The playing field is level – but only at the federal level. A year after the Supreme Court’s landmark decision in U.S. v. Windsor, financial options have definitely improved for gay and lesbian couples who have married or intend to marry. Irritating residency issues remain, however, en route to true equality.
Residing in a state of celebration has definite advantages. On August 29, 2013, the Department of Labor and the IRS jointly ruled that same-sex couples who were married in states of celebration would be treated as married couples under federal tax law regardless of where they choose to live. So where you choose to live can have a major impact on your financial, tax and estate planning strategies. Some couples have had to play musical states since Windsor in pursuit of better financial outcomes.
Should you file jointly? If you wed in a state that recognizes same-sex marriage, you can elect to file joint federal tax returns and claim the marital deduction, which permits one spouse to transfer assets to another without a taxable event. In fact, you might want to check with your tax preparer to see if you could get refunds for past three years of federal returns through amended 1040s.
If you own a home, remember that the IRS allows joint filers to exclude up to twice as much capital gain as a single filer. If you file jointly in the year in which you sell a home, your home sale capital gains tax exemption will be $500,000 rather than the $250,000 for single filers (provided you pass the use and ownership tests).
Filing jointly can have a downside: the “marriage penalty” may await you, especially if you both have high incomes. In 2014, two spouses hit the highest tax bracket at a combined income of $457,000. As single filers, you can each earn $406,000 before vaulting into the top bracket.
Should you revisit existing trusts & insurance policies? The old standbys of gay and lesbian estate planning aren’t quite obsolete, but they aren’t as essential as they once were.
If you married in a state of celebration, you can take advantage of the estate tax exclusion that straight marrieds have enjoyed for decades. The individual exclusion is now set at $5.34 million, so it is $10.68 million for a married couple (it is periodically adjusted for inflation). The estate tax exclusion was recently made portable, meaning that the unused portion of a $5.34 million individual exclusion may be transferred to a surviving spouse.
If you live in a state that doesn’t recognize gay marriage, you should double-check any trusts and life insurance policies in place to see how much inheritance tax protection they afford at both state and federal levels. Life insurance could still be quite useful, of course – it can help you fund retirement or children’s educations, and provide a replacement for lost income.
Don’t let state laws keep you from filing for Social Security spousal & survivor benefits. If you live in a state that recognizes your marriage, the Social Security Administration is ready to process your request and you can factor these benefits into your retirement planning. If you live in a state that doesn’t recognize your marriage, file to claim those benefits anyway – they could be issued to you retroactively someday.
Review those workplace retirement plans & health benefits. By law, a spouse is considered the “default” beneficiary for a workplace retirement plan. So if you named a non-spouse as beneficiary when you enrolled in the plan prior to your marriage, your spouse is in line to receive those assets rather than that other individual. If you still want a non-spouse to inherit those assets in the event of your death, your spouse must furnish written consent to permit that.
Before the SCOTUS knocked out Section 3 of DOMA, married gays and lesbians who wanted to have their spouses covered under their employer’s health care plan routinely spent a few thousand post-tax dollars a year (or more) for that coverage. Pre-tax dollars can now pay for those insurance premiums. Here is another case where you may want to file an amended 1040 to claim a refund (you can do so within two years of any tax you paid that should be refunded, or within three years of the filing of the initial 1040, whichever is later).
Marriage opens some doors with regard to workplace health benefits. If you both work, you (or your spouse) may save money by signing up for the cheaper of two employer-sponsored plans. Your spouse also could have a chance to enroll in a group life plan if your company offers one. Additionally, keep in mind that tax-favored FSAs, HSAs and HRAs may be able to pick up some of your spouse’s healthcare expenses.
Now what if you pay for your own health insurance? If your spouse’s employer won’t extend coverage to an employee’s husband or wife, then see if you can qualify for any subsidies or premium tax credits through the exchanges based on your combined income.
Speaking of combined income and health insurance, there is the possibility that one spouse (the one who earns less) could lose his or her federal credits and subsidies as a result of marrying. That spouse could end up in an uncomfortable place – not poor enough to qualify for Medicaid, earning too much to be eligible premium tax credits and subsidies.
Take a look at your IRAs. Think about making your spouse the beneficiary of your traditional or Roth IRA, if you haven’t done so. Keep in mind that your combined incomes may affect your ability to contribute to a Roth IRA, and your ability to make deductible IRA contributions in the case of a traditional IRA. Joint filers in certain circumstances may want to explore the option of a spousal IRA; contributions to it are tax-deductible if neither spouse is enrolled in an employer-sponsored retirement plan.
Marriage changes the game for same-sex couples when it comes to inherited IRAs. When you are single and inherit an IRA, typically the move is to roll the assets into an inherited IRA and take required minimum distributions (RMDs) from that IRA beginning in the year following the original accountholder’s death. If you inherit an IRA as a surviving spouse, however, you can delay those RMDs from the inherited IRA until the time at which the decedent would have turned 70½. Or, you can roll those IRA assets into an existing IRA of your own, with the RMDs from that IRA based on your age (that is, they don’t have to happen until you turn 70½).
Change can’t come soon enough for older gay & lesbian couples. Too many married couples in their 60s and 70s are left playing a waiting game – waiting for the states in which they reside to progress so that their Social Security benefits will no longer be delayed, wanting eligibility for the tax breaks straight couples have relied on for decades. That kind of financial equality must arrive within their lifetimes, in the interest of fairness, progress and justice.
About the Independent Financial Advisor
Robert Pagliarini, PhD, CFP®, EA has helped clients across the United States manage, grow, and preserve their wealth for the past 25 years. His goal is to provide comprehensive financial, investment, and tax advice in a way that was honest and ethical. In addition, he is a CFP® Board Ambassador, one of only 50 in the country, and a real fiduciary. In his spare time, he writes personal finance books, finance articles for Forbes and develops email and video financial courses to help educate others. With decades of experience as a financial advisor, the media often calls on him for his expertise. Contact Robert today to learn more about his financial planning services.