Legal Arrangements Other than Marriage

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American Indian reservations are not bound by the Supreme Court’s decisions on marriage. Nevertheless a few tribes recognize same-sex marriage but continue to deny insurance and other benefits extended to legally married couples. They include the Central Council Tlingit and Haida Indian Tribes of Alaska, the Coquille Tribe of Oregon, the Suquamish Tribe of Washington, the Cheyenne and Arapaho Tribes, the Confederated Tribes of the Colville Reservation (Washington); the Little Traverse Bay Bands of Odawa Indians (Michigan), Pokagon Band of Potawatomi Indians (Michigan), and the Iipay Nation of Santa Ysabel (California).

Gift, Estate, Income and Other Tax Ramifications of Domestic Partnerships and Civil Unions

The Internal Revenue Code essentially treats unmarried couples as legal strangers. In some, but not all instances, unmarried couples and couples in marriages that are not yet recognized, are able to organize their financial affairs to reduce overall tax liability in ways that couples in recognized marriages cannot. The following is a summary of a few of the federal tax ramifications of being in a non-marital relationship.

Gift and Estate Tax- The rules allowing transfers between spouses to avoid transfer or income taxes do not apply to unmarried couples. Accordingly, any transfers between partners may be taxable (subject to the section 2503(b) annual exclusion), the donor’s available applicable exclusion, and the exclusion from gift tax for tuition and medical expenses under section 2503(e). Furthermore, unmarried couples are not eligible to use the Deceased Spousal Unused Exemption Amount or split gifts on a federal gift tax return.

Capital Gains- Property passing at death receives a new cost basis for income tax purposes equal to the fair market value of the property as determined for federal estate tax purposes. As a result, the appreciation on the property occurring during the decedent’s life is sheltered from income taxation. This benefit is doubled for community property owned by a married couple at death, as both the decedent’s one-half and the surviving spouse’s one-half of all community property obtain the new cost basis at the decedent’s date of death. This is often referred to as the “double step-up”. This is a benefit unavailable to unmarried couples (however, it is available to couples in a registered domestic partnership in certain community property states).

Obligation of Support- Donative transfers between non-spouses may be taxable gifts if in excess of the annual exclusion ($14,000 in 2017). Yet, parties to a domestic partnership or civil union have a legal obligation to support each other under state law, and “gift tax is not applicable to a transfer for a full and adequate consideration in money or money’s worth”. Transfers in excess of the annual exclusion from one partner (and in excess of the value received from the other) may still be characterized as a gift under Code section 2503(b) if in excess of funds needed for basic support. In TAM 8135032 (June 1, 1981), the IRS suggests that where a legally enforceable obligation to support exists pursuant to local law, certain transfers would not be treated as gifts (however, the transfers at issue in this case were found not to be pursuant to legal obligations). In Private Letter Ruling 8225091 (March 25, 1982) the IRS determined that “to the extent that current income of the trust is applied in satisfaction of the donor’s legal obligation to support or maintain his parents there is no gift”. Thus support of a partner pursuant to local law should not be a gift.

Indirect Gifts Arising from Pooled Expenses

The value of taxable gifts between unmarried partners becomes difficult to quantify in the context of shared living expenses. When partners pool income and one party receives more income than the other, pooling may cause a net transfer to the party with less income, resulting in a taxable gift. This result may be partially ameliorated by entering into a contractual arrangement between the partners providing for mutual and adequate consideration. The amount of the gift is the difference between the value of the property transferred and the consideration received. However, the exchange of consideration sufficient to make a promised transfer enforceable for state contract law purposes will not necessarily prevent some part of the transfer from being a gift for federal tax purposes, unless the transferor receives consideration having an economic value equal to the property transferred.

To the extent a net transfer from the greater income earner to the lower income earner is viewed as being paid in consideration for the lower income earner’s love, emotional support, or other services upon which a monetary value may not be placed, the transfer is a gift.

If the contractual arrangement provides that the net transfer from the higher income earner to the lower income earner is an advance to be repaid upon the happening of some event, i.e. the lower income partner finishing school, or becoming gainfully employed, or the higher income partner retiring, the couple will be treated as being in a debtor-creditor relationship. These types of arrangements should be avoided unless the arrangement provides for adequate stated interest and the advanced sums will actually be repaid.

—Read Spousal Consent Rules and Marriage Contracts on ThinkAdvisor.

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