Supreme Court Ruling on DOMA: Sudden Tax Impact

By Ken Berry
The Supreme Court's landmark decision striking down the Defense of Marriage Act (DOMA) will have far-reaching implications on many fronts. In particular, you may be scrambling to figure out the resulting tax impact under federal and state laws. On June 27, the IRS announced that it will move quickly to provide some much-needed guidance on tax aspects affected by the new ruling.
Here's what happened in the Supreme Court case: A same-sex marriage widow sought to claim the estate tax exemption for a surviving spouse. But the claim was barred by DOMA, which defines "marriage" for federal purposes, strictly as a legal union between one man and one woman as "husband and wife." The estate paid the requisite estate taxes, and the widow sued for a refund. Both a federal district court and the Court of Appeals for the Second Circuit ruled the applicable section of DOMA to be unconstitutional. Now the Supreme Court has essentially agreed (U.S. v. Windsor, No. 12-307 6/26/13).
This opens up the floodgates as far as tax practitioners are concerned. From an income tax standpoint, same-sex couples who are legally married will be eligible to file joint federal tax returns, presumably beginning with 2013 returns to be filed in 2014. Accordingly, filing a joint return will affect other parts of the taxpayer's return, including application of tax rates, netting of capital gains and losses, calculation of tax on Social Security benefits, computation of adjusted gross income (AGI), and numerous deductions and credits.
Similarly, the Windsor case could affect other estate and gift tax matters besides the exemption for a surviving spouse's estate. Under federal law, any transfer between legally married spouses is exempted from estate and gift taxes. It also raises the issue of whether a surviving spouse's estate can benefit from any remaining balance of the exemption from a deceased spouse's estate under the "portability" provision recently extended by the American Taxpayer Relief Act. 

What Can You Expect from the IRS?

The IRS certainly has its work cut out for it in the wake of the new decision on DOMA. Here are some of the areas where the agency is expected to provide guidance:
  • Income tax filing status
  • IRAs, 401(k) plans, and other retirement plans
  • American Opportunity Tax Credit (AOTC)
  • Child and dependent care credit
  • Estate tax marital exclusion
  • Estate tax portability
  • Health savings accounts (HSAs)
  • Adoption tax benefits
  • Family stock attribution rules
  • "Innocent spouse" rule
  • FICA payroll tax refunds 
  • Provisions under the Patient Protection and Affordable Care Act (PPACA)
Caution: This list is by no means all-inclusive. Don't be surprised if you run across other "problem" areas.
Furthermore, critical issues will arise concerning benefits available to employees through insurance plans, qualified retirement plans, and other fringe benefit plans. The IRS will work in conjunction with other government agencies to help guide employers and employees through the changing landscape.
The main question in the minds of many professional tax return preparers is whether or not a same-sex couple should file a joint federal return. Frequently, doing so will provide a reduced tax liability for clients. For instance, if a couple owns their principal residence jointly and sells it, they may qualify for tax exemption of up to $500,000 on the sale proceeds, double the $250,000 exclusion for an individual filing as a single person. In another example, if one spouse realized a $10,000 gain from the sale of securities and a spouse is showing a $10,000 loss on the books, selling the stock at a loss would completely eliminate the capital gains tax for the spouse with the $10,000 gain. This benefit isn't available for same-sex partners filing separate returns.
But you can't assume that all same-sex couples will fare better tax wise in the wake of the new case. Due to the existence of the "marriage penalty" within the tax rates, a couple where each spouse earns a substantial amount of income could increase their overall tax liability by filing a joint tax return. 
Finally, it's not yet clear how the IRS will treat same-sex couples who are legally married in states that recognize such marriages – for example, New York – but reside in a state that does not, such as Florida. The Supreme Court's ruling involved a couple who lived in a state that recognizes same-sex marriages. These and other issues regarding the application of federal and state law will have to be clarified. We should have more to report soon.
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