On August 30, the IRS issued guidance in the wake of the U.S. Supreme Court’s decision to overturn Section 3 of the Defense of Marriage Act (DOMA). The guidance, provided in Revenue Ruling 2013-17, offers more clarity on the tax impacts and makes financial planning for those affected more effective. In it, the IRS ruled that all same-sex married couples will be treated as married for federal tax purposes whether or not that couple resides in a jurisdiction that recognizes same-sex marriage. It is important to note that this does not extend to civil unions, domestic partnerships, or similar formal relationships recognized under state law.
Had the IRS issued guidance based on a “state of residence” rule, same-sex couples who legally marry and subsequently relocate to states that do not allow marriage for same-sex couples would not be allowed to file their tax returns as married. The effect is that all legally married couples may enjoy federal taxation benefits (and sometimes penalties) without regard to the state in which they currently reside. The definition of legal marriage resides with each individual state but is also extended internationally, as any couple that is legally married in any of the U.S. states or in any U.S. territory or foreign country will be recognized.
Financial Planning Effects
Now that the IRS has made the effects of this groundbreaking Supreme Court decision more transparent, financial planning will be made a little bit easier. The immediate impact is that legally married same-sex couples may (but are not required to) file amended returns for past years to recoup any taxes paid filing as single individuals instead of married filing jointly. For the current year and all future years, all couples that are legally married must file using one of the two married filing statuses, even if that results in a negative financial outcome. Additionally, certain social security, disability, employer-sponsored health care, and other benefits will now be available to all legally married couples. The IRS announced that it intends to issue further guidance on the application of the Windsor case to employee benefits and related plans.
Income taxes are not the only realm of taxation materially affected by the recent guidance. The initial case of Windsor vs. United States highlighted the effects that this ruling could also have on estate planning. All legally married couples can now use trusts and other estate planning mechanisms to reduce their ultimate tax burden. While the guidance provides a consistent application of federal income taxation, an important side effect that the guidance creates is that estate and income tax planning becomes separate and distinct for federal and state purposes if the state of residence does not legally allow marriage for same-sex couples.
Impact on NaviPlan and Profiles
Due to the complexities surrounding the IRS regulations, Zywave will provide additional information going forward on how NaviPlan will change in response to this recent guidance. Additional development will be necessary to account for the new scenarios that have arisen. Due to the possibility that filers may have a different filing status between federal and state returns for income tax purposes and may have very different rules for estate tax purposes, a simple ‘fix’ is unlikely.
In the meantime, temporary workarounds do exist. For couples legally married and that reside in the 13 states and the District of Columbia that legally recognize same-sex marriage, entering a status of married filing jointly or married filing separately will treat the taxation of income and the estate properly. However, couples that are legally married and that reside in states that do not recognize same-sex marriage will not currently be able to completely and accurately model their tax situation. To most closely do so, entering one of the married tax statuses will be the most acceptable option. While this will incorrectly treat the state filing status as married, this option is preferred because federal taxes generally have a higher impact. Further, users can enter any filing status for any gender, and therefore federal benefits will be reflected accordingly.
As state income tax is not modeled in Profiles, the recent IRS guidance does not have any impact. If the clients are legally married, then the planner would select a marital status of Married (in Professional this is on the Assumptions page) to properly reflect federal tax effects. In both NaviPlan and Profiles, it is up to the user to determine whether or not the married couple does in fact meet the requirements of being legally married according to individual state law.
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