Smart Money: Financial and Tax Planning Issues for Domestic Partners

Is Uncle Sam getting a bigger chunk of your income and wealth?
by Grace S. Yung

Few people realize that there are essentially two different sets of federal tax rules—one set for legally married couples and another set for everyone else. However, domestic partners are likely very well aware that they could be giving up a great deal more of their hard-earned income than their married heterosexual counterparts. And that just doesn’t seem fair.

Where the Road Splits

While actual tax planning techniques and strategies do not discriminate based on sexual orientation, the majority of the differences come into play when an individual is in a committed relationship with someone whom they are unable to marry under federal law.

Because of this—even with the current same-sex marriage laws in several states—many of the tax advantages that are given to legally married spouses are still not available to domestic partners, and this can cause a need for alternative estate planning to be done.

There are three primary areas where federal tax treatment can differ drastically between legally married couples and domestic partners. These include income tax filing, gift taxes, and estate taxation.

• Income Tax Issues. One of the most costly ways in which domestic partners lose out is with the inability to file a federal joint income tax return. This can make a drastic difference in the amount that may be deducted with regard to charitable giving and other types of tax-deductible contributions.

If children are involved, income tax filing status could make a big difference with regard to what is and isn’t allowable as a deduction. For instance, in cases where a domestic partner is not the biological parent of a child—and has not legally adopted the child—there could be the inability to file as a “head of household,” even if he or she has provided over half of the household income. In fact, individuals who do not meet all of the requirements for filing as head of household will be required to file as single taxpayers.

• Gift Tax Issues. For those who are attempting to reduce their estate, the annual gift tax exclusion makes it possible to give money to a number of individuals without the requirement of paying gift tax. In 2012, the maximum amount of the annual gift tax exclusion is $13,000. However, legally married couples are allowed to give away twice that amount to the same individual(s).

• Estate Tax Issues. There are a number of issues that cause a vast difference in estate taxation—beginning with the unlimited marital deduction. For those who are legally married, the first spouse to pass away may pass an unlimited amount of assets—estate tax free—to their spouse. This is not so with domestic partners, causing a great deal more tax liability if not properly planned for in advance.

Moving Forward

These scenarios highlight just some of the areas that need special attention when planning for domestic partners. Given the differences in tax strategies and financial planning techniques, it is imperative to work with a financial professional who is not only up to date on federal and state tax laws, but who also has an in-depth knowledge regarding wealth generation and asset protection methods specifically for domestic partners and the LGBT community.

Editor’s note: This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax adviser.

Grace S. Yung has over 18 years experience as a certified financial planner and is a principal at Midtown Financial Group, LLC, in Houston.