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Keeping Your Balance: DOMA ruling requires income, estate tax planning

James P. Schnell

James P. Schnell

On June 26, the U.S. Supreme Court rendered its decision on the case U.S. v. Windsor, no. 12-307, which effectively invalidated Section 3 of the Defense of Marriage Act.

This section defined marriage as a union between one man and one woman as husband and wife, and spouse as a person of the opposite sex who is a husband or a wife. The case was the result of a same-sex marriage widow who sought to claim the estate tax exemption for a surviving spouse. The claim was barred by DOMA.

The estate paid the requisite estate taxes, and the widow sued for a refund. Both a federal district court and the U.S. Court of Appeals for the Second Circuit ruled the applicable section of DOMA to be unconstitutional. The Supreme Court essentially agreed.

This decision will have far-reaching implications on many fronts. In particular, attorneys, accountants and financial planners will be scrambling to figure out the resulting tax impact and possible planning strategies now available under federal and state laws.

On June 27, the IRS announced that it will move quickly to provide some much-needed guidance on tax aspects affected by the new ruling. Both the Congressional Budget Office and the Government Accountability Office have issued studies examining the implications of recognizing same-sex marriages.

From an income tax standpoint, same-sex couples who are legally married will be eligible to file joint federal tax returns, presumably (at this point) beginning with 2013 returns to be filed in 2014. Filing a joint return will now for the first time affect key components of many returns, including application of tax rates, netting of capital gains and losses, calculation of tax on Social Security benefits, computation of adjusted gross income (AGI), and numerous deductions and credits.

It is also anticipated, the Windsor case will ultimately affect other estate and gift tax matters besides the exemption for a surviving spouse’s estate. Under federal law, any transfer between legally married spouses is exempted from estate and gift taxes. It also raises the issue of whether a surviving spouse’s estate can benefit from any remaining balance of the exemption from a deceased spouse’s estate under the “portability” provision recently extended by the American Taxpayer Relief Act.

What can you expect from the IRS?

Practitioners can expect forthcoming guidance in these areas:

• Income tax filing status
• IRAs, 401(k) plans, and other
retirement plans
• American Opportunity Tax Credit (AOTC)
• Child and dependent care credit
• Estate marital exclusion
• Estate tax portability
• Health savings accounts (HSAs)
• Adoption tax benefits
• Family stock attribution rules
• “Innocent spouse” rule
• FICA payroll tax refunds
• Provisions under the Patient Protection and Affordable Health Care Act (PPACA)

In addition to this list, critical issues will arise concerning benefits available to employees through insurance plans, qualified retirement plans, and other fringe benefit plans. It is expected, the IRS will work in conjunction with other government agencies to help guide employers and employees through the changing landscape.

The main question in the minds of many professional tax return preparers is whether or not a same-sex couple should file a joint federal return. Frequently, doing so will provide a reduced tax liability for clients. For instance, if one spouse realized a $10,000 gain from the sale of securities and the other spouse is showing a $10,000 loss on the books, selling the stock at a loss would completely eliminate the capital gains tax for the spouse with the $10,000 gain. This benefit isn’t available for same-sex partners filing separate returns.

However, practitioners should take care and not assume that all same-sex couples will fare better tax wise. Due to the existence of the “marriage penalty” within the tax rates, a couple where each spouse earns a substantial amount of income could increase their overall tax liability by filing a joint tax return.

Lastly, one issue likely to take a while to sort itself out is how the IRS will treat same-sex couples who are legally married in states who already recognize their marriages (ex., New York) but whom reside in a state that does not, ex. Florida. The Windsor case involved a couple who lived in a state that already recognized same-sex marriages.

Clearly, we will be able to look forward to a tremendous amount of administrative guidance in all of these areas.

James P. Schnell, CPA/ABV, CVA is a tax and business valuation partner with Mengel, Metzger, Barr & Co LLP and may be reached at (585) 423-1860.

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