The U.S. Supreme Court’s recent historic decision in United States v. Windsor will have far-reaching impacts on same-sex married persons in Florida and throughout the United States. The decision—which held that the federal government cannot discriminate against same-sex married persons in the administration of federal laws—affects hundreds of federal laws that apply to married persons, including laws relating to individual income taxes, trusts and estates planning, employee benefits, pensions and retirement planning, family law, and bankruptcy. Although the full reach of the Windsor decision is not yet entirely clear, the decision will have a dramatic impact on all same-sex married couples. These couples should understand the legal and tax opportunities and pitfalls Windsor presents. Here’s a look at the decision and some of its most significant legal and financial implications.
United States v. Windsor
The Windsor case was brought by Edith Windsor after she was ordered to pay $363,000 in estate taxes upon the death of her wife. Windsor and her wife, New York residents, had been legally married in Ontario, Canada. However, under Section 3 of the Defense of Marriage Act (“DOMA”), only heterosexual unions were in the definitions of “marriage” and “spouses” for federal laws and benefits. Because of those restricted definitions, the U.S. government did not recognize Windsor’s marriage, and Windsor could not use the U.S. marital tax deduction that would have eliminated estate taxes on the death of her wife.
In Windsor, the U.S. Supreme Court struck down Section 3 of DOMA, finding it unconstitutional. The Supreme Court reasoned that the restricted definitions violated same-sex married persons’ Fifth Amendment rights of equal protection and due process. The federal government can no longer discriminate against persons legally married in a state or jurisdiction that recognizes same-sex marriage in the administration of federal benefits and rights.
Windsor’s impact in Florida and Other States That Do Not Recognize Same-Sex Marriage
As of November 15, 2013, sixteen states and the District of Columbia permit same-sex marriage. Several counties in New Mexico and five Native American Tribes permit same-sex marriage. In the wake of the DOMA repeal, same-sex married persons residing in these states are now treated identically to heterosexual married persons for all federal laws. This includes persons legally married in foreign jurisdictions who live in a U.S. state that recognizes same-sex marriage.
Initially, it was not clear how the repeal would affect same-sex married persons who moved to Florida or another state that does not recognize same-sex marriage. When the Supreme Court struck down Section 3 of DOMA, it left in place Section 2, which allows the states to refuse to recognize same-sex marriages performed in other states. For persons who live in Florida (where a Constitutional amendment expressly bars the recognition of same-sex marriages), but were married in, for instance, New York or Canada, the Windsor decision left open questions regarding how the DOMA repeal would affect them. There was also uncertainty regarding the impact of the DOMA repeal on common law and civil unions.
IRS position on Windsor
It has become clear that the rights of these persons under federal law will depend on how each federal agency treats these types of out-of-jurisdiction same-sex marriages. For instance, the IRS recently made headlines when it announced same-sex persons are classified as married for federal tax purposes so long as they were validly married in a state that recognizes their same-sex marriage. The IRS is only concerned with whether a marriage was legally entered into (in any U.S. or foreign jurisdiction), regardless of whether the couple lives in a state that recognizes same-sex marriages. This means that same-sex married couples in Florida will be treated as married persons for all federal tax purposes. The IRS determined it would be prohibitively difficult and costly for the IRS and taxpayers if marital status changed from state to state, given our increasingly mobile world. The IRS also clarified it would recognize same-sex common law and civil unions to the extent it does for heterosexual couples (i.e., only if the relationship is recognized as a “marriage” under state law). These new IRS rules went into effect on September 16, 2013, but taxpayers can rely on them for filing amended returns (see more on this below).
Policy changes in other federal agencies
We are still waiting for guidance from other federal agencies regarding whether they will recognize marriages of persons who reside in states that do not recognize same-sex marriages. The Social Security Administration is considering this issue and guidance is pending. In the meantime, the Social Security Administration is encouraging all same-sex married persons in every state to file retirement spousal claims “…right away, even if you aren’t sure you are eligible.” By filing now, the Social Security Administration indicates that applicants will preserve their filing date, which is used to determine the start of potential benefits. The Department of Health and Human Services also has issued some early guidance that certain Medicare benefits will be available to all same-sex married couples regardless of their state of residence but indicated it will be issuing further guidance on the full impact of the DOMA repeal. The Department of Labor (“DOL”) has issued guidance indicating it will follow the same rule as the IRS in enforcing compliance with Federal labor and employment laws.
Estate planning opportunities
The Windsor decision means a same-sex married couple may now take advantage of a variety of federal tax benefits, whether or not they are domiciled in a state recognizing same-sex marriage.
For validly married same-sex couples, the Windsor decision alters some fundamental building blocks of their estate plans. First, same-sex couples can now implement an estate plan incorporating the federal estate tax marital deduction. The estate tax marital deduction, which is unlimited, enables a deceased spouse to leave assets to a surviving spouse free of federal estate tax. For same-sex couples, the deceased spouse is no longer required to use his or her available estate tax exemption when leaving assets to a surviving spouse, as the marital deduction shelters this transfer from federal estate tax. Therefore, with proper planning, a same-sex couple may avoid triggering estate tax on the first death and might pass more wealth to the couple’s beneficiaries upon the death of the surviving spouse.
Second, the Windsor decision enables same-sex married couples to take advantage of “portability,” or the right of a surviving spouse to “claim” a deceased spouse’s unused estate tax exemption. Portability can be beneficial because, in some circumstances, it may give a married couple more flexibility in structuring their estate plan. If the surviving spouse claims the unused exemption, the deceased spouse’s estate no longer faces a “use it or lose it” dilemma. It may be less important for a same-sex couple’s estate plan to create a trust following the death of the first spouse. It may be less important for a same-sex couple to equalize their wealth between each spouse to obtain a favorable estate tax result.
The Windsor decision also mitigates the risk that transfers between spouses will cause taxable gifts. Pre-Windsor, events as common as one spouse paying the living expenses of the other spouse could trigger the gift tax (e.g., if such payments exceed the $14,000 annual gift tax exclusion). Following Windsor, same-sex married couples are entitled to the gift tax marital deduction, which is similar to the estate tax marital deduction in that it permits unlimited, tax-free transfers between spouses. This deduction also helps eliminate some tax reporting, substantiation, and asset titling issues that existed under prior law.
Another benefit of the Windsor decision is that same-sex married couples may now participate in “gift splitting” to third parties. This is useful where it is advantageous for the couple to consider a taxable gift from one of the spouses to a third party as having been made one-half by each spouse.
The Windsor decision may also change a same-sex couple’s perspective on the preferred methods of making significant lifetime gifts. A discussion of this topic is beyond the scope of this article, but same-sex couples should know Windsor alters the playing field regarding a variety of powerful gifting techniques, such as grantor trusts, GRATs, GRITs, charitable foundations, and family limited partnerships.
Generation-skipping transfer tax
In terms of the generation-skipping transfer tax, the Windsor decision puts same-sex married couples on the same footing as other married couples. They are now assigned to the same generation, rather than a generation determined under applicable federal statutes, and may now make the same tax elections.
Further, in the wake of the Windsor decision, our clients should know about new tax reporting issues and opportunities. A taxpayer who made a substantial gift to his or her same-sex spouse during 2012, in anticipation of changing transfer tax laws, may want to consider filing a return (or an amended return) treating this gift as one that qualifies for the marital deduction rather than one that uses available transfer tax exemption.
Windsor’s impact on income taxes
One of the most-touted effects of the Windsor decision is the right of same-sex married persons to file their federal income taxes as joint married filers. The IRS has announced that all validly married same-sex persons will be treated as married persons for federal tax purposes, regardless of where they live. For tax year 2013 and going forward, all same-sex married persons are therefore required to file as married persons. This is the case for any couple that has a U.S. tax filing requirement, including U.S. same-sex couples living overseas.
Much attention has been paid to the perk of joint-filing for same-sex couples since many persons who file as a married couple pay less tax than they would as individuals. Whether filing as married persons is truly a tax boon depends on the couple’s circumstances, and for many couples, the only benefit of joint filing is the reduced paperwork. Some couples filing jointly will suffer the dreaded “marriage penalty,” where their combined tax burden is higher as a result of filing as married persons. This penalty is more likely to affect couples where both spouses are wage-earners. Under the new IRS rules, these same-sex couples will be required to file as married persons and will see their taxes go up under the new regime. Initial government estimates show tax revenues will rise following the DOMA repeal, suggesting many same-sex marriages will be in this group hit with the marriage penalty.
If an original tax return was filed prior to September 16, 2013 (the effective date of the IRS’s recent guidance), same-sex couples may choose—but are not required—to amend their tax returns retroactively for three, or even six, previous tax years. Same-sex couples whose overall tax liability would have been reduced had they filed jointly would benefit by filing amended returns, while couples affected by the marriage penalty would be better off leaving their original returns untouched. Luckily for these couples, the IRS is not requiring them to amend past tax returns; amending old returns is optional.
Dealing with state income taxes
The new IRS rules may create complications for same-sex couples who live in states that do not recognize the validity of their marriage. Prior to the new guidance, these couples had to file as separate individuals at both the federal and state level. They are now required to file their federal taxes as married couples, but their state of residence may still require them to file separately. Since many states use federal taxable income as a starting place for calculating state liability, it is unclear how these states (including Florida) will deal with federal taxes calculated on a married basis. There may be a scramble in early 2014 for new state administrative guidance in response to this issue (likely to result in increased paperwork, rather than any change in tax liability).
Expanded employee and retirement benefits
The impact of the Windsor decision on the administration of employee benefits is broad and far-reaching, both for the employee and the employer.
Regarding the employee, certain employee benefits traditionally afforded to opposite-sex spouses through non-governmental plans will now be open to same-sex spouses. Some of these benefits include:
Pension and 401(k) plans not sponsored by governmental entities:
- A same-sex spouse is now eligible to receive surviving spouse annuities, qualified joint and several annuities, and qualified pre-retirement survivor annuities;
- A same-sex spouse may defer receipt of death benefit distributions from his or her spouse’s retirement account until age 70 ½ for required minimum distributions;
- A same-sex spouse may elect hardship withdrawals regarding certain expenses (e.g., medical, tuition, funeral expenses) incurred by his or her spouse and may treat his or her spouse as the primary beneficiary of a hardship distribution;
- A same-sex spouse who receives a distribution for the death of his or her spouse can roll over the distribution to his or her individual IRA or plan;
- A plan must treat a same-sex spouse as the automatic designated beneficiary of either 50% or 100% of the participant’s benefit (depending on the plan terms), unless the same-sex spouse consents to designating an alternate beneficiary;
- A same-sex spouse can be considered an alternate payee under qualified domestic relations orders; and
- A plan that requires a spouse to consent before a participant may take a loan must obtain the signature of the same sex spouse before issuing a loan.
Welfare plans not sponsored by governmental entities:
- Employer health plans under Florida law are permitted, but are not obligated, to cover same-sex spouses;
- Employer contributions to welfare benefits for a same-sex spouse are no longer taxable to the employee (and both employees and employers may amend old tax returns to seek a refund from the IRS and Social Security for taxes paid on past benefits);
- Same-sex spouses covered by group health plans have rights to COBRA coverage (as a COBRA-qualified beneficiary);
- Same-sex spouses may qualify as dependents under flexible spending accounts, health savings accounts, and health reimbursement accounts;
- Same-sex spouses may enroll in group health plans that permit coverage of same-sex spouses if the participant or participant’s same-sex spouse has a special enrollment right under HIPAA;
- Participants can use their dependent care assistance program accounts on a pre-tax basis to cover expenses incurred for the care of the dependents of same-sex spouses; and
- Employers must provide employees up to 12 weeks of unpaid leave to care for same-sex spouses under the Family and Medical Leave Act.
Plans sponsored by governmental entities in Florida remain prohibited by Florida law from recognizing same-sex spouses. It is unclear whether employer medical plans must offer coverage to same-sex spouses.
These new IRS and DOL rules place the burden on employers to ensure non-governmental pension and 401(k) plans do not discriminate against same-sex spouses in both written documentation and operational practice. Same-sex and opposite-sex spouses must be treated equally under tax-qualified employer retirement plans (e.g., 401(k) plans). Typically, this requires that employers amend the definition of “spouse” in the plan documents, especially if the current definition either references DOMA and/or defines “spouse” as an opposite-sex spouse. Employers may respond to this issue by amending the definition to be gender-neutral. Besides the plan documents, if the plan wording is changed, there are obligations that employers notify employees of the rule changes through separate notices and summaries of material modifications (amending the summary plan description). Employers should review and amend plan documents and current HR policies and procedures and update their employee handbooks. Employers should also discuss these post-Windsor issues with third-party service providers such as insurance providers and third-party administrators.
Regarding federal government-sponsored benefits, such as Social Security and Medicare, the immediate impact of the DOMA repeal is less clear, since the federal agencies administering these benefits have historically looked to state law to determine marital status. However, as indicated earlier, the Social Security Administration is already processing some applications for spousal benefits based on same-sex marriages and is encouraging all same-sex married couples to apply for spousal benefits now to lock in their filing date for benefits. Some Medicare spousal benefits are already available to same-sex marriages, regardless of their state of residence, and further guidance should be forthcoming from the Department of Health and Human Services.
Bankruptcy and immigration
The Supreme Court’s decision in Windsor now affords same-sex couples the right to jointly file for bankruptcy protection. By filing jointly, same-sex married couples will: pay less to file a joint petition than if they filed separately; streamline the administrative aspects of their bankruptcy by having a single case; and jointly receive the protections of the automatic stay.
Immigration law is another area subject to major changes in the wake of the Windsor ruling. The federal government already has issued “green cards” based on same-sex marriages and will look to the place of marriage rather than the place of residence as a basis for marriage.
Property rights in Florida
The Windsor ruling does not require states to recognize same-sex marriages performed in other jurisdictions.
Same-sex married persons still cannot hold real or personal property in Florida as tenants by the entireties, which is a form of ownership where husband and wife jointly own property and have rights of survivorship. If property is held in Florida by persons as tenants by the entireties, that property is protected against a creditor who has a judgment against only one of the spouses. The creditor’s judgment against one spouse is ignored when selling property held as tenants by the entireties. The Windsor decision will not extend this protection to same-sex married persons in Florida.
The Windsor decision also will not affect the homestead property rights of same-sex married persons. Under the Florida homestead rules, if one spouse owns homestead real property, the surviving spouse has certain rights regarding property ownership (regardless of the provisions in the decedent spouse’s will) and has certain protections against creditors. Further, both spouses must join on any deed or mortgage of homestead property, even if the property is owned solely by the other spouse. The Windsor decision will not extend these state homestead protections to same-sex married persons in Florida.
For same-sex couples residing in Florida, this may create the unusual situation where they can file jointly for bankruptcy under federal law but be denied the full creditor and asset protections afforded to heterosexual couples by Florida law.
The Post-Windsor Landscape
The Supreme Court’s decision in Windsor has significant implications for all same-sex married persons with ties to the United States. These couples should understand the far-reaching impact of the Windsor decision, including on estate planning, income taxes, and retirement and employee benefits.
The Windsor ruling also has laid the groundwork for possible future changes in the law. There are pending cases working their way through the legal system that may dramatically change the rights of same-sex married persons under state laws and the rights of states to not recognize same-sex marriages legally performed in other jurisdictions. Depending on the outcome of those cases, the legal rights and obligations of same-sex married persons may continue to evolve.