Close Close

Regulation and Compliance > State Regulation

Why tax planning for same-sex couples is still more complex than it should be

Your article was successfully shared with the contacts you provided.

June was chosen as the month to celebrate LGBT pride to commemorate the Stonewall riots that occurred at the end of that month in 1969. June was also the month when the Supreme Court handed down its Windsor decision in 2013 and struck a blow against part of a law that prohibited federal recognition of same sex marriages. This year, June may be host to another LGBT milestone, with another Supreme Court decision on same sex marriage.

While it is difficult to predict how the Supreme Court may rule, one possibility is that it will overturn the existing same sex marriage structure and require that same sex marriage be allowed by all states.  Another possibility is that the Court will take a more incremental step and require all states to recognize a same sex marriage licensed by another state, but still allow individual states to choose whether to license same sex marriage within their own jurisdiction. A third possibility is that the Court will uphold the status quo whereby states can choose whether to recognize same sex marriage and are not required to recognize a same sex marriage performed in another jurisdiction.

The U.S. Supreme Court could also take a narrow approach that requires only those states involved in the case (Kentucky, Michigan, Ohio and Tennessee) to recognize same sex marriage in their jurisdiction.  Though we cannot predict the Supreme Court results since there are innumerable possibilities as to ways the ruling could be decided with various different impacts, we can provide a framework for understanding some of the current challenges faced by same sex married couples and some of the ways they might be impacted by a Supreme Court ruling this June. 

These various possibilities can be better understood by considering how current law applies in different situations.

In scenario No.1, a couple marries in New York and lives there for the rest of their marriage. This couple will be recognized as married for all purposes. They can enjoy all spousal employee benefits, file their federal and state income tax returns as married filing jointly or married filing separately, and they will enjoy all spousal benefits under Social Security. Upon the death of one spouse, the surviving spouse will also enjoy all spousal benefits and planning options under the federal and New York estate tax regimes.  If the marriage fails, they will have access to divorce laws and process just the same as any other married couple.

In scenario No.2, the couple marries in New York and moves to Michigan, a state that does not recognize same sex marriage. In Michigan the couple will not be able to file their state income tax return as a married couple, which means that they will have to file as married at the federal level, prepare federal income tax returns as if they were single, and then use the pretend or “dummy” federal single tax returns as the basis for preparing their Michigan state income tax returns. When the time comes to apply for Social Security, the couple will not qualify for spousal Social Security benefits since the marriage is not recognized in the couple’s state of residence.

The Social Security Act uses a state of residence test to determine eligibility for spousal benefits. The Obama administration has tried to interpret federal law as broadly as possible, but the Social Security Act does not seem open to an interpretation based on the state of celebration rule, applied generally by the federal government, under which a marriage is recognized for federal law purposes regardless of where a couple lives provided that the marriage was sanctioned in a jurisdiction that recognizes same sex marriages. The Obama administration has proposed a legislative change to the Social Security Act to allow for the state of celebration rule to apply and expand spousal benefits accordingly. The fate of such possible legislation is uncertain.

More on this topic

So, in the event that the marriage fails, the couple might be surprised to learn that there is no mechanism to file for divorce under Michigan law. Fortunately for this couple, Michigan does not have an estate or inheritance tax at this time, but if such taxes were reinstated the surviving spouse would not qualify for the usual spousal benefits.

New York and Michigan represent the bookends of the disparate treatment that a same sex married couple will receive under current law. But they do have relatively clear and straightforward rules. Contrast that with a state like Missouri, which does not license a same sex marriage but where there is some legal requirement to recognize a couple married outside of Missouri that moves into the state. Under current Missouri law it seems that a same sex couple married in another state that moves to Missouri will be recognized as married for state income tax purposes, but it is not entirely clear that the couple will be recognized as being eligible for divorce under Missouri law or as a married couple for Social Security purposes.

Suffice it to say that the current variety of rules that apply to a same sex marriage is a recipe for confusion and possibly mistake among life insurance agents, financial advisors and tax professionals. Depending on how the Supreme Court decides the case currently pending before it, the rules may be simplified, further muddied, or stay the same.

What happens if the Supreme Court decides that states must license same sex marriages in their jurisdiction? This approach will remove all financial, tax and retirement planning uncertainty since a same sex marriage will be recognized in all respects like any other marriage. 

If the Supreme Court takes the more incremental approach and does not require states to license same sex marriage but to recognize a valid same sex marriage from another jurisdiction, it is possible that  those married in another jurisdiction would be treated the same as if the marriage were permitted by their state of residence. If so, this would also create an unusual circumstance where a same sex couple might have to go outside their state of residence to become married, but once that is done would be entitled to all benefits afforded a married couple in their home state that refuse to license such marriages directly.  Less likely, but seemingly still possible, is that a state takes the position that it can recognize the marriage in some but not all respects.

Of course, if the Supreme Court preserves the current legal framework, then the uncertainty and planning challenges described earlier will remain unabated. 

Financial, tax, retirement and estate planning is hard enough without the increased complexity introduced by the maze of federal and state rules that treat same sex married couples differently. While constitutional law is complex and any Supreme Court decision and impact unpredictable, for the sake of clear planning rules, a legal decision that simplifies and reduces the various planning traps would be beneficial for same sex couples and advisors alike.