Wednesday, July 16, 2014
New York Marriage Equality - Tax Implications
Originally published on forbes.com on June 29, 2011.
Wedding Bells for Robin and Terry
I’ve been agonizing over what my first post on the Forbes platform should be. Fortunately, Governor Cuomo and the New York State Senate have bailed me out. New York now has marriage equality. The tax issues of same sex couples have been a significant focus of Passive Activities and Other Oxymorons (The blogspot title that is too long for Forbes). Robin and Terry are a couple of indeterminate gender and marital status, whom I invented to help me avoid awkward pronoun problems. Over the past year they have had a wide range of incomes and a variety of professions. They are currently of the same gender and live in Greenwich Village. They called me excitedly. They are planning an open air wedding in Washington Square. What’s really neat is that they are thinking about having the reception at McSorley’s, the oldest bar in New York City. Don’t want to miss that. Back when the drinking age was 18 and people were sometimes careless about proof of age, McSorley’s was the favorite watering hole of Xavier High School students. I was thinking of making Robin and Terry Xavier graduates, like me, but I’m not sure, maybe they went to Holy Rosary Academy in Union City, like my sister.
The tax issues of a same sex couples are rather complicated. By getting married, they will make them even more complicated. Of course if they want to be super complicated they could become California registered domestic partners. I’m holding off on introducing Robin and Terry’s friends Blynn and Ashley for now, so I won’t get into that.
Defense of Marriage Act
What complicates same sex marriage is the Defense of Marriage Act. According to Section 3 of DOMA, in order for a marriage to be recognized for purposes of any federal law it must be between a man and woman and a spouse has to be someone of the opposite sex. According to a 2004 GAO report there were 1,138 provisions in the United States Code in which marital status enters into determining eligibility for "benefits, rights and privileges". Probably the one that generates the most excitement is the ability to file a joint return. A group called "Refuse to Lie"has started a principled civil disobedience campaign around the issue. Much as I admire that type of thing, my attitude in tax matters is "It is what it is. Deal with it." I have no expectation that things are going to be fair or make a lot of sense.
The ironic thing is that a couple not being married for federal income tax purposes can be advantageous. There is a "marriage penalty" built into the rate structure that kicks in at fairly high income levels, where there is not significant disparity in income. Even better a couple who does some planning can exploit the fact that they are unrelated individuals. I gave a few examples of these opportunities in a post entitled "Just Because They Won’t Let You Do It Doesn’t Make it A Good Idea." One example would be Terry’s expensive business use car, that has a lot of basis left relative to its fair market value due to depreciation limits. Terry can sell the car to Robin and take an ordinary loss.
Most planners and tax preparers don’t think much about collection issues, so they often ignore the biggest down side to filing joint returns. Joint and several liability. If Robin and Terry are allowed to file a joint return and Robin goes missing, the IRS can collect the entire tax from Terry. There is something called "innocent spouse" relief, but it is not easy to qualify for. I’ve mentioned this in a number of posts including one titled "What’s So Great About Sliced Bread?"
There are four different individual federal tax tables. The worst is Married Filing Separately. Next is Married Filing jointly. Then comes Single. Then comes Head of Household. Of course since you are sticking two peoples income together in the MFJ table it can come out better than two single returns. It will tend to work out that way if you have disparate incomes and one of them is pretty high. It does not end there though. There are a host of phase-outs and thresholds that are tied to adjusted gross income. So if Robin has a lot of medical expenses and Terry has none, the total of deductible medical expenses will be lower if you combine their returns. On the other hand viewing the couple as a single taxpayer might produce very significant savings if, for example, one of them has large capital gains and the other has large capital losses.
Most married couples don’t get to choose between Married Filing Jointly and Single (or Head of Household). They can choose Married Filing Separately but that is almost always worse. At this point in time, though, there is an argument that gay married couples actually can make that choice. Here is why. Under the Defense of Marriage Act, they are not considered to be married for federal income tax purposes. So nobody can complain if they each file as single (except those Refuse to Lie people, but we are being practical here, not idealistic). DOMA has been the subject of litigation, though. In Gill v OPM, a Massachusetts federal district court ruled that Section 3 of DOMA is unconstitutional. There were a variety of plaintiffs in the case contesting a denial of a variety of federal benefits (probably not all 1,138). Included in the plaintiffs were couples who would have benefitted from filing joint returns. A subsequent decision on the estate tax unlimited marital deduction also found Section 3 of DOMA to be unconstitutional. The Justice Department is supposed to defend the constitutionality of statutes passed by Congress regardless of what the current administration thinks of them. In the case of DOMA, however, the Justice Department has decided to throw in the towel. They concluded that the constituionality of DOMA is indefensible. Now conservatives have a perfectly good face saving way to quit on this issue. You could look at it as a states rights issue. They are not doing it though. Congress has hired counsel to continue the defense of DOMA, which ironically provides a temporary subsidy to gay marriage.
Should Robin and Terry Marry - Their Accountant Weighs In
Let's put DOMA aside for a moment. Suppose Robin is making $200,000 per year and does not itemize. At 2010 rates that will produce a federal tax of about $48,000. Assume that Terry is not making anything. A joint return will produce a tax of about $39,000. Just for fun let's assume that Robin loves Terry very much, but still thinks that Terry is kind of sketchy in some ways and it would be unwise to file a joint return. Married filing separately will cost Robin $52,000.
Of course if DOMA applies Robin is single for federal purposes regardless and has a federal tax of $48,000.
Marriage Equality - Be Careful What You Wish For
So DOMA costs Robin and Terry about $9,000 in federal taxes. If they had been married in Massachusetts - dare I suggest Northhampton- and then moved to Greenwich Village, the state of New York would have recognized their marriages, for the most part. (Even before last week, New York recognized same sex marriages performed in other states). Unfortunately, this did not include state income taxes, where by statute, marital status is the same for state purposes as it is for federal purposes. The difference is not large about $1,000, but it kind of adds insult to injury.
I'm sure the Refuse to Lie people wouldn't be moved by this observation, but it is worth looking at what would happen if Robin and Terry each made $200,000 giving them a joint income of $400,000. Under DOMA they are both single, each paying $48,000 for a total of $96,000. If permitted to file a joint return, their tax would be $108,000. So DOMA is saving them $12,000 and another $4,000 in state and city tax.
At least according to one commentator , it is unclear as to whether the new marriage equality bill overrides the revenue law that ties marital status to what is determined at the federal level. From the viewpoint of a preparer, I would hope that it does not. New York has a fairly complicated state return. If you have a couple whose return has a lot of moving parts doing a joint return for New York and two single returns for federal will raise a host of complications particularly if there are carryovers into subsequent years.
Refuse to Lie ?
My advice to Robin and Terry would be to go ahead and "lie" if filing as single saves them money. If a joint return would be a better deal, there are two options, depending how wild and crazy they are feeling. One is to just go ahead and file a joint return. There is certainly a reasonable basis given the way court decisions on DOMA have gone in the last year. The more conservative course is to follow DOMA and file as single, then subsequently amend before the statute of limitations expires. There should be guidance from the New York State Department of Taxation and Finance on what position they will be taking on the effect of the marriage equality bill fairly soon.
I'd also consider advising them to wait until they can have the wedding at St. Patrick's Cathedral.