This year marks the first year in which same-sex couples are filing income tax returns in the post-Windsor v. U.S. case era. The Windsor case, of course, was the pivotal legal challenge to the Defense of Marriage Act, in which the Supreme Court of the United States upheld a previous ruling from the U.S. Second Circuit that DOMA was an unconstitutional violation of equal protection rights.
Prior to Windsor, the Defense of Marriage Act prohibited federal officials from recognizing same-sex marriages for the purposes of federal business. So even same-sex couples with legal marriage certificates in the states that granted them had to file federal taxes as single taxpayers/heads of households.
The Windsor case opened the door for the Treasury Department, overseeing the Internal Revenue Service, to announce last August that henceforth, same-sex couples that held a valid certificate of marriage in any state would be treated as legally married under federal rules, even if they weren’t living in the state that granted them the marriage certificate. As a result, same-sex married couples now get to choose from the same miserable and confusing set of tax filing options that heterosexual couples do.
Who Can File as Married?
You can file as married if you have a marriage license. Domestic partnerships and civil unions don’t count for this purpose. You have to be technically married under the laws of the state that granted the license.
Consider Amending Returns
Tax law is retroactive for the purposes of determining the marital filing status of same-sex couples. That means that if you were married prior to 2013, you have the option of going back and filing an amended return. This gives same-sex spouses a potentially powerful option: You may go back to tax years prior to 2013 and recalculate your tax liability under the rules for married couples. If your tax liability is lower filing as married than single, you can take advantage of the lower taxes by filing a Form 1040X, along with the other relevant tax forms that have any changes on them based on new information. Just as powerfully, though, you have an option. You don’t have to do so, and in fact you shouldn’t, if your calculations indicate that you will face a marriage penalty if you change your tax status. This is potentially a huge issue if you lived apart from your spouse for the year, for example. Tax deductions for married individuals filing separately are hugely limited.
We’re still trying to figure out how that works for states that recognize common law marriages. However, the general thrust of SSM jurisprudence is that laws that benefit hetero couples, such as common law marriage, must also benefit same sex couples. My own sense is that any challenges to the common law marriage of same sex couples, in states that recognize common laws will eventually be resolved in favor of the same-sex taxpayer. However, this gives same-sex common law marriage partners another planning opportunity. Generally, even in states that allow for common-law marriage, the couple has to publicly and outwardly present themselves as married.
Who Should File as Married?
Individual circumstances are going to vary a great deal. A lot of it has to do with the distribution of income between the two members of the couple, and the deductions taken. Eligibility for workplace retirement and medical benefits also fits into the mix. However, in the main, filing as married doesn’t benefit that many people, given the choice.
This means that if the law allows a couple to choose between single, married filing separately or married filing separately, it is usually better to file single.
For example: If there are children in the household, taxpayers can take advantage of the higher tax bracket threshold levels for heads of households.
If both spouses have roughly equal incomes and they are relatively high, filing separately subjects less income to higher tax brackets.
Tip: If there are children in the household, then the Child Tax Credit becomes a factor. If you file as married filing jointly, the tax credit gets phased out at the $110,000 income level. But you can keep the credit of one parent files as single as head of a household, which has a $75,000 income threshold for the phaseout. A high-income earner can file as single, while his or her partner files as a head of household and gets the benefit of the credit.
Furthermore, if you have one partner in the relationship with little to no income of his or her own, you can exercise similar planning to ensure you get the benefit of deductions and credits for medical expenses, spousal IRA contributions, dependent care credit, and other expenses which would go to waste if one partner had insufficient gross income to deduct against. Filing jointly lets the high-income earner’s tax return take on the deductions that would simply be expenses if both filed separately.
Shortly after the Windsor decision, the Treasury Department came out with set of rules to make it possible for same-sex spouses to take advantage of the special benefits afforded to traditional spouses. What does this mean?
- You can fund an IRA for a non-working spouse
- You can roll an inherited IRA – to the extent it is taxable – into your own IRA, or treat the IRA as your own. You can wait until you turn age 70 ½ to take RMDs, if you are younger than your deceased spouse.
- If you survive your partner, and the owner died before the RMD required beginning date, you can pass inherited IRAs onto younger generations, thus delivering a huge tax benefit of a ‘stretch IRA.’ The younger the IRA owner, the more they can defer tax (traditional IRAs), or the longer that money can grow tax-free, in the case of Roth IRAs.
The new rules now allow those who inherit 401(k) plans from a same-sex spouse to roll an inherited 401(k) balance over into his or her own IRA. You do not have to use the rules for inherited IRAs anymore. Again, this gives you the option to roll the IRA into your own IRA and treat it as your own, rather than accept the RMD dates from your deceased spouse.
Want a loan against your 401(k)? Once you’re married, you’ll have to get your spouse’s ok. But you were going to do that anyway, right?
It’s not strictly a tax issue, but it’s important nevertheless: In the past, same-sex domestic partners or longtime companions who were not married had no claim to their deceased partner’s IRAs or 401(k)s unless they were specifically listed as a named beneficiary. Probate laws essentially ignored same-sex couples. If the deceased had not been diligent about naming beneficiaries, the surviving partner risked getting disinherited in favor of brothers, sisters, children or other family members with a stronger claim under intestate and probate laws. Formal status as married allows surviving spouses to inherit property under intestate laws, where designated beneficiaries have not been chosen and where there is no will in place expressing a contrary desire on the part of the deceased.
Did you buy or sell anything from your spouse?
IRS rules put restrictions on tax benefits arising from transactions between “related parties.” For example, losses on a sale of a business or investment property to a related party are not deductible. Obviously, two spouses are related. But if you have the option to file as unmarried, you may want to consider doing so if you want to take a loss on a transaction with your spouse.
Estate Taxes and Death Issues
Generally, two U.S. persons who are married enjoy the benefit of the unlimited marital exemption. That is, when one spouse dies, assets transfer to the sole ownership of the surviving spouse with no estate tax liability (special rules apply to those who are domiciled outside of the United States.) If you are likely to have estate tax issues, chances are you will be better off filing as married.
This is also true if you have significant assets in IRAs, where a spouse who inherits an IRA from a deceased husband or wife has valuable options on the tax treatment of the inherited IRA that are not extended to non-spouses.
Yes, there are even advantages to same sex marriages in the case of divorce. Specifically, the federal recognition of same sex marriages for the purposes of administering tax law allows splitting same-sex couples to access qualified domestic relations orders. This is extremely valuable where one partner amassed a large pension, 401(k) or 403(b) balance, because it allows courts to equitably divide the pension without incurring a huge tax liability through early distribution.
Case law and regulation in some areas has yet to catch up with the legal collapse of DOMA in the courts and the decision of the Treasury Department to formally recognize same-sex marriages. Common-law marriages, in particular, are under some cloud as to whether a same-sex relationship can amount to marriage, but that is primarily an issue that will play itself out at the state level. The federal government seems to be looking for a license.
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