Planning for Same-Sex Couples and the Current State of the Defense of Marriage Act

still Developing Laws Create Challenges and Opportunities for LGBT Couples and Estate Planners

 Estate and tax planning for same-sex couples can be an increasingly challenging endeavor given today’s political environment, with couples’ legal rights constantly evolving from state to state, and discussions surrounding the federal government’s recognition of such state rights also being hotly debated.  Same-sex couples, in states that have recognized gay marriage, such as Massachusetts and Rhode Island, must be concerned with planning in light of the federal government’s refusal to acknowledge the validity of their state sanctioned unions.  Whereas a straight married couple can often fall back on default provisions in the law in the event that proper estate planning has not been done, same-sex couples have no such level of minimum protection.  Likewise, same-sex couples are forced to play by different rules when it comes to federal tax laws, as the federal government does not recognize same-sex couples’ state marriages.

Enforcement of the Defense of Marriage Act

While gay and lesbian couples have traditionally not been afforded the same benefits bestowed upon their straight-couple counterparts, the tide may be turning.  In March of 2012, the Obama administration announced that it would no longer defend the constitutionality of The Defense of Marriage Act (DOMA), signed into law by President Clinton in 1996; however, just what this means in terms of the federal government’s recognition of same-sex marriages is still unclear.  Under DOMA, the federal government defines and recognizes marriage as a legal union between one man and one woman only, and also sets forth that no state may be required to recognize a same-sex marriage performed in another state.

In a letter from Attorney General Eric Holder to Congressional House Speaker John Boehner last month, Holder stated that while President Obama considers the law unconstitutional, he has nonetheless instructed federal agencies to continue to comply with it.  Thus, absent a Congressional repeal of DOMA, it appears same-sex couples and members of the LGBT community will continue to be without the protection and legal recognition afforded to other married couples for the foreseeable future.

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Recognition of Marriages by States vs. Federal Government

From an estate and tax planning point of view, the practical effects of such a lack of recognition by the federal government are numerous, and should be carefully considered.  Any property left outright to a same-sex partner is potentially subject to the federal estate tax regardless of the legitimacy of that couple’s union under state law, because such a transfer would fail to receive the benefit of the marital deduction, which allows spouses to transfer assets to one another tax free at death.  While the estate tax is currently only levied on estates greater than $5 million, the future of the federal estate tax is uncertain, and the exemption amount may well be lower in years to come.

Furthermore, any jointly owned property will be fully taxable in the first partner to die’s estate unless the surviving partner can show that he or she owned half of such property.  Property owned jointly by a married couple is presumed to be owned 50% each, however, again, since the federal government does not recognize same-sex marriages, this automatic presumption does not apply.

In order to avoid such consequences, same-sex couples with sizeable estates should maximize their tax savings by using traditional planning techniques.  Some of those techniques include lifetime gifting within the annual exclusion amount, the use of irrevocable trusts, grantor retained annuity trusts or qualified personal residence trusts.

By taking advantage of the gift tax annual exclusion amount, a donor can gift up to $14,000 to one or more individuals without incurring a gift tax or using any of his or her lifetime exemption on gift or estate taxes.  This is a simple way to shift wealth away from one’s taxable estate.  Placing assets into an irrevocable trust will not only remove assets from one’s taxable estate, but will also have the added benefit of controlling the assets’ disposition on the Grantor spouse’s death, and will protect the trust assets from creditors in the event that the Grantor spouse has a spendthrift partner.  A grantor retained annuity trust (GRAT) is an irrevocable trust in which a grantor can transfer assets which generate income and have substantial value and appreciation potential, while retaining an interest for a period of years and reducing future estate taxes; similarly, a qualified personal residence trust (QPRT) holds gifted real estate that will ultimately pass to the trust’s beneficiaries outside of the Grantor’s taxable estate, with the amount of gift taxes assessed on the initial transfer of property having been reduced because of the Grantor’s retained interest in the property (his or her right to continue living in the property during lifetime).  All of these planning mechanisms are useful ways of reducing the size of one’s estate will still controlling the assets as if they were owned by the Grantor.

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Massachusetts Planning for Couples in Same-Sex Marriage

Even same-sex couples without sizeable estates need to be cognizant of the various pitfalls arising out of a lack of proper planning.  Although Massachusetts began recognizing same-sex marriages as early as 2004 in Goodridge v. Dept. of Public Health, 440 Mass. 309 (2003), estate planning for same-sex couples has still proved complicated.    Because marriage revokes a will unless it was made in contemplation of marriage, same-sex couples who had previously created wills should be aware of the need to execute new wills after the marriage becomes effective.  Alternatively, if same-sex spouses pass away in Massachusetts without having executed wills, they should be aware that in light of the Goodridge decision, the Massachusetts intestacy statute now gives significant rights to their surviving spouse, allowing the surviving spouse to opt for Massachusetts’ spousal elective share, regardless of the couple’s intentions.

The law in Massachusetts surrounding the rights of same-sex couples did not end with the Goodridge decision, however.  After the decision was handed down, it became evident that further legislative action was necessary to fully embody the spirit of the Court’s decision.   In July of 2009, Governor Deval Patrick signed the MassHealth Equality Bill into law, mandating that state agencies such as MassHealth recognize same-sex marriages.  Given this change in law, same-sex couples should be aware of the MassHealth regulations governing long-term care qualifications, as they will now receive the same treatment and benefits as straight married couples when applying for MassHealth programs, as will be further discussed below.

Rhode Island and the LEGALIZATION OF SAME-SEX MARRIAGE

Prior to a July 2011 bill passed by the Rhode Island General Assembly authorizing civil unions, a couple legally wedded in Massachusetts would have lost their minimal statutory inheritance rights simply by moving into Rhode Island, where such statutory rights did not previously apply to same-sex partners. Rhode Island recently took the next step in leveling the playing field for gay couples, and on May 2, 2013, became the tenth state in the Union to legalize gay marriage. Governor Lincoln Chafee signed the bill into law following overwhelming approval in the House effective August 1, 2013.

Significant in the bill is Section 15-1-8, which states that any two persons having a legal union other than marriage that “provides substantially the same rights, benefits and responsibilities as a marriage” entered into in another state shall be recognized as a valid marriage in Rhode Island. Thus, in nearby states such as New Jersey, couples who have entered into a civil union will be afforded all of the rights and privileges as married couples should they choose relocate to Rhode Island.

Furthermore, under Section 15.3.1-12, civil unions entered into prior to Rhode Island’s legalization of same-sex marriage may be merged into full-fledged marriage upon application for a marriage license; however, the marriage date will be effective as of the date of the recording of the marriage certificate, not the date of the civil union.

From an estate planning standpoint, it remains to be seen whether there will be a smooth transition in terms of the state’s recognition of the legal rights that flow from same-sex couples’ new status under Rhode Island law.

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SAME-SEX RIGHTS IN FLORIDA

Unlike Massachusetts and Rhode Island, Florida does not allow same-sex marriage or civil unions, making same-sex couples' planning options far more limited.  Florida voters passed an amendment to their state constitution in November 2008 defining marriage as between one man and one woman, adding that no other union "treated as marriage or the substantial equivalent shall be valid or recognized."  Thus, same-sex couples married in Massachusetts or Rhode Island will not enjoy the legal rights and privileges recognized by their home states should they decide to relocate to Florida.  

Although the marriage and civil union issue has not been favorable for same-sex couples in Florida, the battle over adoption rights has proven otherwise.  In 2010, a Florida state appeals court upheld a lower court ruling which held that Florida's decades-long ban on adoptions by same-sex couples was unconstitutional. Neither the Florida Governor nor the Attorney General appealed the ruling.

While the legal rights afforded same-sex couples in Florida are more limited than those afforded same-sex couples in many northeastern states, Florida's overturn of the long-standing adoption ban is nevertheless encouraging, and evidences that state's more incremental approach to awarding full-fledged rights to same-sex couples.  Same-sex couples in Florida can and should, however, rely on the many available planning techniques, such as wills, trusts, powers of attorney, and health care proxies, which assist in setting forth their wishes that would not otherwise be recognized in the absence of such documents.  In addition to these basic techniques, Florida same-sex couples should also consider utilizing cohabitation agreements, which are more fully discussed below.  

Planning Concerns

In terms of long-term care planning, same-sex couples can now combine their total assets for eligibility purposes, making qualification for MassHealth coverage much easier.  Additionally, MassHealth no longer punishes transfers between same-sex spouses, as has traditionally been a benefit only for straight couples.  This means that a spouse facing a potential long-term stay in a nursing home may transfer his or her home to the non-institutionalized spouse so as to avoid MassHealth’s placing a lien on the property to cover the cost of care for the institutionalized spouse.  Prior to the law taking effect, same-sex couples faced a five-year look back period on all transfers of property, meaning that any transfers of property created a disqualification period.

Interestingly, the change in law does have drawbacks for same-sex couples. Because MassHealth imposes asset limits between spouses, it may make sense to remain unmarried for qualification purposes.  Under the agency’s regulations, the at-home spouse is allowed to have approximately $110,000 in assets, while the institutionalized spouse is only allowed to have $2,000 in assets.  Conversely, an unmarried couple would have no restrictions imposed on the amount of assets the at-home partner would be allowed to hold; thus, if most of the couple’s assets are already titled in the name of the at-home spouse, it could be advantageous to remain unmarried.

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Lifetime Planning Considerations

There are also significant considerations that same-sex couples should be mindful of during their lifetimes.  For instance, children are typically thought of as the only dependents one can claim on a tax return, but even a same-sex spouse can be claimed as a dependent, resulting in a sizeable tax deduction.  In order to claim a spouse as a dependant, however, the taxpayer must provide over half of the year’s household income, and the dependent spouse’s principal residence must coincide with the claimant-taxpayer’s.  In addition to making annual exclusion gifts to shift money away from the wealthier same-sex spouse’s estate, same-sex spouses can also receive deductions for paying one another’s medical, dental, or educational expenses, provided such payments are made directly to the provider of such services.

Maximizing income tax deductions for same-sex couples is also a critical consideration.  Because same-sex couples are not permitted to file joint federal income tax returns, it is important to title shared property into the name of the partner or spouse who will be able to most fully utilize any tax deductible expenses, such as payment of real estate taxes.  The couple should be mindful, however, that the individual paying the real estate taxes is the same individual whose name the home is titled in.  If the non-owner pays the taxes, no deduction would be allowed and the payment would actually be considered a taxable gift to the owner-spouse.

Similarly, any charitable contributions the same-sex couple intends to make during any tax year should be made by the spouse who will receive the greater income tax benefits from such contributions.  Thus, titling property and claiming deductions properly can help a same-sex couple greatly when it comes time to pay taxes to the federal government.  Even realigning the title in assets between same-sex spouses can benefit the couple greatly, especially when one spouse has significant gains and the other spouse has corresponding losses.  Although, such a realignment might give rise to gift taxes, the potential income tax savings that might result from these transfers may well outweigh the tax implications.

Community Property Treatment

In a few states, same-sex couples now benefit from a new IRS ruling regarding community property.  In the community property states of California, Washington and Nevada, same-sex couples who are married or have a registered partnership with the state are now recognized by the IRS to the extent that they are community property owners.  This is extremely advantageous for same-sex couples where one partner is in a high income tax bracket and the other is either a stay at home spouse or in a lower income tax bracket.

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As a result of the IRS ruling recognizing same-sex couples as community property owners, all property and income is considered to be earned half by each spouse. The practical effects of such a ruling mean that for a hypothetical couple where one spouse earns $100,000 per year and the other spouse has no income, for tax purposes they will each report earnings of $50,000 on their returns, resulting in a sizeable savings for the couple of several thousand dollars.  Prior to the IRS ruling, each spouse simply reported whatever he or she earned and paid the corresponding income tax.

Despite this favorable IRS ruling on community property for same-sex couples, it remains unclear whether, for tax purposes, surviving spouses in same-sex marriages in these states will receive a full step up in basis in community property upon the first spouse to die.   Traditionally, when one spouse passes away leaving community property to his or her surviving spouse, the 50% share left to the survivor receives a full step up in basis, meaning that the property’s basis becomes its fair market value on the date of the deceased spouse’s death, which can be extremely advantageous if the property had appreciated greatly during the deceased spouse’s lifetime.

Decision Making For Same-Sex Spouses

Often lost in the seemingly more important world of taxes and financial planning is the need for same-sex couples to establish health care proxies and powers of attorney.  A health care proxy allows another individual to act on your behalf when making medical decisions in the event that you are unable to act for yourself.  In the absence of an established health care proxy between same-sex partners, courts will typically look to an incapacitated person’s closest biological family member to make medical decisions for them, especially in states where same-sex marriages are not recognized.  Thus, designating a same-sex partner as one’s health care proxy ahead of time is crucial not only to make one’s wishes known, but to ensure that the proper person is carrying those wishes out.

Likewise, a power of attorney is also critical in order to guarantee that a same-sex partner is able to act on his or her incapacitated partner’s behalf when it comes to handling financial matters, such accessing certain bank accounts, having the authority to make decisions with regard to real estate, or selling assets.

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Cohabitation Agreements

In the absence of civil unions or full-fledged marital rights for same-sex couples, another useful planning tool is a cohabitation agreement.  Cohabitation agreements function much the same way prenuptial agreements do, allowing couples who have chosen to live together, to create contracts concerning their respective rights and obligations in the event the cohabitation breaks down.

Cohabitation agreements commonly contain provisions governing support and maintenance agreements between cohabitants, property division, and childcare duties.  By preparing such an agreement in advance, same-sex couples can often avoid the same kind of turmoil that married couples often go through upon divorce. Same-sex cohabitants should be aware, though, that not all rights and obligations can be dealt with through these kinds of agreements.  Traditional planning of the aforementioned kind, utilizing wills and trusts, is strongly recommended.

Conclusion

These are just some of the many considerations same-sex couples must evaluate in a different light than couples whose partnerships are recognized by law.  Given that the law surrounding civil unions and same-sex marriage is so muddled on both a state and federal level, it is essential that LGBT couples consult legal counsel to ensure that any planning they put into place will be effective and efficient.  The number of potential traps for the unwary are infinite, and until DOMA is fully repealed, same-sex couples would be wise to take advantage of the various estate and tax planning techniques that can put them on virtually the same footing as straight couples. 

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