Whether to Wed: 5 Tax Issues Facing Same-Sex Couples
In August, the U.S. Internal Revenue Service took a meaningful step toward marriage equality in America. The IRS reported that same-sex couples legally married in recognition states will be treated as married for federal tax purposes. The ruling came a few months after the Supreme Court struck down Section III of the 1996 Defense of Marriage Act (DOMA), which contained the provision effectively barring same-sex married couples from receiving federal marriage benefits.
It was a step forward, but there’s still a long way to go on the road to marriage equality. DOMA still grants states the right to refuse to recognize same-sex marriage, and as of March, a majority of states exercised this right, although court decisions are pending in a number of states regarding the issue.
As the nation sorts out its political and legal future, same-sex couples who wish to marry face a difficult and complicated legal environment. Wall St. Cheat Sheet was able to speak with Scott Squillace, a lawyer and author of Whether to Wed: A Legal and Tax Guide For Gay and Lesbian Couples, about the legal and tax issues facing same-sex couples who are either already married or are thinking about getting married.
1. “Place of domicile” versus “place of celebration”
The lack of blanket recognition for same-sex marriage has created a complicated patchwork legal environment that is one of the biggest problems facing same-sex couples today. Because different states have different laws regarding same-sex marriage, one of the most common questions is whether a same-sex marriage performed in a recognition state is still recognized in a non-recognition state. The answer is somewhat tautological: for most state-level issues (which marriage is), no; for some federal issues, such as income taxation, yes.
The IRS addresses the issue in its FAQ on same-sex marriage. If a same-sex couple is married in a recognition state, the federal government will recognize the marriage for tax purposes no matter where they live, even if they live in a non-recognition state. So if you marry in Massachusetts but move to Texas, you can still file jointly, if you wish.
But there is other legal and financial friction involved with living in a non-recognition state. For example, since divorce, like marriage, is managed at the state level, same-sex divorce in a non-recognition state “can be tricky, or even impossible,” according to Squillace. The state can’t dissolve a marriage it doesn’t recognize. Friction like this can arise in any instance in which the state has authority over the law, which includes some taxes, property laws, and laws relating to healthcare.
2. The marriage penalty
Now that the IRS recognizes same-sex marriages for federal tax purposes, some couples could find their tax bill going up. The IRS treats income from married people different than income from those who are unmarried, and while marriage opens the door to certain tax benefits, it could also unfortunately mean higher taxes if both people are earning wages.
For example, if you and your partner each earned $80,000 in 2013, you would fall into the 25 percent tax bracket if you filed individually. As joint filers, however, with a combined income of $160,000, your marginal tax rate would increase to the 28 percent bracket. If you itemize deductions, federal recognition of your marriage may suddenly put you within striking distance of the alternative minimum tax (AMT).
3. Capital gains
While there are some possible financial downsides to marriage, there is at least one definite financial upside: capital gains. When you sell your home and make a profit, you are allowed to exclude a certain amount of that money from your taxable income. The amounts are $250,000 if you are an individual and $500,000 if you are married and filing jointly. This is a sweet, sweet deal for those who are being forced to relocate for work or to accommodate a growing family. These profits can go a long way toward covering moving expenses, the purchase of a new home (or a downpayment on one), or could be put to use in a college fund or retirement account.
4. Estate taxes
Currently, twelve recognition states and four non-recognition states levy their own estate taxes. These taxes can kick in for estates valued as little as $910,725 (in Rhode Island) and can be as high as 19 percent (Washington). One of the benefits of marriage is that surviving spouses are allowed an unlimited deduction on estates. This can be a big factor in deciding whether to marry.
5. The value of a qualified financial adviser
The big takeaway from all of this is that there are a number of legal and financial headwinds that same-sex couples should be prepared to face should they choose to marry. It’s a lot to process, and the situation can overwhelm the financially literate and legally savvy. Squillace’s book doesn’t have all the answers, and he encourages same-sex couples to seek legal and financial advice as they head toward marriage or consider estate planning.
But not all financial advice is the same, and Squillace argues that same-sex couples should seek an adviser who has experience dealing with the marriage laws in their particular state. But this can be tricky. Legal and financial services for same-sex couples is a growing business, and financial institutions are eager for new customers. Big banks in particular, Squillace says, are “spending considerable marketing dollars advertising to the LGBT community, and they all purport to have a practice in this area, but I’ve found that few of them have actually done training with their folks on what the different issues are.”