Are All Marriages Created Equal? Certainly Not in the Eyes of the Internal Revenue Service
The Defense of Marriage Act (DOMA) was passed in 1996, and prohibits the federal government from recognizing the legal marriage of same-sex couples. DOMA defines marriage as “a legal union between one man and one woman” and a spouse as “a person of the opposite sex who is a husband or a wife.”
While IRS regulations never define marriage, the service has issued guidance that they follow federal law. As a result, the IRS does not recognize same-sex couples as legally married, even if the same-sex marriage is recognized by their home state.
Same-sex couples are unable to file their tax returns with a married filing joint status. Each of the individuals must separately file either as single, or, if they are able to claim a ‘qualifying child,’ as head of household. The filing status determines the amount of exemptions claimed on the return, the standard deduction available, how other credits and deductions are limited, as well as the tax brackets. A same-sex filer generally cannot claim the exemption for their spouse ($3,800 for 2012). An exception to this rule exists when one spouse qualifies as a dependent of the other. This applies when one of the spouses earns less than the exemption amount, where the couple lives together, and the other spouse provides the support of the family.
Each child can be claimed as a dependent only by one parent, and thus a family needs to be broken up for reporting purposes. Children of same-sex spouses and domestic partners are not considered a ‘qualifying child’ unless legally adopted by the taxpayer. The adoption credit is not allowed for a stepchild in the case of an opposite-sex married couple, but is allowed for same-sex couples. Any credits and deductions related to a child are allowed only on the return with the dependency claim.
Certain items of income, deductions, and credits differ on the returns of same-sex couples. Amounts exempted from tax for married filers are not excludible for same-sex couples. Individuals may phase out of deductions before married couples due to lower levels for single taxpayers. In other cases, due to marriage penalties built into credit and deduction limitations, same-sex couples may be able to take those joint filers cannot.
When an employer provides health insurance to an employee and their family, these benefits are generally not taxable to the employee. However, in a same-sex marriage, the employee must pay federal income tax on the additional premium paid by the employer for their same-sex spouse and spouse’s children if they are not ‘qualifying’ dependents of the employee. These premiums are also subject to FICA, Medicare, and FUTA taxes.
When a federally recognized married couple retires, they are allowed to receive either the higher of their own calculated Social Security benefits or half of their spouse’s calculated benefits. Also, the surviving spouse is entitled to receive retirement benefits based on the deceased spouse’s working history. Both of these benefits are disallowed for same-sex married couples.
When a spouse dies, the balance in the deceased spouse’s 401(k) or IRA account is allowed to roll into the surviving spouse’s retirement account, and distributions are not mandatory until age 70 1/2. However, in same-sex marriages, the surviving spouse is allowed to roll the deceased spouse’s retirement into an inherited IRA account and take payments over their lifetime, but they are not allowed to defer payments until age 70 1/2. Default spouse elections cannot be relied upon for same-sex couples, and it is recommended to specifically name beneficiaries.
Gift splitting is allowed between spouses, and there is an unlimited marital exclusion for gifts. However, in a same-sex marriage, any gifts exceeding $13,000 ($14,000 for 2013) are considered taxable. Alimony to a same-sex former spouse is not deductible, and would be treated as a gift subject to the limitations.
Presently, for 2012, the annual estate exemption is $5 million (scheduled to be reduced to $1 million in 2013). Generally, when the first spouse dies, their estate transfers to the surviving spouse tax-free. Same-sex couples are not allowed this benefit, and when the decedent’s estate transfers to the surviving spouse, any amount over the annual estate exemption is taxable.
Since same-sex couples must file independently, the difficult task arises of separating their financial information. In community-property states, such as California, couples are required to split reporting 50/50 and to attach a statement to their federal return showing the division. However, in non-community property states, such as Massachusetts, there are no requirements for how to divide income and expenses. Therefore, strategy can be applied to lower taxes. The taxpayer with the highest level of income should take more of the itemized deductions until they phase out. If one taxpayer takes all the deductions, the other is still entitled to take the standard deduction, which for 2012 is $5,950 for a single filer.
Same-sex couples may face increased costs of tax preparation and higher scrutiny. In order to file the tax returns of a married same-sex couple, multiple versions are created.
Two individual federal returns are filed, and an additional joint federal return is then ‘mocked up’ to transfer data to a joint state return. In addition, many tax preparers will create multiple scenarios to maximize the benefit of credits and deductions. Due to the complicated nature of the filings, hiring a tax professional is advised. Since filing involves the separation of income and deductions, and the IRS does not look at a couples’ returns together, notices may be received when the IRS cannot match up to forms reported under joint Social Security numbers.
Many taxpayers are uncomfortable with filing single, especially since they sign their return stating that, under penalties of perjury, the return is true and correct. To alleviate some of this discomfort, many advocacy groups recommend adding a footnote to the tax forms and an asterisk by the filing status. The footnote should indicate that while the taxpayer is legally married in their state, they are not filing as such under compliance with DOMA. Another option would be to file a protective amended return showing how the tax return would be prepared as a joint return. This type of filing is a formal claim for a revision to the return pending expected changes in the law. Since there are several cases currently challenging the constitutionality of DOMA, there are grounds for filing protective amendments. Should DOMA be overturned, the amendment would be on file to initiate a refund or payment.
In almost all cases, there are some tax inequities associated with non-recognition of same-sex couples. Whether this increases or decreases the amount of tax owed depends on the individual tax situation. Same-sex couples are advised to stay informed about their treatment under federal tax law and to make efforts to mitigate their risk.
Kristi Reale, CPA, CVA is a senior manager with Meyers Brothers Kalicka, P.C. in Holyoke. In addition to the tax, accounting, and consulting services, she provides clients, she is also a certified valuation analyst; firstname.lastname@example.org. Charlotte Cathro is a tax manager with Meyers Brothers Kalicka, P.C.; (413) 536-8510; email@example.com