The Supreme Court Strikes Down DOMA – The Tax Effects

(Last Updated On: January 24, 2017)

As every sentient being in America now knows, in one of its most highly anticipated decisions, in Windsor the Supreme Court has struck down Section 3 of the Defense of Marriage Act (DOMA) as an unconstitutional deprivation of equal protection.

DOMA required that same-sex spouses, though legally married in a state allowing such marriages, be treated as unmarried for purposes of federal law.  Although it was not generally viewed as a tax law, DOMA carried significant tax consequences for same-sex couples and, in fact, it was a tax case that was before the Court.

The full effect of the Court’s decision on federal tax law is not entirely clear, as the Internal Revenue Service may decide to use different criteria than it has in the past in determining the effects of state law on federal taxation.  This article seeks to briefly outline what the effects will be under present standards, but this website will alert readers to later developments.

To summarize the Windsor case and the decision:

In 1963, Edie Windsor met Thea Spyer in New York City.  Subsequently, they entered into a committed relationship and lived together in New York.  In 2007, they were married in Canada.  Spyer died in 2009, leaving her estate to Windsor.  Because of DOMA, the estate did not qualify for the unlimited estate tax marital deduction.  As a result, Windsor, as executor of the estate, had to pay $363,053 in federal estate tax.  She then sued for a refund and a declaration that DOMA violates the equal protection clause of the Fifth Amendment.  The Supreme Court has found in her favor and she will be refunded the taxes paid, with interest.

Persons similarly situated, i.e., those who marry in a jurisdiction that allows same-sex marriage and also live in a state that allows same-sex marriage, will now presumably be able to take advantage of, inter alia, various Department of Defense benefits and immigration law provisions affecting legally married spouses.  As for taxes, the following are among the tax breaks seemingly now available to legally married same-sex couples:

•    The right to file a joint return, which can produce a lower combined tax than the total tax paid by the spouses filing as single persons (but this can also produce a higher tax, especially if both are relatively high earners);
•    The opportunity for tax-free employer health coverage for the same-sex spouse;
•    The opportunity for either to utilize the marital deduction to transfer unlimited amounts during lifetime to the other, free of gift tax;
•    The opportunity for the estate of the first spouse to die to get a marital deduction for amounts transferred to the surviving spouse, thereby, as in Windsor, postponing the imposition of estate tax until the death of the second spouse to die, if then;
•    The new “portability” feature, meaning that the estate of the first spouse to die can transfer the deceased spouse’s unused estate tax exemption to the surviving spouse;
•    The opportunity to consent to make “split” gifts, i.e., gifts to others treated as if made one-half by each; and
•    The opportunity for the survivor to stretch out distributions from a qualified retirement plan or IRA after the death of the first spouse under more favorable rules than apply for non-spousal beneficiaries.

What about persons under fact patterns different from those in Windsor?  This can be quite tricky in the case of legally married same-sex couples who live in a state that does not recognize same-sex marriages.  It is important to note that Section 2 of DOMA, which allows states to refuse to recognize same-sex marriages performed under the laws of other states, was not challenged in the Windsor case and therefore still stands, at least for the time being.  What happens, then, to couples that:  1) live in a state that allows same-sex marriage, but later move to a state (e.g., Virginia) with a ban, or 2) live in a state with a ban, but visit and get married in a state where same-sex marriage is legal.

Under existing IRS practice, the couple will not be treated as married for federal tax purposes.  The IRS (and the Social Security Administration) applies the law of the state where the couple lives, not where they were married.  A continued application of these rules would mean that the couple would not be able to avail itself of the opportunities listed above.  If, for example, a couple were to marry in Maine, which allows same-sex marriage, but then move to Virginia, or if the couple were Virginia residents who travel to Maine and get married, gifts between them would not be eligible for the marital deduction, and might have gift tax consequences that would not arise with a heterosexual couple.

Disparities in the law can be quite dramatic.  For example, entitlement to benefits from the Defense Department is based on where the couple lives, and not where they were married.  Immigration law regarding a spouse is also applied based on residence.  So a couple may be characterized as “married” by some federal agencies but not others.

Same-sex couples have long made decisions about where to live, work, and even raise children based on the legal climate.  For many couples, those decisions will, despite Windsor, still need to be made, and it may be some years before the landscape is uniform or even determinable.