Tax Changes for Same-Sex Married Couples if Defense of Marriage Act Found Invalid – Part I
By Vivian L. Holley, JD, MA, CFLS, MFT and Rebecca Lovell
On December 7, 2012, the Supreme Court of the United States decided to hear two cases, one challenging the federal Defense of Marriage Act (DOMA) and the other challenging California laws and Proposition 8 which define marriage as a union between one man and one woman. Under the current federal law, same-sex couples who marry are treated differently than are opposite-sex married couples. Specifically, the lack of federal recognition of same-sex couple’s marriage prohibits these couples from receiving the same tax treatment as opposite-sex married couples even if they’re legally married under their state’s law.
The federal case comes from Windsor v. United States and is a challenge of Section 3 of DOMA, which prevents same-sex marriages from being recognized on the federal level. The trial and appellate courts in Windsor found Section 3 of DOMA unconstitutional, and an appeal was made by the Bipartisan Legal Advisory Group of the House of Representatives since the US Justice Department would not defend DOMA because the administration’s position is that it is unconstitutional. If the Supreme Court upholds the lower courts’ decision and find Section 3 of DOMA invalid, the federal government would then recognize same-sex marriages in states in which they are legal.
The Supreme Court’s decision to hear both the federal and California cases provides an opportunity to address tax implications for same-sex married couples, both positive and negative. I previously wrote about how children are psychologically impacted by their same-sex parents’ inability to marry. Speculation as to what will occur for same-sex married couples has been in the media recently. The San Francisco Chronicle’s Kathleen Pender shed light on these tax issues, which include changes in income tax, amended returns, health benefits, social security, and estate tax. I now look at these issues in light of the Tax Payer Relief Act of 2012.
Currently, same-sex married couples cannot file their federal tax returns as married filing jointly or married filing separately. Rather, they must file as single or head of household. In California, however, same-sex married couples and registered domestic partners must file their state taxes as married filing jointly or married filing separate. Further, the federal tax returns differ from traditional single or head of household filings. In community property states such as California, instead of filing their own income separately, same-sex married couples must each report half of their community property income. This rule which comes from a 2010 Internal Revenue Service regulation for community property states, can be onerous and, at times, expensive for same-sex married couples and registered domestic partners.
In many cases, filing as single or head of household results in lower taxes than does filing as married. A possible rationale behind this difference in taxes is that it is less expensive to live as a married couple, i.e. sharing household and other related expenses, than it is to live single. There are exceptions to this —for example, if a married couple has a large disparity in income—however, many same-sex married couples financially benefit from filing as single or as head of household under the current law. It is, in effect, a tax return windfall for many same-sex married couples and registered domestic partners.
The higher taxation of married couples is often called “the marriage tax penalty” because it imposes higher taxes on married couples than single persons. Once the combined taxable income of couples reaches about $150,000, they begin to pay a marriage tax penalty. One of President Bush’s tax cuts provided temporary relief from the marriage tax penalty, and this relief was renewed by Congress on January 1, 2013. If this tax cut expires in the future, the marriage tax penalty will return. If DOMA is invalidated, then this marriage tax penalty would apply to both opposite-sex married couples and same-sex married couples.
If the Supreme Court finds DOMA invalid, same-sex married couples will have the option to amend their past tax returns. Married same- sex couples may choose to amend if filing their tax returns married filing jointly or married filing separately would be financially beneficial to them. Amended returns generally must be filed within 3 years of the due date—usually April 15—or from the date filed if an extension was granted. The Supreme Court’s decision is expected in June of 2013, so married same-sex couples who want to amend their 2009 tax return should consult their tax preparer for more information regarding how to preserve their ability to amend their tax return. Of course, if a same-sex married couple benefited from filing as single or head of household, amending past returns may not be financially advantageous for them, especially if their taxes increase due to the marriage penalty tax.
While many employers allow same-sex married spouses or domestic partners in their group health insurance plan, same-sex married or domestic partner employees must pay income tax on the value of the insurance that their partner receives. Opposite-sex married couples do not have to pay this tax. If DOMA is found invalid, same-sex married couples will not have to pay this tax. Same-sex married couples or registered domestic partners may be able to amend their past tax returns to reflect this change in the event DOMA is invalidated; however, the cost of amending the tax returns may outweigh the financial benefits.
Changes to social security benefits for same-sex married couples may be both positive and negative. Under current law, same-sex married couples cannot get spousal benefits under social security. Spousal benefits provide that while each spouse is alive, he or she receive a benefit based on their work record, but if one spouse has a lower benefit than the other, they may receive up to one-half of their spouse’s benefit instead of taking their own. Moreover, when the spouse with higher benefits dies, the spouse with lower benefits may get up to 100 percent of the other’s benefits. If DOMA in found invalid, then same-sex married couples may be entitled to the same spousal benefits under social security that opposite-sex married couples already receive.
The downside of this treatment lies in the increased tax married couples will have to pay on their social security benefit if they file a joint return. As of 2012, tax payers who file as single or head of household pay tax on up to 50 percent of their benefit if their income is above $25,000, and up to 85 percent of their benefit if their income is higher than $34,000. Those who file jointly, however, pay tax on up to 50 percent of their benefit if their combined income is higher than $32,000 and pay tax on up to 85 percent of their benefits if their income is higher than $44,000. By combining incomes, same-sex married couples may ultimately be subject to tax on more of their social security benefits than if they were to file as single or head of household.
The estate tax applies to a person’s estate upon their death if it exceeds a certain amount. Now, the estate tax only applies to the person’s estate if it exceeds $5 million, adjusted for inflation, and any estate under that amount is not subject to the estate tax. Estates above the $5 million mark are subject to an estate tax that, as of January 1, 2013, tops out at 40%. However, these numbers are only valid for 2013, and are set revert to $1 million and a top-out tax rate of 55% in January 2014 unless Congress decides otherwise.
Married couples receive a privilege upon death known as the ‘unlimited marital deduction’. When one spouse dies, they may leave an unlimited amount to the surviving spouse without having to pay the estate tax. This benefit is currently limited to opposite-sex married couples. The case currently before the Supreme Court, Windsor v. United States, stems from this issue. Edie Windsor and Thea Spyer, a same-sex married couple, were legally married in New York. When Thea passed away in 2009, she left her entire estate to Edie. Though Edie and Thea were legally married in the eyes of the state of New York, Edie had to pay $363,000 in federal estate tax because their marriage was not recognized on the federal level. Edie filed a refund claim, but the IRS denied her claim on the grounds that because was not technically a spouse under DOMA, the unlimited marital deduction did not apply and thus she had to pay the applicable estate tax. Same-sex married couples who might otherwise pay a steep estate tax—like Edie Windsor—will benefit greatly from the unlimited marital deduction if DOMA is found invalid.
In these difficult economic times, it makes rational sense for the federal government to collect taxes on everyone equally and apply the same laws across the board. Should the Supreme Court invalidate the Defense of Marriage Act, one of the results will be equality in the tax structure. Because of this result of equalizing taxes for all married couples—opposite and same-sex alike—the Supreme Court’s upcoming decision may provide not only marriage equality, but also fiscal equality for all.