PLANNING FOR INDIVIDUALS [Part 4/7]
On June 26, 2013, the U.S. Supreme Court struck down Section 3 of the Defense of Marriage Act in E.S. Windsor, 2013-1 ustc 50,400. The Court held that Section 3, which had defined marriage for federal purposes as the union of one man and one woman, was unconstitutional. Subsequently, the IRS announced a general rule in Rev. Rul. 2013-17 recognizing same-sex marriages nationwide.
Place of Celebration Approach. All same-sex marriages are recognized for all federal tax purposes, regardless of whether a couple resides in a jurisdiction that recognizes same-sex marriage or in a jurisdiction that does not recognize same-sex marriage. All legally married same-sex couples will be treated as married for all federal tax purposes, including income and gift and estate taxes.
Under the place of celebration approach used by the IRS, a couple that marries in a state that recognizes same-sex marriage and subsequently moves to a state that does not recognize same-sex marriage will continue to be treated as married for all federal tax purposes. The IRS has taken the same approach to common law marriages for over 50 years.
The Supreme Court did not strike down Section 2 of DOMA, which provides that states do not have to recognize same-sex marriages recognized in other states. The result is a patchwork of laws, with some states recognizing same-sex marriage and others not. As of the time this Briefing was prepared, 13 states and the District of Columbia recognized same-sex marriage.
The IRS announced different rules for different tax years:
- Tax Year 2013 and Subsequent Years. For tax year 2013 and beyond, same-sex spouses generally must file using a married filing separately or jointly filing status
- Prior Tax Years. For tax year 2012, and all prior tax years, same-sex spouses who file an original tax return on or after September 16, 2013 (the effective date of Rev. Rul. 2013-17), generally must file using a married filing separately or jointly filing status. For tax years 2011 and earlier, same-sex spouses who filed their tax returns timely may choose, but are not required, to amend their federal tax returns to file using a married filing separately or jointly filing status, provided the period of limitations for amending the return has not expired.
Married same-sex couples should explore the potential benefits of filing amended returns for open tax years. Generally, the limitations period for filing a refund claim is three years from the date the return was filed or two years from the date the tax was paid, whichever is later. Some taxpayers may have filed protective claims to keep the limitations period open for certain years.
Along with filing status, IRS recognition of same-sex marriage nationwide allows same-sex couples to take advantage of many tax incentives that include special rules for married filing jointly taxpayers, such as the adoption credit.
As a result of DOMA, taxpayers may have paid taxes on the fair market value of employer-provided health care coverage for their same-sex spouse.
In Notice 2013-61, the IRS announced two optional special administrative procedures for employers to make claims for refunds or adjustments of employment taxes for certain benefits paid to same-sex spouses. Under the first procedure, employers may use the fourth quarter 2013 Form 941, Employer’s Quarterly Federal Tax Return, to correct any overpayments of employment taxes for the first three quarters of 2013. Under the second procedure, employers may file one Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund, for the fourth quarter of 2013 to correct any overpayments of FICA taxes for all quarters of 2013.
IRS recognition of same-sex marriage does not apply to registered domestic partners, individuals in a civil union, or similar relationships. Taxpayers in these types of relationships must continue to file their federal income tax returns as single individuals, even if they are able to file state returns jointly. Registered domestic partners may not file as married filing jointly or married filing separately, because the individuals are not considered married or spouses for federal tax purposes.
A registered domestic partner can itemize his or her deductions regardless of whether his or her partner itemizes or claims the standard deduction. Although Code Sec. 63(c)(6)(A) prohibits a taxpayer from itemizing deductions if the taxpayer’s spouse claims the standard deduction, this provision does not apply to registered domestic partners because they are not considered married for federal tax purposes.
ESTATE AND GIFT TAXES
After a number of years during which significant uncertainty existed over the federal estate and gift tax system, ATRA finally provided a permanent structure under which planning can now take place. ATRA permanently provides for a maximum federal unified estate and gift tax rate of 40 percent with an inflation-adjusted $5 million exclusion for gifts made and estates of decedents dying after December 31, 2012.
The applicable exclusion amount, as adjusted for inflation, is $5,250,000 for gifts made and estates of decedents dying in 2013. The exclusion is projected to increase to $5,340,000 in 2014.
ATRA also preserved the annual gift tax exclusion. This exclusion allows taxpayers to give up to an inflation-adjusted $14,000 to any individual, gift tax free and without counting the amount of the gift toward the lifetime $5 million exclusion, adjusted for inflation.
The $14,000 limit applies to 2013 gifts. The same $14,000 limit is projected for 2014.
There is no limit on the number of individual donees to whom gifts may be made under the $14,000 exclusion. Spouses may “split” their gifts to each donee, effectively raising the per donee annual maximum exclusion to $28,000. Spouses may give an unlimited amount of gifts to one another without any gift tax imposed.
Maximizing each year’s annual gift tax exclusion (now at the $14,000 level) has been a traditional year-end tax strategy that should continue post-ATRA. The annual exclusion cannot be carried over and added onto next year’s exclusion; it is a classic use-it-or-lose-it benefit. For example, $14,000 given to Individual X on December 31, 2013, and another $14,000 given to Individual X on January 1, 2014 are both gift tax free. If a split gift election between spouses is made, those gifts may be doubled to a $56,000 maximum given tax free. Funds given to support a dependent do not count toward the $14,000 limit; nor do funds given directly to college to pay tuition or to a medical service provider.
Gifts of appreciated property are counted for purposes of the annual exclusion and gift tax, in general, at their market value, rather than the donor’s basis. However, the donor’s basis must be used in computing any gain on a subsequent sale by the donee. Frequently, a donee may be in a lower tax bracket than the donor, therefore gifting appreciated property potentially saves income tax as well as gift tax. In particular, those donees currently within the 10 or 15 percent rate income tax bracket may realize a zero percent capital gain tax. “Kiddie tax” implications (in which the donee may be taxed at the same rate as the donor), however, must be considered within this strategy.
LIFE CYCLE CHANGES IMPORTANT TO YEAR-END STRATEGIES
In addition to changes in the tax law, year-end tax strategies should also consider personal circumstances that changed during 2013 as well as what may change in 2014. These “life cycle” changes include:
- Change in filing status: marriage, divorce, death or head of household changes
- Birth of a child
- Child no longer young enough for child credit
- Child who has outgrown the “kiddie” tax
- Casualty losses
- Changes in medical expenses
- College and other tuition expenses
- Employment changes
- Personal bankruptcy
- Large inheritance
- Business successes or failures
JDKatz, P.C. is a full-service law firm focused on tax law, business and transactional law, estate planning and elder law. We are dedicated to minimizing your existing liability and risks while providing valuable tax planning to streamline your tax issues in the future. Please call us at 301-913-2948 to schedule an appointment to meet with one of our trusted attorneys, or visit http://www.jdkatz.com.