Planning for Same-Sex Couples and the Current State of DOMA Post-Windsor
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 rules surrounding the federal government’s recognition of such state rights also in flux. The newest challenges for same-sex couples arise in light of the United States Supreme Court’s recent decision striking down Section 3 of the Defense of Marriage Act (DOMA), which defined marriage as between a man and a woman. United States v. Windsor, 133 S.Ct. 2675 (2013). As a result of Windsor, the federal government now considers “lawfully married” same-sex partners as spouses when interpreting federal laws and regulations. Thus, same-sex couples must now revise their planning strategies so as to take into account the federal government’s newfound acknowledgement of same-sex marriages, post-Windsor (with some important caveats, discussed below). Previously, only a straight married couple could fall back on default provisions in the law in the event that proper estate planning had not been done, with same-sex couples having no such level of minimum protection. Same-sex couples were also forced to play by different rules when it came to federal tax laws and other federal regulations, as the federal government did not recognize their marriages, pre-Windsor. With the Windsor decision however, updated planning must be considered in what is still an uncertain legal environment.
Enforcement of the Defense of Marriage Act Post-Windsor
While gay and lesbian couples have traditionally not been afforded the same benefits bestowed upon their straight-couple counterparts, the tide has turned. In March of 2011, the Obama administration announced that it would no longer defend the constitutionality of DOMA, signed into law by President Clinton in 1996; however, that announcement alone did little to change the federal government’s lack of recognition of same-sex marriages. With the Windsor decision, which struck down Section 3 of DOMA as unconstitutional, the federal government no longer adheres to the strict definition of marriage as being between one man and one woman. Section 2 of DOMA remains unchanged by Windsor, however, which means that the states continue to be allowed to decide whether or not to recognize same-sex marriages.
Recognition of Marriages by States and Federal Government
From an estate and tax planning point of view, the practical effects of Windsor are numerous, and should be carefully considered. Prior to Windsor, property left outright to a same-sex partner was potentially subject to the federal estate tax regardless of the legitimacy of that couple’s union under their state’s law, because such a transfer failed 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 $5.25 million, the future of the federal estate tax remains uncertain, and the exemption amount may well be lower in years to come.
With the Windsor decision, same-sex couples “lawfully married” will now have the benefit of provisions like the marital deduction, but just how “lawfully married” will be interpreted by the federal government is unclear. In states such as Rhode Island and Massachusetts where same-sex marriages are lawful, couples will have no issues with the federal government’s recognition of their marriage for purposes of interpreting such IRS rules and regulations. The waters are murkier, however, when the couple’s marriage was celebrated in a “recognition” state, such as Massachusetts or Rhode Island, but where the couple returns to a “non-recognition” state, such as Texas, to live. Whether the IRS, which has no definition of “spouse” or “marriage,” will recognize the validity of a same-sex married couple residing in a non-recognition state is unclear. Guidance on these issues is expected from the IRS before the end of the year. Until such issues are cleared up, same-sex couples living in non-recognition states are advised to continue following previously recommended estate planning techniques, which assumed the federal government did not recognize their marriage.
For instance, any jointly owned property may still 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, since it is unclear whether the IRS will recognize same-sex marriages where the couple lives in a non-recognition state, the automatic presumption cannot be counted on.
Same-sex couples with sizeable estates living in non-recognition states should maximize their tax savings by using traditional planning techniques. Some of these 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.
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 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 Legalizes 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. The law will take affect on 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.
Additional Planning Concerns
In terms of long-term care planning in Massachusetts, 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 $115,920 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.
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 in non-recognition states may not be 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 these same-sex couple intend 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.
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.
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 both wills and trusts, is strongly recommended.
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. Same-sex couples living in states like Rhode Island and Massachusetts, which recognize same-sex marriage, can begin planning with some degree of certainty. Given that the law surrounding civil unions and same-sex marriage remains muddled on both a state and federal level, especially for those couples residing in non-recognition states, it is essential that LGBT couples consult legal counsel to ensure that any planning they put into place will be both effective and efficient. The number of potential traps for the unwary are infinite, and until the dust settles in the post-Windsor environment, 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.