return as if they were individuals. DOMA’s repeal then allows them to share:

      • A single tax return, rather than two. Typically, your state return is based on its federal counterpart. But, under DOMA, there was a mismatch between filing statuses: in some states, you’re a married couple, but, federally, you’re single. As a result, under the former law, LGBT couples often had to consult with a tax expert. Today, tax filing is much simpler.
      • Itemized deductions. Earlier, under DOMA, in some cases, only one half of the couple could claim itemized deductions and dependents. A single return will allow them both to do so.

A word from the experts, on the messy system in place for LGBT couples under DOMA:

Same-sex couples had to prepare a federal return “as if” they were married. “This is extra work that is costly and time consuming.” But it’s necessary if a couple is recognized by the state but not the federal government.

–Shawn Koch, a financial advisor based in Portland, OR

4) Would all couples see a lower tax bill with federal recognition?

Not necessarily.

Gay couples formerly filed as two Individuals because their marriage was not recognized by the federal government. And federal income tax brackets are in fact easier on high-income individuals than they are on most high-income married couples. So, with DOMA’s repeal, in the states listed at the top of this piece:

      • Same-sex couples earning more than $146,400 may see their tax bill go up. On this point, the devil is in the details, so we provide further analysis below. 

Case study: Which gay couples will see a higher tax bill with DOMA’s repeal?

Under DOMA, a gay couple was classified as two Individuals (this is still the case in states that do not recognize same-sex marriages). And sometimes they’re better off that way, as our table demonstrates, in red.

Why? Because, after DOMA, a couple may bump up to a higher tax bracket. For example, under former law, a gay couple wasn’t taxed at 28% until, collectively, they earned $175,700 in taxable income. As a married couple, they’ll hit that higher rate much sooner, at $146,400. So, even if they do earn that same amount of $175,700, they stand to pay a whole $879 more because of the change.

Marginal tax rates for a gay couple of equal earners

Under DOMA After DOMA Income threshold the same (=) or less (<) after DOMA?
Marginal rate Income threshold Income threshold = or <
10.0% $0 $0 =
15.0% $17,850 $17,850 =
25.0% $72,500 $72,500 =
28.0% $175,700 $146,400 <
33.0% $366,500 $223,050 <
35.0% $796,700 $398,350 <
39.6% $800,000 $450,000 <
Notes: (1) We assume both halves of this couple work and earn the same amount in wages. (2) Due to DOMA, this gay couple had to file as two Individuals. After DOMA, they will file as a Married Couple (MFJ)