Life insurance and financial service professionals say the U.S. Supreme Court’s ruling on June 26 striking down provisions of the Defense of Marriage Act (DOMA) is a major achievement for the gay and lesbian communities, which have long sought to secure federal recognition of state-registered same-sex marriages. But industry experts also qualify the victory, noting the decision may actually complicate planning for some couples or be of limited value to others depending on place of residence or status.

Emphasizing the positive

“The repeal of DOMA [in U.S. vs. Windsor] was a great win for gay and lesbian couples, as the ruling finally recognizes same-sex marriages at the federal level, not just at the state level,” says Debra Abbott-Walker, a Fairfield, Conn.-based agency recruiter and registered rep at Pruco Securities, a unit of Prudential Financial, Newark, N.J. “It will make some planning aspects easier because couples will now enjoy federal benefits that previously were unavailable. For advisors, this is huge.”

These benefits, says experts, flow from the more than one 1,000 federal laws and programs governing married couples. Gays and lesbians living in states that recognize same-sex marriages will now, for example, be covered by federal marriage provisions respecting Social Security, veterans/military benefits and immigration benefits, such as the ability for a foreigner to apply for legal residency when married to a U.S. citizen.

Those working for the federal government will now also enjoy employment benefits for married couples. Among them: federal health insurance for spouses; plus wages, worker’s comp, health insurance and retirement plan benefits for the surviving spouse of a deceased federal worker.

Also widely touted are estate planning and estate tax benefits. Married same-sex couples can, for example, create a qualified terminable interest property (QTIP) trust that allows surviving spouses to use trust property tax-free. Also available is qualified domestic trust (QDOT) trust which permits non-U.S. citizen surviving spouses to postpone paying estate taxes.

Also of keen interest, observers say, is the federal unlimited marital deduction, which enables same-sex couples to transfer estate assets to beneficiaries free of gift and estate tax. This IRS provision alone can save costly and time-consuming implementation of tax-avoidance techniques.

However, advisors note the deduction should prove unnecessary following the American Taxpayer’s Relief Act of 2012. Signed by President Obama on January 2, the law sets the estate tax exemption level at $5 million per individual and $10 million per couple. These exclusion amounts, sources say, are sufficiently high as to render estate tax a moot issue for the overwhelming majority of same-sex couples.

The more significant tax impact of the DOMA decision, observers agree, concerns income taxes. Gay and lesbian couples residing in states where their marriages are recognized can now file a joint federal income tax return, an option that can yield substantial income tax savings.

“One of the big benefits of filing jointly under our progressive income tax code is the ability for couples to avoid higher tax brackets by splitting their income,” says Nick Kasprak, an analyst at the Tax Foundation, Washington, D.C.

Kasprak cautions, however, that high-earning newlyweds may be subject to a marriage penalty (i.e., paying more tax on a jointly filed federal return than they would as single filers with the same income).  Under current tax rates, for example, two individuals filing as “single,” each earning $87,850, would each pay a marginal tax rate of 25%. But as married couple filing jointly, their combined income ($175,700) would subject them to a higher, 28 percent marginal tax rate, costing an additional $879 in tax.

Another tax benefit for married same-sex couples, adds Kasprak, is reduced paperwork. Before DOMA was struck down, same-sex couples in states where marriage was legal could file jointly a state income tax return, but had to file singly on the federal return. When deducting state income tax from the federal tax and vice versa, couples often resorted to drafting a fake federal return as if they were married, then used the fake return to determine state deductions. Likewise, they would develop a dummy single state return to determine their federal tax deduction.

“This procedure can be very complicated and, frankly, stupid,” says Kasprak. “Now the process will be much easier. Couples can file either single or joint returns at both the federal and state level.”

Kasprak adds that married couples in recognition states should also be able to file amended returns for the 7 years preceding the DOMA decision to secure additional tax savings. But he questions whether the IRS would require amended returns, noting this would be an “administrative nightmare.”

Product benefits

The benefits for same sex couples in recognition states aren’t limited to the federal tax code. In the workplace, gays and lesbians can now add a spouse to a family health plan. A significant other can also be designated an automatic, joint and 50 percent survivor income beneficiary of an individual’s defined benefit retirement plan. Previously, the only option may have been to select a single-life annuity payout with no death benefit, the undistributed balance reverting back to the plan.

As regards life insurance, Herbert Daroff, a principal of Baystate Financial Partners, Boston, says that most carriers already avail gay and lesbian couples of second-to-die policies that pay a death benefit to surviving heirs only after the death of the second spouse — the benefit being lower premiums compared to policies that pay out after the first death — but some providers pre-DOMA didn’t offer the products in non-recognition states because of questions as to the policyholder’s insurable interest. Will they now?

The resolution of this issue, says Daroff, has implications not only for gays and lesbians applying for second-to-die policies, but also those looking to buy separate policies on each other.

“Whether limitations will still apply in certain states, we don’t yet know,” says Daroff. “But the case for demonstrating insurable interest is stronger now than it was before the SCOTUS decision. Insurers in non-recognition states will now have a tougher hurdle to mount when arguing that a policyholder has no insurable interest in his or her spouse.”

A related dividend of the SCOTUS decision, says Daroff, is asset protection. In states that recognize same-sex marriage or marriage-equivalent relationships, gay and lesbian couples can hold their home and other joint property as “tenants by the entirety.” When one spouse/partner dies, the other inherits the property, thereby insuring protection from most creditors (excepting mortgage holders and tax collectors). Post-DOMA, this asset protection will now be recognized under federal law.

Covering the caveats

The SCOTUS decision will be of immediate benefit to gay and lesbian couples residing in the 13 states (plus the District of Columbia) that recognize same-sex marriage. But eligibility for federal marriage benefits, experts caution, is uncertain in cases where couples marry in a state that recognizes same-sex marriage, but reside in or move to a non-recognition state. The IRS and Social Security Administration, for example, make determinations based on where couples reside (the state of domicile) and not where they marry (the state of celebration).

The ruling remains also largely a question market for couples in marriage-equivalent relationships — those state-registered as domestic partnerships or civil unions — which 8 states currently recognize.

Frederick Hertz, an attorney at SameSexLaw.com, San Francisco, says federal agencies that have addressed the issue, among them the Office of Personal Management and U.S. Citizenship and Immigration Services (formerly INS), have stated they won’t treat such relationships as married for federal purposes.

That’s not necessarily a bad thing. Observers note that some couples might prefer to retain state protections respecting community property (tenancy by the entirety), healthcare provisions and insurance benefits, while circumventing marriage penalties under federal tax law. But Hertz warns the distinction may soon be moot, as most states that now allow civil unions and domestic partnerships will (he predicts) “upgrade” these relationships to marriage within the next five years.

Advisors, observes Hertz, also need to be mindful of how clients view their relationships; and of touchy situations that can arise when it’s necessary to explain that self-perceptions as to the status of these relationships conflict with the law. Case in point: When couples in a domestic partnership, civil union or marriage (but living in a non-recognition state) endeavor to file a joint federal income tax return.

“You’ll have to decide what you’re willing to do to meet the regulatory requirements of your profession,” says Hertz, who spoke on post-DOMA same-sex marriage issues during a July 11 webcast hosted by the Financial Planning Association, Denver. “This can be very tricky because some clients will be offended if your forms refer to them as unmarried.

“It may prudent to draft letters of agreement with your clients wherein you acknowledge their assertions as to their marriage status under federal law, but your analysis indicates they are not,” he adds. “Then get their consent to the terminology you recommend for the forms.”

Adding to the planning challenges for gay and lesbian couples, Hertz says, is the treatment of same-sex marriage and marriage-equivalent relationships by municipalities and employers. Couples whose relationships are registered in New York or San Francisco, for example, are entitled to employee benefits for married couples provided by an employer or agency based in either of these cities. But such benefits may not extend to couples living in a non-recognition state.

Also to consider is the treatment of contracts in different jurisdictions. A pre-nuptial agreement set up in California by a same-sex couple hailing from Texas (a non-recognition state) may not be valid. In such cases, says Hertz, the couple would have to draft an agreement in Texas addressing their non-marital state status; and if married in California, their federal married status.

Because of the disconnect between state provisions regarding marriage and divorce — same-sex couples don’t need to be residents of a recognition state to marry there, but residency is often required when filing for a divorce — gays and lesbians may also face legal problems when inadvertently entering a bigamous relationship.

To illustrate, Hertz cites a woman who married her lesbian girlfriend in California; the couple then relocated to Washington (then a non-recognition state) where a court denied their application for divorce, viewing the filing as a form of recognition. The woman then married a man in Washington, believing her earlier, non-recognized marriage to be void. However, Washington State now recognizes such marriages.

“As a result, the woman’s second heterosexual marriage is now retroactively bigamous, says Hertz. “She now has serious legal problems. You need to be aware of these types of pitfalls.”

Ignore the DOMA decision?

And plan for them. Because of the myriad federal, state and municipal laws respecting same-sex marriage, domestic partnerships and civil unions, advisors recommend that gay and lesbian couples plan, near-term, as if their state-registered relationships were not recognized. Why?

Couples now living in New York, Massachusetts or Connecticut, though now entitled to federal and state benefits afforded married individuals, could see their legal status upended by unforeseen events. Their employers could require them to move to a non-recognition state. Better job prospects in these jurisdictions could also force an out-of-state relocation, as could an unanticipated need to care for an aging parent.

“You can’t look into a crystal ball and see where you’ll be five or ten years.” says Pruco Securities’ Abbott-Walker. “I’ve put in place mechanisms for my gay and lesbian clients — health care proxies, wills, trusts and beneficiary designations in life insurance policies — and I don’t expect this level of planning to change following the SCOTUS decision. I’m very comfortable with that.”

As is Baystate’s Daroff, who emphasizes that planning for unexpected changes in the law is especially important when doing special needs planning for children unable to care for themselves due to a physical or mental disability. This may entail, for instance, stipulating in an estate planning document that one spouse in a same-sex marriage be designated the guardian of the other’s special needs child — though applicable state law may provide for a surviving spouse’s custody of the child.

“We have a large, active practice in the special needs planning space,” says Daroff. “We’ve always made sure to cover in estate planning documents the desires of clients in respect to their special needs kids and not rely on law currently on the books.”

See also:

The death of DOMA

DOMA ruling puts PPACA tax credits at risk

The end of DOMA: Married in the eyes of the IRS