The DOMA Decision and Its Income Tax, Estate and Employee Benefits Implications
by Cynthia Lande >
Download a PDF of this article
On July 29, the U.S. Supreme Court ruled in the case of U.S. v. Windsor that Section 3 of the Federal Defense of Marriage Act (“DOMA”) is unconstitutional on equal protection grounds. Section 3 of DOMA states that for purposes of federal law, “marriage” is defined as a legal union between one man and one woman as husband and wife, and “spouse” refers only to a person of the opposite sex who is a husband or a wife.
The facts of U.S. v. Windsor involved two women who were New York residents and had married in Canada. One of the women died in 2009 and left her entire estate to the other. The surviving spouse sought to take a marital deduction on the decedent’s Federal estate tax return but was barred from doing so under DOMA. She paid the estate tax owed and filed a claim for refund, which eventually made its way to the U.S. Supreme Court on appeal. In a 5-4 decision, the Supreme Court ruled that Section 3 of DOMA is unconstitutional as a violation of the Fifth Amendment to the U.S. Constitution.
The Supreme Court’s decision in Windsor has major implications for taxpayers and employers in the United States. This article outlines some of those implications relating to income taxes, estate planning and employee benefits.
Income Tax Changes
Filing Status. Same-sex spouses will now be considered married for purposes of determining the appropriate filing status. This means that same-sex spouses will be required to file their annual income tax returns using the married filing separately or married filing jointly filing status going forward. Additionally, surviving spouses of same-sex marriages may be able to file under the qualifying widow/widower status for the two years following their spouse’s death. Same-sex spouses should also consider whether to amend prior-year returns. Recent IRS guidance indicates that same-sex spouses will be allowed to amend prior-year returns for any open tax years (generally returns filed in the three prior years).
Income Thresholds & Phase-Outs. Many income tax deductions are subject to income thresholds, floors or phase-outs. Most thresholds, floors and phase-outs are determined on separate scales for single and married filing jointly taxpayers. Depending on the annual income levels of the spouses, the modified thresholds, floors and phase-outs for married filing jointly taxpayers may increase or decrease the availability of certain income tax deductions and credits.
Tax Rules at Divorce. Alimony is generally taxable to the recipient and deductible for the payer. These rules apply only to spouses and can be altered by a divorce decree. It may be appropriate to review prior divorce decrees to determine whether alimony payments are being treated appropriately for tax purposes in light of the Windsor decision.
Estate Planning Changes
Marital Deduction. The issue at the center of the Windsor decision was whether the marital deduction under Internal Revenue Code Section 2056 applied to assets left by one same-sex spouse to the other. The Supreme Court confirmed that same-sex spouses are entitled to the unlimited marital estate tax deduction.
Portability. Portability (a concept made permanent by the American Tax Relief Act of 2012) allows the estate of a surviving spouse to use the unused estate tax exclusion of the predeceased spouse. Following Windsor, the concept of portability applies to same-sex spouses, creating additional estate planning opportunities for same-sex spouses.
Gifting. Spouses are allowed a combined annual exclusion from gift taxes of $28,000 for 2013. If one spouse makes a gift to a third party, the gift can be treated as made one-half by the spouse making the gift and one-half by the other spouse. This is often referred to as “gift-splitting.” Following Windsor, same-sex spouses can also benefit from gift-splitting up to the annual exclusion amount.
Employer-Provided Health Benefits. Employer provided health benefits are only excluded from an employee’s taxable income if the benefits cover the employee, the employee’s spouse or the employee’s dependents. Prior to Windsor, employer-provided health benefits covering a same-sex spouse could only be excluded from the employee’s taxable income if the spouse also qualified as a dependent of the employee for tax purposes. Following Windsor, employer-provided health benefits covering the same-sex spouse of an employee may be excluded from the employee’s taxable income. This change may be reason for both taxpayers and employers to amend prior-year returns. Recent IRS guidance indicates that special administrative procedures are available to employers seeking a refund of overpayments of FICA taxes and income tax withholding with respect to benefits and compensation provided to same-sex spouses.
Cafeteria Plans, Health Savings Accounts, and Flexible Spending Accounts. Following Windsor, same-sex spouses may benefit from an employer’s cafeteria plan, health savings account, or flexible spending account.
Payment of Retirement Benefits. Specific retirement benefit distribution methods apply to married individuals. A few examples are the default distribution method under qualified plans, rollover options, and hardship withdrawals. With same-sex spouses now treated as married for federal law purposes, the distribution methods available to same-sex spouses under a qualified plan may be significantly different than previously.
Qualified Plan Spousal Protections. A number of protections apply to the spouses of participants under qualified plans. For example, spouses must consent to the selection of non-standard payment forms and the selection on non-spouse beneficiaries. Following Windsor, these same protections apply to same-sex spouses.
What To Do
Following Windsor, there are steps that same-sex spouses and employers should be taking.
Same-Sex Spouses. Same-sex spouses should review their estate plans, prior-year tax returns and qualified benefits. It may be appropriate to amend the estate plan or prior year returns. It may also be appropriate to review elections under qualified retirement plans to ensure that the applicable distribution method under the plan has not changed.
Employers. Employers in states that recognize same-sex marriage (like Iowa) should review their benefits documents and procedures to make sure that they treat same-sex spouses the same as other spouses. Employers may also choose to distribute information to employees notifying them of the changes following the Windsor decision. Lastly, employers should consider whether it may be appropriate to amend prior year employment tax returns under certain IRS guidance.
Because not all agencies have released guidance on implementing the Windsor decision and uncertainty regarding implementation remains, both same-sex spouses and employers should continue to watch for guidance in areas that may impact them.
Cynthia B. Lande is an associate at BrownWinick and has a general practice including, but not limited to, general business transactions, taxation, employee benefits and estate planning. Cynthia can be reached at (515) 242-2476 or lande@brownwinick. com.