Richard Mason of ProQuest LLC writes: For most taxpayers filing a return, marital status is one of the few straightforward determinations in complying with the tax code; however, the recent history of the Defense of Marriage Act of 1996 (DOMA) highlights the ambiguity that sometimes accompanies the determination of marital status for federal tax purposes. This ambiguity, which can also affect couples in a common law marriage, has practical tax implications; thus, tax professionals should understand the consequences when marital status appears to be flexible.
A Changing Landscape
When signed into law, DOMA defined marriage as a legal union between one man and one woman for federal purposes (DOMA section 3) and did not require states to recognize same-sex marriages from other states. The basic implication was that same-sex couples legally married in their state were treated as single taxpayers for federal tax purposes. They would file their federal income tax return as single or head of household and submit a joint return for state income tax purposes if residing in a state where same-sex marriage was legal.
But in February 2011, Attorney General Eric Holder announced that the Justice Department would no longer enforce DOMA section 3, as applied to legally married same-sex couples, because President Obama had concluded that it was unconstitutional. The following is an excerpt of the statement released by Holder:
After careful consideration, including a review of my recommendation, the President has concluded that given a number of factors, including a documented history of discrimination, classifications based on sexual orientation should be subject to a more heightened standard of scrutiny. The President has also concluded that section 3 of DOMA, as applied to legally married same-sex couples, fails to meet that standard and is therefore unconstitutional. Given that conclusion, the President has instructed the Department not to defend the statute in such cases. (Statement of the Attorney General on Litigation Involving the Defense of Marriage Act,Department of Justice, http://www.justice.gov /opa/pr/2011/February/1 l-ag-222Jitml)
In June 2013, the U.S. Supreme Court decided two cases involving DOMA. One case, Windsor v. U.S., highlighted a federal estate tax issue: Edith Windsorsued over a $363,000 federal tax bill because her same-sex spouse's estate would have been exempted from federal estate taxes had she been married to a man (12-2435 2d Cir.; see also Bob Van Voris, "Defense of Marriage Act Faces Widow's Tax Case Appeal," Bloomberg News, Sept. 27, 2012). The Second Circuit Court of Appeals had mied DOMA to be unconstitutional, and onJune 26, 2013, the Supreme Court agreed and upheld the Second Circuit court's decision.
The other case, Hollingsworth v. Perry, involved the legality of Proposition 8, a constitutional amendment prohibiting same-sex marriage, in California; although this case did not involve DOMA, it did concern samesex marriage. The Supreme Court dismissed and vacated the Ninth Circuit court's decision because the state of California did not defend Proposition 8. Chief Justice Roberts argued the following:
We have never before upheld the standing of a private party to defend the constitutionality of a state statute when state officials have chosen not to. We decline to do so for the first time here.
Background
Currently, 13 states (California, Connecticut, Delaware, Iowa, Maine, Maryland,Massachusetts, Minnesota, New Hampshire, New York, Rhode Island, Vermont, and Washington) and the District of Columbia grant same-sex marriage licenses. From February 23, 2011, when the Justice Department announced it would not enforce DOMA, to June 26, 2013, when the Supreme Court ruling struck down DOMA, it remained unclear which marital status a legally married same-sex couple would be entitled to. In the wake of the Supreme Court ruling in Windsor, these couples should now file joint returns going forward.
On August 29, 2013, the Treasury Department announced that same-sex couples legally married in a state will be treated as married for federal tax purposes, regardless of where they currently reside (http://www.treasury.gov/presscenter/press-releases/Pages/jl215 3 .aspx). This policy will only apply to legally married couples and not to registered domestic partnerships, civil unions, or similar relationships recognized by certain states. Same-sex couples married before the DOMA ruling will have the option of filing amended returns for one or more prior tax years, although they will not be required to do so, according to the announcement.
Thus, there appears to be little ambiguity going forward for legally married same-sex couples; however, for same sex couples who previously filed as single under DOMA or have not yet filed prior-year returns, flexibility still exists with respect to marital status on the federal tax return. Furthermore, in states that recognize common law marriages, marital status for federal tax purposes is not always straightforward. Although these states have several requirements that must be met in order to qualify as a common law marriage, the couple must ultimately "represent themselves to others as being married" (Texas Family Code section 2.401 [2]), something that the couple could choose to do, depending upon the tax consequences of the action. Same-sex common law marriages present an even greyer area for determining marital status. Finally, even unmarried couples contemplating marriage should consider the tax consequences and benefits of legally marrying.
Being treated as a married couple for federal tax purposes is not necessarily more beneficial for all taxpayers; thus, a couple with an ambiguous marital status should carefully consider the consequences of being treated as married versus being treated as single. The following sections discuss federal tax areas where marital status is significant.
Tax Rates, Brackets, and Deductions
The most visible difference between married and single taxpayers is their filing status. Married taxpayers file jointly (MFJ) or separately (MFS). Individual taxpayers file as single or as head of household. Although the brackets and standard deduction are higher for MFJ, a couple with children that has an ambiguous marital status is likely better off filing separate, nonmarried returns because of the higher bracket thresholds for heads of households. As shown in Exhibit 1, if both spouses have comparable income, filing a pair of nonmarried returns subjects less income to the higher tax brackets and will result in a significantly higher standard deduction than filing a joint return.
Related to filing status are various limitations and phaseouts. For example, the child tax credit is phased out at $110,000 for MFJ, but at $75,000 for heads of household. A couple with children could claim the credit by exercising a nonmarried status and allow the spouse who falls below the threshold to file as head of household and claim the child and the credit, while the higher-income spouse files as single.
The choice between filing a joint return and filing with a nonmarried status is also impacted by other deductions. For example, the dependent care credit for a disabled spouse (Internal Revenue Code [IRC] section 21 [b][l][C]), deductions related to qualified tuition and student loan interest (IRC sections 221 and 222), and deductions related to medical expenses (IRC section 213[a]) might be lost if the spouse who incurs these expenses has no taxable income and separate nonmarried returns are filed. In this case, MFJ allows the spouse with taxable income to claim as deductions the costs incurred by the low- or no-income spouse.
In the case of employee benefits, it can be beneficial to be married or to file as single, depending upon a couple's specific circumstances. For example, spousal contributions to individual retirement accounts (IRA) count toward the contribution limitation, and if the spouse participates in an employer-sponsored plan, the deductible amount to traditional IRAs is phased out at a certain income level, as shown in Exhibit 2 (IRC section 219[g][l]). On the other hand, spouses qualify for many employee benefits, such as employer-provided healthcare (as in Golinski v. U.S. Office of Personnel Management, 824 F. Supp. 2d 968), and the spouse's earned income can increase the total amount that the couple can contribute to the IRA (IRC section 219[c][B][ii]).
In addition, if federally unmarried spouses receive health insurance benefits, the transfer of these benefits may be subject to gift taxes. But the authors believe that benefits will rarely exceed the annual gift tax exclusion amount ($14,000 in 2013); thus, this issue is not likely to be significant to many. Of course, if other monies or noncash assets are transferred between couples, their value combined with health insurance benefits could exceed the exclusion amount.
One interesting aspect is the tax treatment of alimony and separate maintenance payments. Alimony payments are deductible to the payer and considered income to the payee. Property settlements, in the context of a divorce, are not deductible or subject to tax. The issue of alimony payments and property settlements between divorced same-sex couples is a relatively new area. The IRC defines alimony and separate maintenance payments as transfers made under a divorce or separation instrument (IRC section 71[b]). But, under DOMA, same-sex spouses were not considered spouses. Traditionally, separation agreements and divorce decrees are a state issue. It remains unclear whether the 1RS will presume such a document between a same-sex couple to be valid.
So do same-sex couples include alimony as income and get a deduction for it? The authors are unaware of any cases in which the 1RS questioned the treatment of payments between divorced same-sex spouses. It could be argued that, because no other classification applied until the overturning of DOMA, such payments should be treated as gifts between the ex-spouses under the current IRC. It would be interesting to see if there are situations where one ex-spouse claimed the deduction (ignoring DOMA), while the other did not include it in income (adhering to DOMA).
Earned Income Tax Credit
The earned income tax credit is designed to provide refundable credits to lowerincome individuals as an incentive to work (IRC section 32). The credit is generally largest (as high as $5,891 in 2012) for families with three or more children and income between $13,050 and $17,100 (head of household) or$22,300 (MFJ). Income above these levels reduces the credit, and reporting more than three children does not increase it. For couples with an ambiguous marital status, the determination of single or married can result in significant differences in this credit. As an extreme example, consider a couple with six children, where each spouse has earned income of $17,100; Exhibit 3 illustrates their economic choices and the clear advantage of filing two separate head of household returns.
Related-Party Issues
Many IRC provisions deal with related-party issues, mostly due to the fear that related parties can distort transactions in order to avoid taxation-for example, losses on sales between related parties are not deductible. Consider a case in which Jamie sells Jessie a business asset for $5,000 that he originally purchased for $8,500 and claimed depreciation deductions of $3,060; a loss of$440 would be incurred (proceeds of $5,000, minus adjusted basis of $5,440[$8,500 - $3,060]). This loss would not be deductible if Jamie and Jessie are treated as related parties for tax purposes (IRC section 267[b]). Generally, spouses are considered related parties for any of these specific provisions (IRC section 267[c][2] and [4]); thus, with respect to transactions between spouses, couples with an ambiguous marital status would be better off filing as single in order to avoid falling into the related-party category. This would allow them to claim losses on sales of business or investment property to each other.
Spouses are also considered family for purposes of the family attribution rules on stock redemptions (IRC section 318) and for purposes of determining the 100-shareholder limitation for S corporations (IRC section 1361[b][l][A]). Thus, in the case of the former (IRC section 318 attribution rules), taxpayers would benefit by not being treated as spouses because they would not constructively own each other's shares, increasing the likelihood of a redemption being treated as a sale instead of the less favorable dividend treatment. (Note that this distinction would become more important if the preferential treatment of dividends were eliminated.) In the latter instance (S corporation owner limit), being considered a spouse increases the effective number of individuals that can be shareholders of S corporation stock.
Estate and Gift Tax Issues
For purposes of estate and gift taxes, filing as a married couple is almost always more beneficial; transactions between spouses and gifts made while married are eligible for special tax treatment. Although estate tax and gift tax returns are never filed jointly, several mies apply exclusively to spouses. Wealth transfers between spouses during lifetime and at death are always tax free (IRC sections 2523[a] and 2056[a], respectively). Spouses also have the option to gift split, whereby they treat gifts made to third parties as made half by each spouse. The advantage of this is that the annual exclusion amount ($14,000 per donee in 2013) is effectively doubled (IRC section 2513 [a]) because each spouse is considered to have made half of the gift.
Under current estate tax law (as amended in the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 and made permanent in the American Taxpayer Relief Act of 2012 [ATRA]), spouses can maximize the unified credit available by utilizing the deceased spouse's unused credit amount (IRC section 2010[c][4]). If one spouse's estate is smaller than the current exemption equivalent of $5.25 million (in 2013), not all of the credit is needed to reduce the tax liability to zero. The remainder of this credit can-by executor election-be added to the surviving spouse's credit and effectively create a combined exemption equivalent of $10.5 million (in 2013) for a married couple. If a nonmarried taxpayer dies and leaves some of the credit amount unused, it would be lost forever.
One spouse can create a qualified terminable interest property trust for the other, which enables that spouse to maintain control over how the assets are distributed after the surviving spouse dies. The transfer to the surviving spouse is considered a taxfree transfer between spouses. This transfer would not be tax free to a nonspouse- it would be subject to the gift tax-so this transfer vehicle is attractive only to couples that file as married.
Insights for Tax Planning
Numerous potential tax issues may arise due to the recent changes at the federal and state level, both by statute and in the courts, with regard to the status of same-sex marriages. After the Department of Justice decreed in 2011 that it would no longer enforce DOMA, a period of uncertainty over marital status existed for same-sex couples filing federal tax returns. In June 2013, the U.S. Supreme Court struck down a key component of DOMA, and in August 2013, the Treasury Department announced that same-sex couples legally married in a state will be treated as married for federal tax purposes, regardless of where they currently reside. Although same-sex couples can now amend past tax returns to file as married, they are not required to do so. Same-sex couples that have not yet filed a prior-year tax return still have the option to comply with DOMA for that year, allowing some flexibility in marital status.
Moreover, both heterosexual and samesex common law couples (in states that recognize this arrangement) that have not yet represented themselves as married face some ambiguity (and perhaps flexibility) in determining their marital status for federal tax purposes. Being treated as married or unmarried has significant tax consequences. CPAs should be sensitive to the needs of different individuals in these situations, while continuing to provide frank and realistic tax advice. ?
Mark Jackson, PhD, is an assistant professor of accounting at the University of Nevada-Reno and can be contacted at markjackson@unr.edu. Sonja Pippin, PhD, CPA, is an associate professor of accounting at the University of Nevada-Reno and can be contacted at sonjap@unr.edu; Richard Mason, PhD, JD, is an associate professor of accounting at the University of Nevada-Reno and can be contacted at mason@unr.edu.
