New DOMA Update: An In-Depth Look at the Tax Implications of US v. Windsor.
(Parker's Federal Tax Bulletin: July 5, 2013)

On June 26, in yet another 5-4 decision, the Supreme Court struck down Section 3 of the Defense of Marriage Act (DOMA). The decision in U.S. v. Windsor, 2013 PTC 167 (S. Ct. 6/26/13) has broad tax implications. In the short term, practitioners will have an opportunity to begin filing amended returns to obtain income tax refunds for any same-sex clients who were married under state law but precluded from filing a joint federal income tax return because of DOMA.

CLIENT LETTER: For a client letter that explains the DOMA ruling's impact on taxpayers in same-sex marriages and encourages the proactive implementation of appropriate tax strategies. Click here

Also, individuals who were in a situation similar to the plaintiff, Edith Windsor, will be able to file refund claims for estate taxes paid on property inherited from a same-sex partner to whom the individual was married under state law. Additionally, employer-provided benefits that were previously taxable to partners in a same-sex marriage are now excludible from income, so refunds can be claimed on this basis also. The Court's decision also allows married same-sex partners to receive federal benefits if their partner is a federal employee and such partners are also be eligible for social security survivor benefits upon the death of a partner.

OBSERVATION: It is unclear how the new law recognizing same-sex married couples will apply to couples married in a state that recognizes such marriages but living in a state that does not recognize such marriages.

COMPLIANCE TIP: Under the statute of limitations, an individual generally has three years from the due date of the return (not including any extensions) to file an amended return and claim a refund of tax.

DOMA Defense of Marriage Act

The Defense of Marriage Act, Pub. L. 104-199, was enacted in 1996. Section 3 of DOMA provided that, in determining the meaning of an Act of Congress in any ruling, regulation, or interpretation of the U.S. administrative bureaus and agencies, the word marriage meant only a legal union between one man and one woman as husband and wife, and the word spouse referred only to a person of the opposite sex who was either a husband or a wife.

Facts of the Windsor Case

Edith Windsor and Thea Spyer, both New York residents, were married in Canada in 2007. Because New York recognizes same-sex marriages, the couple was treated as married under state law and filed joint state income tax returns. When Thea died in 2009, she left her entire estate to Edith. Edith sought to claim the federal estate tax exemption for surviving spouses, but was barred from doing so by Section 3 of DOMA. Edith paid over $363,000 in estate taxes and filed for a refund, which the IRS denied.

Edith brought a refund suit in a district court, contending that DOMA violated the principles of equal protection incorporated in the Fifth Amendment. While the suit was pending, the U.S. Attorney General notified the Speaker of the House of Representatives that the Department of Justice would no longer defend Section 3's constitutionality. In response, the Bipartisan Legal Advisory Group (BLAG) of the House of Representatives voted to intervene in the litigation to defend Section 3's constitutionality. The district court permitted the intervention. The district court ruled against the United States, finding Section 3 unconstitutional and ordering the IRS to refund Edith's tax with interest. The Second Circuit affirmed that decision, but the IRS did not refund the tax and the case was appealed to the Supreme Court.

Court's Analysis

The majority of the Court's justices held that Section 3 of DOMA is unconstitutional because it violates the Fifth Amendment.

The Court noted that, by history and tradition, the definition and regulation of marriage has been treated as being within the authority and realm of the separate states. However, the operation of Section 3 of DOMA, with a directive applicable to over 1,000 federal statutes and the whole realm of federal regulations, was directed to a class of persons that the laws of New York and of 11 other states sought to protect, the Court said. The Court cited Loving v. Virginia, 388 U. S. 1 (1967), for the proposition that the regulation of domestic relations is an area that has long been regarded as a virtually exclusive province of the states. The significance of state responsibilities for the definition and regulation of marriage, the Court noted, dates back to when the Constitution was adopted. Section 3 of DOMA, the majority stated, rejected this long-established precept. The Court found that a state's decision to give same-sex persons the right to marry conferred upon such individuals a dignity and status of immense import. But, the Court said, the federal government used this state-defined class for the opposite purpose to impose restrictions and disabilities.

The question before the Court was whether the resulting injury and indignity was a deprivation of an essential part of the liberty protected by the Fifth Amendment. The Court concluded that, by seeking to injure the very class New York sought to protect, Section 3 of DOMA violated basic due process and equal protection principles applicable to the federal government. The Constitution's guarantee of equality, the Court stated, must at the very least mean that a bare congressional desire to harm a politically unpopular group cannot justify disparate treatment of that group. The Court thus concluded that Section 3 of DOMA was unconstitutional; its unusual deviation from the tradition of recognizing and accepting state definitions of marriage operated, the Court said, to deprive same-sex couples of the benefits and responsibilities that come with federal recognition of their marriages. According to the Court, this was strong evidence of a law having the purpose and effect of disapproval of a class recognized and protected by state law. DOMA's avowed purpose and practical effect, the Court said, was to impose a disadvantage, a separate status, and so a stigma upon all who entered into same-sex marriages made lawful by the unquestioned authority of the states.

The principal effect of DOMA Section 3, the Court observed, was to identify and make unequal a subset of state-sanctioned marriages. It contrived to deprive some couples married under the laws of their state, but not others, of both rights and responsibilities, creating two contradictory marriage regimes within the same state. It also forced, the Court said, same-sex couples to live as married for the purpose of state law but unmarried for the purpose of federal law, thus diminishing the stability and predictability of basic personal relations the state had found it proper to acknowledge and protect.

Conclusion

The Supreme Court's decision allows same-sex partners married and living in states that allow same-sex marriages to file joint federal income tax returns, take advantage of the marital deduction for estate tax purposes, receive tax-free health benefits by virtue of their partner's health care plans, and receive federal tax benefits conferred on spouses of federal employees.

OBSERVATION: It should be noted that joint returns aren't always beneficial. If both partners in a same-sex marriage have high taxable incomes, filing a joint return could result in more taxes being paid. For example, the modified adjusted gross income threshold amounts for calculating the net investment income tax, which is in effect for tax years after 2012, is $200,000 for taxpayers filing as single and $250,000 for couples filing joint returns.

The decision in Windsor opens up a Pandora's box full of tax question, many of which will require practitioners to wait on the IRS for guidance or for the courts to settle:

(1) If a same-sex couple lives in a state that doesn't recognize same-sex marriages but travels to a state that does recognize such marriages and gets married, will the couple be considered married for federal tax purposes, even though they live in a state that doesn't recognize their marriage?

OBSERVATION: While the IRS generally uses a place of domicile rule for determining marital status, this is not the case with common law marriages. In Rev. Rul. 58-66, the IRS ruled that if applicable state law recognizes common-law marriages, the status of individuals living in such a relationship that the state would treat them as husband and wife is, for federal income tax purposes, that of husband and wife, and this IRS position with respect to a common-law marriage would also equally apply in the case of taxpayers who enter into a common-law marriage in a state that recognizes such a relationship and who later move into a state in which a ceremony is required to initiate the marital relationship. Thus, it could be the case that a same-sex couple married in a state that does recognize such marriages but living in a state that does not recognize such marriages could file a joint federal return but would have to file as single for state tax purposes. This could be problematic where the state return is based on federal tax return numbers.

(2) If an individual is married to a same-sex partner in a state like New York that recognizes such marriages, the fair market value of employee benefits received as a result of such marriage are excludible from the non-employee spouse's income. But, what if the employee is transferred to a state that doesn't recognize same-sex marriages are previously tax-free spousal benefits converted to taxable non-spouse benefits?

(3) What happens if one partner in a same-sex marriage has already filed his or her 2012 Form 1040 as single while the other partner is on a valid extension, with the expectation of filing by the October 15 deadline. Assuming they don't choose to amend both to married filing jointly (MFJ) (which presumably would be allowed), would the spouse on extension be able to file as single or be required to file as married filing separately (MFS)?

(4) If one partner in a same-sex marriage amends his or her return from single to MFS (e.g. to reclaim imputed income from a spouse's employment benefits), is the other also forced to amend?

(5) What if a same-sex couple has a child and one filed as head of household in prior years and received child tax credits and earned income credits? Would they now be required to amend as MFJ or MFS and be forced to return the credits taken?

(6) From an employer's perspective, how will the Windsor decision affect employment benefit plans for employers in different states? Will private companies need to consider providing spousal benefits to same-sex married employees regardless of which state the employee lives in?

Parker will continue to provide in-depth reporting and analysis as further guidance on these issues becomes available.

Staff Editor Parker Tax Publishing

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