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Supreme Court Decision on DOMA Impacts Tax Rules for Same Sex Couples

Federal tax rules for same-sex couples have recently been issued in response to the Supreme Court decision in Windsor, No. 12-307 (U.S. 6/26/13). This landmark case invalidated a key provision of the 1996 Defense of Marriage Act (“DOMA”) and resulted in major changes in the tax landscape for many same-sex partners.

These new tax rules were laid out in I.R. 2013-72  on August 29, 2013 and Revenue Ruling 2013-17 on September 16, 2013 and are effective on that date.  (Note that taxpayers who wish to rely on the terms of this Revenue Ruling for earlier periods may choose to do so, as long as the statute of limitations for the earlier period has not expired. More on this below.)

Although there are still some unresolved issues, the following will lay out many of the basic federal income tax rules for same-sex married couples:

  1. State of Celebration Rule:  Same-sex couples that are legally married in jurisdictions that recognize their marriages are treated as married for federal tax purposes.
    • The rule applies even if this couple is currently living in a jurisdiction that does not recognize same-sex marriage.  The IRS states that this is consistent with its long-standing position (Rev. Rul. 58-66) that for federal tax purposes the IRS will recognize marriages based on the law of the state in where consummated and will disregard later changes in domicile.
    • For example, a same-sex couple validly married in New York will still be treated as married when they move to Pennsylvania.
  2. Married:  Being married is any same-sex marriage legally entered into in one of the 50 states, the District of Columbia, a U.S. territory or a foreign country.
  3. Domestic Partnerships:  Registered domestic partnerships, civil unions or similar formal relationships are not considered legal marriages.
  4. Married For All Purposes Under Federal Law:  Under the ruling, legally married same-sex couples are treated as married for all federal tax purposes, including income and gift and estate taxes.
  5. Federal Income Tax Benefits For Married Same-Sex Couples:  Married same-sex couples can now enjoy the tax benefits associated with  being treated as married for all federal tax provisions, including but not limited to:
    • Filing status
    • Claiming personal and dependency exemptions
    • Taking the standard deduction
    • Employee benefits
    • Contributing to an IRA
    • Claiming the earned income tax credit
    • Claiming the child tax credit.
  6. Married Filing Jointly or Married Filing Separately Only Option After September 16, 2013:  After September 16, 2013, legally married same-sex couples generally must file their 2013 federal income tax return using either the married filing jointly or married filing separately filing status.
  7. Two High Income Family:  In some cases, especially where both spouses are high wage earners this may result in greater taxes than under earlier law.
  8. Civil Unions In Certain States May End Up Paying Less Taxes:  Civil unions or domestic partnerships that can still file singly or as head of household may end up in better tax shape in certain situations.
  9. Prior Year Tax Refund Possibility: Individuals who were in same-sex marriages may, but are not required to, file original or amended returns choosing married filing jointly for federal tax purposes for one or more earlier tax years still open under the statute of limitations.
  10. Statute of Limitations For Refunds:  Generally, the statute of limitations for filing a refund claim is three years from the filing date of the return or two years from the date of the tax payment, whichever is later.
    • As a result, refund claims can still be filed for tax years 2010, 2011 and 2012.
    • Special Situations: For example, agreements with the IRS to keep open the statute of limitations for tax years 2009 and earlier will allow taxpayers to file refund claims for such open years .
    • For how to file an amended return please read Amending Tax Returns with the IRS.
  11. Protective Claim: When the right to a refund is contingent and may not be determined until after the time period for amending returns expires, a taxpayer can file a protective claim for refund. The claim is often based on current litigation (constitutionality); expected changes in tax law; and other changes in legislation or regulations. A protective claim preserves the right to claim a refund until resolution of the matter.
    • Example:  Pennsylvania same-sex couples not considered married under current rules may want to file protective claims for any year where the statute of limitations period is ending.
  12. Fringe Benefits: Employees who purchased same-sex spouse health insurance coverage from their employers or other fringe benefits on an after-tax basis may treat the amounts paid for that coverage as pre-tax and excludable from income.
    • The IRS now provides a mechanism to pursue for filing refund claims under Notice 2013-61.  The notice provides two streamlined administrative procedures for making adjustments or claiming refunds.
  13. IRS Further Guidance: The IRS will be issuing further guidance on cafeteria plans and on how qualified retirement plans and other tax-favored arrangements should treat same-sex spouses for periods before September 16, 2013.
  14. State Taxes: State tax return filing status is still controlled by state law.  If same-sex marriages are not legal in their state then they cannot file as married.  This is the case even though the marriage took place in a state where same-sex marriages are recognized.
  15. Estate Planning:  Review estate plans to take advantage of the federal estate and gift tax breaks now given same-sex marriages. For insights into estate planning please read Estate Planning 2013: Now What? A Must Read for Everyone
  16. Estate Tax Refunds: Additionally, claims for refunds of any estate taxes paid on deceased spouses that are still open under the statute of limitations should also be carefully examined.
    • Taxpayers who wish to file a refund claim for gift or estate taxes should file Form 843, Claim for Refund and Request for Abatement.

These are just some of the tax and financial implications in this area.  Same-sex couples affected by these changes should explore estate planning, retirement planning, employee benefits, and social security implications with their estate planning attorney, accountant and financial adviser team.

Stay tuned because this area will continue to evolve and change.

As required by United States Treasury Regulations, you should be aware that this communication is not intended by the sender to be used, and it cannot be used, for the purpose of avoiding penalties under United States federal tax laws.

Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm’s full disclaimer.

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Estate Planning For Elderly Parents

As our older parents age it is harder for them to deal with the financial details of their lives. With the complicated financial products out there and the low-interest rate environment it becomes very difficult for them to make sound financial decisions. In addition, dealing with one’s own mortality can prevent parents from focusing on their estate plan. As many know, if they fail to have a will, trust or overall estate plan, the state will decide who gets their wealth via the laws of intestate succession.

The situation becomes even more acute in those many cases where there are second and sometimes third or more marriages. Most of these couples do not appreciate the problems that can occur for the surviving family members. A Russian Roulette situation can arise for the families depending on who dies first. Planning and careful drafting is almost certainly necessary in these situations to avoid family warfare and large and usually inevitable litigation costs. Couple this with the emotional toll that these situations engender, you can readily see why estate planning is so vital.  (For more on the estate planning process readers should explore Estate Planning Mistakes: 5 Not So Easy Pieces)

The point here is that children need to help their parents in getting their financial and estate plan in order. However, they must tread very carefully to avoid having their parents think they are acting in a self-serving way. Additionally, children should carefully deal with and tell their siblings of such involvement to avoid any later challenges of overreaching, duress, fraud and undue influence.

So how does one talk with their elder parents about these important issues? To get some ideas about how to approach parents on these vital issues please read my article entitled Estate Planning for Elderly Parents: Discussing Finances and Estate Planning with Your Aging Parents

Copyright © 2012 – Steven J. Fromm & Associates, P.C., 1420 Walnut Street, Suite 300, Philadelphia, PA 19102. All rights reserved.

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In our fast paced world, many retirement plans are drafted and then often neglected.  In extreme cases, plans are put aside without ever being updated.  Some plan sponsors have failed to restate their plans for years or even decades.  For many individuals, retirement plan accounts represent the largest portion of their wealth.  As the following discussion will illustrate, the failure to protect this most valuable and important asset by keeping the retirement plan in full compliance with applicable retirement plan laws could result in some very nasty, costly and unforeseen financial repercussions.

The retirement plan laws have always required that plans be updated for tax law changes.  Before 2003, the IRS allowed plans to be periodically restated for tax law changes that occurred over many years.  This resulted in large, periodic major plan restatements.  However, since 2003 the IRS has required amendments to retirement plans for each new tax law resulting in more frequent “interim amendments.”  [For those of you interested in a more detailed discussion of these required interim amendments since 2003, please go to my questions answered at my Linked-In profile.]  For many plans, the deadlines for many of these plan restatements or interim amendments have now expired.  Current rules provide that plans that have not been redrafted to comply with required prior restatements or interim amendments cease to be qualified as of their applicable deadlines.

In the worst case scenario, the IRS may demand that the plan be retroactively disqualified.  If the IRS is successful in disqualifying the plan, the plan sponsor’s tax deductions for contributions taken in the year of disqualification and in later years would be disallowed.  The taxes owed by the plan sponsor due to the disallowance of previously claimed retirement plan deductions plus applicable interest and penalties could be enormous.  In addition, participants of the plan would have to treat as taxable income the value of their plan account as of the date of such disqualification.  The taxes, interest and penalties to the participants from the date of plan disqualification could be equally exorbitant. This would be a truly disastrous and harsh result for both the employer plan sponsor and participants in the disqualified plan.

However, in most cases, the current policy of the IRS is to impose monetary penalties instead of the more severe penalty of plan disqualification.  Even so, when the IRS raises these failures as the result of an audit the penalties can be quite severe.   Penalties can range from $2,500 to $80,000 depending on the failures involved and the size of the plan.  It is worth noting that in recent years, the IRS has increased its auditing of retirement plans.

 Here is Good News: How to Solve This Looming Problem 

The IRS has a voluntary remedial program called the VCP (voluntary compliance program) to correct these plan document deficiencies.  The IRS position is that retirement plans may be re-qualified only by having the plan sponsor voluntarily come forward before an IRS audit by submitting the newly drafted delinquent restatements and/or interim amendments to the IRS in accordance with some very detailed procedures and documentation pursuant to Revenue Procedure 2008-50.  Once the IRS reviews and hopefully approves the application and the newly drafted required documentation, the plan is deemed to be in full compliance with applicable law and such plan is retroactively tax qualified.

Instead of paying a steep monetary penalty, the VCP submission results in the paying of a filing fee to the IRS.  Sometimes, if the violation is quite limited the filing fee can be as low as $375.  (Remember, you will still need to pay for documentation services associated with plan restatements and interim amendments.  However, these costs would have been incurred in any event to keep your plan in full compliance with the law.)  The important point here is that the use of the VCP program avoids the risk of plan disqualification or the imposition of a large monetary penalty.

 How We Can Help:

Numerous VCP program applications under the applicable Revenue Procedure 2008-50 have been submitted by this office.  This application along with the needed plan restatements and interim amendments must be carefully drafted to ensure efficient negotiations and a successful outcome with the IRS.

The Bottom Line:

Plan sponsors should immediately and voluntarily move to correct plan deficiencies pursuant to the more taxpayer friendly and cheaper VCP program before the IRS audits your plan.  Once the IRS commences an audit, the VCP submission strategy is no longer an option and your plan is exposed to disqualification and/or severe monetary penalties.

Looking forward, you must establish a program with your plan adviser to ensure that your plan is kept in compliance with the laws concerning plan restatements, interim amendments and the changing IRS submission requirements and deadlines.  This will avoid having to deal with all of these problems again in the future.  In fact, the Revenue Procedure requires a disclosure in the VCP application as to what new procedures the plan sponsors will use to avoid this problem in the future.

 Do Not Wait

Do not wait for the IRS to audit your retirement plan as it then will be too late to get the cheaper and less painful VCP deal.  For a free initial consult to assess your retirement plan situation, please do not hesitate to call me, Steven J. Fromm, Esquire at 215-735-2336.  All consultations are confidential and covered by attorney-client privilege.

Copyright © 2009, Steven J. Fromm

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As with most things in life, when things are bad, there usually is something good that can come out of it.  Our current economic troubles have resulted in many closely held or small businesses being worth far less then they used to be.  This is not a good situation for businesses that are hanging on to survive or have to be sold for various reasons.  However, for people wanting to minimize estate and gift taxes and have been putting off taking a cold hard look at their estate plan, now may be the perfect time to explore the gifting of shares in their businesses.

For example, some businesses have senior family members who own all or most of the shares of the outstanding stock of their corporation.  With the value of the business being down right now, more shares could be gifted to younger family members involved in the business.

Example:  Mr. Senior owns 80% of Deflated, Inc., while his two sons who work in the business own 10% each.  Deflated was worth $3,000,000 in 2007.  By the end of 2008, it was worth $2,500,000.  Mr. Senior talks to tax counsel and after exploring the tax strategies and planning tools discussed below decides to gift 20% of his shares worth $500,000 to each of his sons, leaving him with a 40% stock interest.

The tax advantages are as follows:

1.  The stock gifted to each son was previously worth $600,000. The current market value of such stock to each son is now only $500,000.  If Deflated, Inc. goes back to its value once the economy recovers, then Mr. Senior has just transferred $200,000 ($100,000 to each son) to his sons estate and gift tax free.  At a current marginal estate tax rate of 45%, Mr. Senior’s family can save $90,000 (45%*$200,000).

2.  The gifts to each son are gifts of a minority interest in Deflated, Inc. and such gifts lack marketability due to the limited market for such shares.  Estate and gift tax rules allow discounts for these factors that reduce the value of assets transferred.  (Caveat: There are some legislative proposals being floated in Washington seeking to limit this tax strategy. Stay tuned.) These discounts for minority interests and lack of marketability conservatively can be 25%, sometimes more.   With such discounts the gift of each $500,000 is reduced by $125,000. At a current marginal estate tax rate of 45%, Mr. Senior’s family can save another $112,500 (45%*$250,000).

3.  Outright gifts of stock are eligible for the annual donee exclusion of $13,000.  In addition, Mr. Senior has a spouse who will join in this gift, which will allow for a second $13,000 exclusion.  So the taxable gift to each son is now reduced by $26,000 (Mr. Senior’s annual exclusion of  $13,000 and his spousal joinder of another $13,000).  Additional savings to the family is $23,400 (45%*26,000*2 sons).

4.  If Mr. Senior makes no further gifts and dies with his reduced ownership interest of 40%,  his estate can claim the minority interest and lack of marketability discounts against his remaining shares.  If Mr. Senior dies in 2014, when deflated is worth $4,000,000, his family can take a 25% lack of marketability/minority interest discount, saving his family another $180,000 (45%*$400,000 marketability/minority interest discount[$1,600,000 forty-percent interest*25%]).

Bottom Line:  Mr. Senior can take advantage of the lousy economy, the lack of marketability and minority interest discounts and the annual donee exclusions with a spousal joinder to save his family a tremendous amount of future estate and inheritance taxes.

Caveat:  Remember that this type of planning depends on the particular factual setting of each client.  One difference in the facts can change the outcome.  Also, be aware that state inheritance taxes have not been considered in the above example.  Finally, the above should not be considered as legal advice.  Please consult with tax counsel to discuss your particular factual situation.

Copyright © 2009, Steven J. Fromm.

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