The Supreme Court ruling legalizing marriage in all states for same-sex couples is a landmark decision in the equal rights arena. However, the ruling also has important financial and tax implications — implications that same-sex clients now need to be advised upon in order to avoid any planning surprises down the road. While the ruling eliminates the patchwork of state-specific rules that could confuse even the most competent financial advisor, it is critical that advisors in all states familiarize themselves with the important planning issues that same-sex couples now need to consider — whether or not they have chosen to marry. Some of the issues are fairly simple and well-settled, but the subtleties and complexities of the rules need to be considered in order for same-sex married couples to make informed planning decisions going forward.
Estate and gift tax issues
While same-sex spouses now have the same rights as opposite-sex spouses to inherit from one another even in the absence of a will, federal estate tax rules have evolved in recent years to make it easier for married couples to avoid transfer taxes when passing wealth after death. Same-sex clients are now able to take advantage of these special rules.
For example, the $5.43 million (in 2015) exemption is portable between spouses if an election is made on a properly-filed estate tax return — meaning that same-sex couples can now count on shielding a combined $10.86 million from estate taxes without worrying about which spouse technically owns the assets. Same-sex married couples should be advised to review their estate planning documents to take into account the fact that these taxpayers are now entitled to both the portability election and the marital deduction.
Similarly, in the gift tax arena, married couples are permitted to pool their $14,000 (in 2015) annual gift tax exclusion so that each couple is able to make annual tax-free gifts of up to $28,000 per donee.
See also: Tax changes for 2015: What to expect
Married same-sex couples in all states will now have the right to file both joint federal and state income tax returns, rather than two separate returns, for the 2016 tax year, as well as for all other open years. For couples who had filed separate federal returns for simplicity because they lived in a state that did not recognize same-sex marriage, amending a past year’s return could lead to higher returns in some cases.
For other same-sex couples, however, choosing to marry and file a joint return can actually increase tax liability. In the past, same-sex couples generally had the opportunity to file two single (or two head-of-household) tax returns without worrying about the “marriage penalty” for filing separately that applies to a legally married couple.
As a result of the Supreme Court’s ruling, same-sex couples now must make the same cost-benefit analysis that applies to opposite-sex couples in determining whether to file jointly. A single taxpayer crosses the earnings threshold into the 39.6 percent tax bracket when he or she earns more than $400,000 for the year — meaning that two single 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, if a couple is not married, they can earn $400,000 ($200,000 each) before their itemized deductions and personal exemptions become subject to the phaseout rules that gradually reduce their value. Once that same couple is married, the penalties kick in at $250,000 — total.
The investment income tax will also apply to a married couple earning a combined $250,000 (while two unmarried taxpayers could earn $400,000 before crossing the threshold).
Same-sex couples who marry may find that a greater portion of their Social Security benefits may be subject to taxation, as the couple’s combined income could cause them to pass the thresholds that apply in determining whether (and to what extent) these benefits are taxable.
However, same-sex couples may now take advantage of Social Security spousal benefits. A married spouse who never worked (or who isn’t 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.