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By striking down key provisions of the Defense of Marriage Act (DOMA) on June 26, the Supreme Court has brought about a major change in the way same-sex couples will be viewed in the eyes of the Internal Revenue Service.
In almost all areas of the Internal Revenue Code—from federal income tax to estate planning—the law carves out special rules that apply for married couples filing joint tax returns. While the ruling does not mean that all states must recognize same-sex marriages, it does mean that the federal government—including the IRS—will be required to treat those same-sex marriages that are recognized as valid for purposes of federal law.
While the ruling obviously represents a major step toward equality in general, in some areas, such as estate and Social Security planning, the ruling also represents a big win (tax-wise) for same-sex couples. High income same-sex clients, however, need to be prepared for the reality that their tax bills might be going up this year.
Federal estate tax rules have evolved in recent years to make it easier for married couples to avoid taxes when passing wealth after death. Same-sex clients will now be able to take advantage of these special rules. For example, the $5.25 (in 2013) exemption is automatically portable between spouses, meaning that same-sex couples can now count on shielding a combined $10.5 million from estate taxes without worrying about which spouse technically owns the assets.
Similarly, in the gift tax arena, married couples are permitted to pool their $14,000 (in 2013) annual gift tax exclusion so that each couple is able to make annual tax-free gifts of up to $28,000 per donee.
Same-sex couples may reap the greatest win based on their entitlement to Social Security spousal benefits under federal law. A married spouse who never worked (or who is not ready to begin claiming benefits) is still entitled to claim Social Security spousal benefits when his or her spouse uses the “file and suspend” strategy.
Under this strategy, one spouse files for benefits and immediately suspends those benefits after the second spouse begins claiming spousal benefits. This allows the couple to claim some Social Security benefits while allowing their earnings-based retirement benefits to grow.
Federal Income Tax
The federal income tax arena is where higher earning same-sex couples may experience a larger tax bill. Under the legislation enacted early in 2013, a single taxpayer crosses the earnings threshold into the 39.6% tax bracket when he or she earns more than $400,000 for the year—meaning that two “single” (in the eyes of federal law) taxpayers could live together and earn almost $800,000 before entering the highest tax bracket. Two “married” people, on the other hand, become subject to this rate when they have combined earnings of only $450,000 for the year.
Similarly, a same-sex couple whose marriage is not federally recognized can earn $400,000 ($200,000 each) before their itemized deductions and personal exemptions become subject to the phase-out rules that gradually reduce their value. Once that same couple’s marriage is federally recognized, the penalties kick in at $250,000—total.
The investment income tax, which is new for 2013, will also apply to a married couple earning a combined $250,000 (while a same-sex couple whose marriage was not federally recognized could earn $400,000 before crossing the threshold).
The end of DOMA obviously represents a huge victory for same-sex couples and it is a major step on the road to equality. Higher earning same-sex clients, however, need to be prepared for the reality that their tax bills might be going up now that they are married in the eyes of the IRS.
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