Life became more interesting—and complicated—this summer for advisors with lesbian, gay, bisexual and transgender clients.
In June, the U.S. Supreme Court ruled the Defense of Marriage Act unconstitutional because it denied federal recognition of same-sex marriages. On August 29, the IRS announced that it would recognize same-sex marriage for all federal tax purposes.
“These decisions have created a lot of benefits for gay couples,” Bruce Hoffmeister, senior financial planner at Wilmington Trust, said at roundtable in New York City last week.
As a result of the Supreme Court ruling, the federal government must now recognize same-sex marriages for couples that live in states where they are legal and provide the same benefits. As a result, same-sex married couples can benefit from many tax and estate planning strategies previously reserved for opposite-sex married couples. The ruling does not apply to civil unions, registered domestic partnerships or other legal relationships.
The IRS recognition means that married same-sex couples, regardless of where they live, can now give property to a spouse during life or upon death, free of federal gift or estate taxes, by taking advantage of the unlimited marital deduction. They may also defer estate taxes until the death of the surviving spouse through “portability,” which allows a surviving spouse to take advantage of the deceased spouse’s unused federal estate and gift tax exemption, in addition to his or her own exemption.
Confusion In 2014?
Roundtable speakers roundtable predicted there is going to be a lot of head scratching among advisors next year, when same-sex couples legally married in the U.S. or a foreign country will have to file a joint income tax return for the 2013 tax year.
At present, only 13 states and the District of Columbia recognize same-sex marriage. Legally married same-sex clients who live in non-recognition states face the prospect of filing joint returns for their federal taxes, but single returns for their state taxes, as most of those state tax regimes are based on federal taxable income.
The cumbersome, laborious paperwork involved may prompt many non-recognition states to change their rules—in effect, recognizing same-sex marriage for tax purposes while holding out on legal recognition, Hoffmeister said.
Adding to the confusion, the Social Security Administration has not yet ruled on the recognition of same-sex marriage for benefits in non-recognition states. The agency currently determines spousal benefits based on place of residence rather than place of marriage, but Hoffmeister expects this to change soon, probably within a year. “Same-sex married couples will receive benefits regardless of where they live, just like their neighbors,” he said.
If same-sex couples are to benefit from the DOMA decision, they should have an estate plan, Hoffmeister noted. Affluent same-sex couples should review their plans to ensure they are comprehensive and effective, planning around benefits now available from unlimited marital deductions and qualified retirement plans. Financial advisors should monitor their clients’ plans since laws regarding same-sex marriage are rapidly evolving, he added.
Trusts Matter
Same-sex couples can now use several stalwart trust strategies once available only to opposite-sex married couples, Hoffmeister said, including the important qualified terminable interest property trusts (QTIPs). These allow the first spouse who dies to control the ultimate disposition of the property after the surviving spouse’s death while still taking advantage of the estate-tax marital deduction and providing an income stream to the survivor. At the latter’s death, future beneficiaries named in the trust become the trust’s beneficiaries.
Same-sex couples that are not legally married also have access to trust strategies to reduce estate taxes and protect their partners and children, he said.
Grantor retained income trusts, which can be set up only between individuals unrelated by marriage or birth, provide an income stream for the trust’s creator while reducing estate taxes for his or her surviving partner or the non-biological or adopted children of the trust’s creator. Irrevocable life insurance trusts can shield life insurance proceeds from federal estate taxes for couples that are unable to marry and so cannot take advantage of the unlimited marital deduction, Hoffmeister said.
Especially important are revocable living trusts for same-sex couples that have reason to believe their wills could be challenged by family members, he said. Assets are retitled into the trustee’s name, usually the trust’s creator. The trust provides for the grantor and his or her partner and children during any period of incapacity before death, and because the trust owns the assets, the designated successor trustee can take over for a smooth transition. The trust has the same provisions the grantor would have put in a will, and avoids probate at death.
