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Tax Considerations for Same-Sex Couples

by Jonathan March, Brad Cless
September 13, 2022

Tax treatment as a married couple can provide numerous tax-saving opportunities, but in some cases, it can result in negative tax consequences. Below we summarize tax benefits and things to be aware of in a handful of key areas.

Consistent Filing Status Across All U.S. Filings

The filing status of a same-sex married couple should be the same for federal and state purposes (states are not able to treat same-sex married couples as single individuals).

The IRS ruled that it will not treat same-sex domestic partner relationships as a same-sex marriage; those in a domestic partner relationship must get legally married in order to be treated as married for federal purposes.

Tax Opportunities of Filing a Joint Tax Return

For some same-sex married couples, the opportunity to file a joint return may create a tax savings depending on the makeup of their income, deductions and the credits of both spouses that can be reported on the tax returns. Generally, filing using the married filing separately returns creates more limitations on each spouse related to itemized deductions, loss limitations and available credits. A married filing jointly return reports all income, deductions and credits of both spouses on the same tax return. In some cases, jointly filing a federal income tax return can result in a lower combined tax bill than if the couple were unmarried. This typically occurs when one spouse earns most or all of the income.

Divorce

While each state has their own rules about how to approach divorce, same-sex divorce is allowed in all states. There may be complications in a same-sex divorce if there was a domestic partnership or civil union registered with the state prior to the legalization of same-sex marriage. As with any divorce, the same-sex couple should consult legal counsel about the process and complications specific to their situation. Certain court-ordered payments to an ex-spouse can qualify as deductible alimony. In contrast, transfers of money between unmarried individuals generally aren’t deductible and may be treated as gifts for federal tax purposes.

Social Security

Same-sex married couples receive the same benefits from the Social Security system as those in opposite-sex marriages. These benefits of marriage might include higher benefit amounts based on the relationship status, children of the same-sex couple receiving benefits and benefits available for surviving or divorced spouses.

Employee Benefits

Many companies offer employee benefits that can include a spouse, such as health insurance and life insurance. Federally recognized marriages of same-sex couples qualify for the same employee benefits as those of opposite-sex couples. Depending on the state, similar employee benefits are allowed for same-sex couples in a domestic partnership.

Federal tax law allows one spouse to receive certain tax-free benefits from the other spouse’s employer. The most common examples are tax-free health care coverage and tax-free reimbursements from health care flexible spending accounts (FSAs). Same-sex married couples should look into whether they, as a federally recognized married couple, are now eligible for any new employer benefits. They also might be able to file amended returns and receive a refund for previous years when taxes were paid on benefits.

Retirement Plans

The same rules that apply to opposite-sex married couples apply to same-sex married couples relating to retirement plan distributions. The SECURE Act of 2019 creates more beneficial options for surviving spouses who inherit retirement accounts, which are attributed to same-sex couples who were married when the account owner died. The surviving spouse has more flexibility and can use their life expectancy for required minimum distributions (RMDs).

When one spouse dies, the surviving spouse can roll over qualified retirement plan balances — such as from 401(k) plans — inherited from the deceased spouse into his or her own IRA. Then, the surviving spouse can put off taking annual RMDs from the rollover IRA until after he or she reaches age 70 1/2.

In contrast, when a non-spouse inherits a qualified retirement plan balance and transfers it to a rollover IRA, he or she will usually have to start taking RMDs sooner and in larger amounts. This means that the non-spouse loses the benefit of tax deferral and may also be subject to more income tax as a result of having to take the distribution.

Similar tax treatment applies to IRAs. When one spouse dies, the surviving spouse can also roll over IRA balances inherited from the deceased individual into his or her own IRA. Once again, the RMD rules that apply in this situation allow surviving spouses to defer distributions longer than non-spouses who inherit.

Same-sex married couples who may be eligible should review their retirement plan beneficiaries and planning strategies related to these accounts and determine if any changes should be made. While there is still much uncertainty, anyone who had previously inherited a retirement plan from a same-sex spouse should review whether that IRA might qualify for deferral as a spousal rollover going forward.

Marital Deduction

Another benefit of same-sex couples being married is the availability to use the marital deduction at the first spouse’s death. The marital deduction allows the entirety of the estate of the first spouse to die to transfer tax free to the surviving spouse. In a community property state, assets held directly by both spouses get a step up in basis to the fair market value at the date of death of the first spouse to die.

In addition, when one spouse dies, his or her estate can elect to allow the surviving spouse to use any unused estate tax exemption. The surviving spouse can use the exemption to shelter more gifts from the federal gift tax and have more estate tax exemption available when he or she dies. Same-sex married couples with larger estates may benefit from reviewing and revising their estate plans in light of the new tax breaks that may be available to them. They also may be able to obtain refunds for taxes previously paid.

Gift Splitting

The benefit of being married is being able to double the annual gift to each person or family member by each spouse gifting up to the full amount without using up any lifetime exemption of either spouse. Same-sex married couples can split gifts of separate property, which is a benefit available only to married couples.

U.S. citizen spouses can make unlimited transfers to each other during life or at death free of federal gift and estate tax under the marital deduction.

Marriage Penalty

One big disadvantage of being considered married for federal tax purposes occurs when both spouses have healthy amounts of taxable income. In this scenario, a married couple can owe a larger combined federal income tax bill than if the two individuals were single taxpayers. As a result, same-sex couples now considered married for federal tax purposes could find themselves facing larger tax bills. In these situations, smart tax planning is critical.

For questions or tax planning assistance, contact our Private Client Advisory Tax team.

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