The U. S. Supreme Court's June 2013 ruling in United States v. Windsor has changed the landscape for same-sex couples. Under the ruling, which invalidated Section 3 of the Defense of Marriage Act (DOMA), the federal government can no longer treat lawfully married same-sex couples differently from lawfully married opposite-sex couples. For other same-sex couples, though, challenges remain. This article discusses some issues to be aware of as you plan for your goals.
What this ruling means
Same-sex couples lawfully married and living in a state (or in Washington, D.C.) that recognizes same-sex marriage are entitled to federal benefits including:
- Social Security survivor, retirement and death benefits
- Pension survivor benefits
- Tax-free health insurance benefits for employee's spouse
- Estate and gift tax marital deductions and portability of applicable exclusion amount
- The right to split gifts
- Guaranteed leave under the Family and Medical Leave Act
- The right to petition for a green card or immigrant visa for a spouse
- The right to file joint federal income tax returns
- Spousal IRA rollovers
- COBRA spousal coverage
- Certain federal education benefits provided to spouses.
Same-sex spouses who live in a state that does not recognize their marriage may not have access to all of these benefits. Eligibility for some of the above federal benefits currently depends not on the state in which the marriage took place (the place of celebration) but rather on the state in which you're living when you apply for them (the place of domicile or residence). For example, following the Windsor ruling, federal agencies have begun to issue guidance — not always consistent — on the services and programs for which they have responsibility. For instance:
- The IRS and Department of Treasury announced that same-sex spouses are entitled to all federal tax benefits as opposite-sex spouses, regardless of their state of residence. Thus, same sex spouses who have been lawfully married in any state (or the District of Columbia) or foreign jurisdiction that permits same-sex marriage will be treated as married for purposes of federal income, gift, and estate tax laws.
- The Department of Labor has stated that an employee’s marital status in his or her state of residence will determine marital status under the Family and Medical Leave Act.
- The Department of Health and Human Services has announced that same-sex spouses entitled to Medicare, regardless of whether the state in which they reside recognizes their same-sex marriage, will be eligible for equal benefits as opposite-sex spouses, including joint placement in nursing homes throughout the country.
- The Social Security Administration has begun issuing benefits to same-sex spouses who reside in states that allow or recognize same-sex marriages, but has put on hold issuing benefits to same-sex spouses who do not reside in such states. Further guidance is expected.
- The Department of State has stated that it will recognize as valid for immigration purposes a same-sex marriage lawfully entered into, regardless of the couple’s state of residence.
- Additional guidance from other federal agencies is expected.
From a planning perspective, lawfully married same-sex couples can no longer create Grantor Retained Income Trusts (GRITs) naming a spouse as the remainder beneficiary. However, unmarried partners may still do so. On the other hand, lawfully married couples are now entitled to all federal estate, gift and income tax benefits available to opposite-sex spouses, including the marital deduction, portability of exemption and joint filing.
What this ruling does not mean
- The ruling does not apply to civil unions, domestic partnerships or any other non-marriage relationship that is not a "lawful marriage," as that term is defined for state purposes.
- The ruling does not mean that any particular state must honor another state's same-sex marriage.
- The ruling does not create a fundamental right for same-sex couples to be married.
- The ruling does not address which equal protection standard is to apply to gay marriages.
- DOMA itself has not been invalidated. Only Sec. 3 of DOMA, which had defined marriage as between one man and one woman, has been declared unconstitutional.
Wealth Transfer With Different Rules
Since domestic partner¹ relationships are not currently recognized at the federal level, including when it comes to federal taxation, they are not eligible for the unlimited gift and estate tax marital deduction. Unlike same- and opposite-sex spouses, domestic partners cannot retitle, pass or transfer assets to each other during their lives or at death without potentially incurring estate or gift taxes. Moreover, without a will, domestic partners do not automatically qualify for succession rights to a deceased partner's property. And were one to die intestate (that is, without a will), a domestic partner is not likely to be appointed personal representative of his or her partner's estate, as appointments are governed by state law and the partner is not considered a family member in most states.
Even though same-sex spouses and domestic partners may face planning challenges of different degrees, a well-conceived wealth transfer strategy can help same-sex spouses and domestic partners work toward the tax-efficient transfer of assets, as well as providing the surviving spouse or partner with the liquid assets necessary to cover immediate expenses. It can also give partners the legal recognition required to handle each other's financial affairs if one of them becomes incapacitated.
As with most aspects of planning for same-sex spouses and domestic partners, the critical first steps center on getting the appropriate documents in order. A will is a good beginning, because it specifies how probate assets are to be distributed after death as well as who should serve as personal representative and trustee to settle the estate and distribute assets. Domestic partnership agreements or, in the case of same-sex spouses, pre- or post-nuptial agreements, are also helpful in documenting intentions, defining rights and providing useful protection for both partners. It's also important to make sure to designate beneficiaries for any investments that spouses or partners make individually, including investments in life insurance, IRAs and workplace retirement plans, because these assets will not pass as probate assets under a will. For same-sex spouses, it is critical to review beneficiary designations on certain qualified plans (for example, 401(k) plans or pension plans); federal law requires that the spouse be designated the beneficiary unless he or she waives his or her rights.
Both same-sex spouses and domestic partners may be able to lessen the impact of estate taxes, protect assets, and create cash flow by using a variety of trusts and other wealth transfer vehicles. Some of the strategies that are effective for same- and opposite-sex married couples just won't work for domestic partners, but there are also a few instances where the federal tax status — or lack of it — of domestic partners can produce favorable results. Examples here include Grantor Retained Annuity Trusts (GRATs) and GRITs.
A recent increase in the lifetime federal gift and estate tax exemption to $5.25 million has lessened some of the wealth transfer issues faced by many same-sex couples, though portability — the ability of one spouse to utilize the unused federal exemption of the other spouse — gives same-sex spouses a leg up on domestic partners and further illustrates the challenges faced by domestic partners.
Income tax planning
As a result of Windsor, lawfully married same-sex couples are now required to file their federal income tax returns with a "married" status (either married filing jointly or married filing separately), meaning that they will no longer be able to file as single or head of household. However, because the current federal tax code does not recognize domestic partners as married individuals, domestic partners cannot file joint federal income tax returns. The selected filing status determines tax rate brackets and levels of available exemptions and deductions. Depending upon the domestic partners' financial circumstances, a particular filing status may be more advantageous.
States that legally recognize same-sex marriages — or provide the equivalent of state-level spousal rights to same-sex couples — have generally allowed for state income taxation in the same manner as married opposite-sex couples. In other words, while a joint return may be filed in some states, separate individual returns are also an option and, depending upon financial circumstances, may be preferable. However, it remains to be seen whether this option will still be available in states with same-sex marriage or whether these states will now, like the IRS, require same-sex spouses to file with a "married" status.
Assuming that a same-sex married couple can now file as married, there may be questions about whether they should or could amend past income tax returns to change their filing status. Because DOMA has been declared unconstitutional, this presumably means it was never effective in the first place. In such circumstances, it is not clear what the deadline is for filing amended returns or what administrative flexibility would be offered by the IRS.
Social Security and retirement benefits
While same-sex spouses are entitled to Social Security survivor, retirement and death benefits, as well as pension benefits on equal footing with opposite-sex spouses, other domestic partners begin retirement planning at a disadvantage. For one thing, if one partner dies, unless the couple is married Social Security survivor benefits do not pass to the surviving partner. Similarly, surviving partners do not benefit from their partner's private sector employee pension plan or federal employee pension, if the partners are not married pursuant to state law. That said, a non-spousal beneficiary is eligible to roll over funds received from a 401(k) upon the death of the account owner into her or his own "inherited IRA." This retains the income tax-deferred nature of the account with required distributions made over the beneficiary's life expectancy; the beneficiary would pay the income tax only on the amounts when they are received, rather than having to take all of the 401(k) assets in a lump sum and pay income tax on the entire amount of the funds immediately. This still falls short of the options available to a same sex or opposite-sex spouse, who can achieve even greater tax benefits by rolling over his or her spouse's 401(k) or an IRA to his or her own IRA. This action delays the start of required minimum distributions, thus increasing tax-deferral benefits.
In the case of incapacitation, unless they are married domestic partners are not usually first in line to be appointed each other's guardians, because they are not considered family members under the laws of most states. In some cases, non-married domestic partners are not automatically granted hospital visitation or other rights upon a partner's death, including funeral planning or body disposition rights.
Once again, creating the appropriate documents is the most effective protection. This applies to all domestic partners, including same-sex married spouses. Until same-sex marriages are recognized in all U.S. jurisdictions, one should not take anything for granted. Each partner should work with an attorney to explicitly grant the other partner the right to access personal information and make critical decisions if one of the partners becomes incapacitated or dies. Among the important documents are a durable power of attorney, which designates someone to make financial decisions in the event of incapacity; a living will, which documents health care wishes; an advanced health care directive or health care proxy, which designates someone to make medical decisions in the event of incapacity; and a Health Insurance Portability and Accountability Act (HIPAA) release, which allows for access to medical records.
For domestic partners, these documents are particularly important. Most documents and planning are about distribution of assets after death. These documents affect health, well-being and quality of life during a partner's lifetime.
Adoption and childcare
A domestic partner's right to adoption is not guaranteed. Parenting agreements and issues around guardianship of minor children can be complex for domestic partners and same-sex spouses. To help ensure that your children will be provided for in accordance with your wishes, both during your lifetime and following your and your partner's deaths, skilled planning professionals, attorneys and accountants can help to negotiate the various options regarding parenting, surrogacy and adoption as they relate to domestic partners. They can also help to establish parenting and guardianship agreements, as well as advising on possible tax advantages of adoption credits and "head of household" filing status (generally for unmarried partners) — all in order to help ensure to the greatest degree possible that both partners play the role in their children's lives that they expect and wish to play.
Thorough Planning Is the Best Protection
The bottom line is that the issues surrounding estate and tax planning for domestic partners, including same-sex spouses, are many and complex. Given a constantly shifting legislative and judicial environment, they are likely to remain so. For all same-sex couples, it's important to work closely with professional advisors skilled in all facets of estate planning services, tax strategies and personal financial planning — and who also are knowledgeable about, and sensitive to, the challenges faced by domestic partners, including same-sex spouses. Developing a thorough estate plan through an estate attorney, getting the right documents in place, and then keeping them up to date offers the best way for partners to protect themselves and their loved ones, and to ensure that their wishes are met, now and in the future.
We are committed to providing you with the education and guidance you need in order to help you achieve your goals. To learn more about financial strategies for domestic partners, including same-sex spouses, please contact your advisor.
This material has been adapted from content originally developed by Gregory Cerbone, Chief Fiduciary Officer, U.S. Trust.
¹For convenience, we will use the term "domestic partner" to include same-sex partners in a registered domestic partnership, a civil union, or any committed same-sex relationship not including a legally married spousal relationship (unless otherwise indicated in the text). Because same-sex partner relationships are defined differently across the country, it is important to work with your advisor to ensure you understand the implications of your relationship status.
Note: Any examples are hypothetical and are for illustrative purposes only.
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