The LGBT community recently celebrated an historic victory over DOMA, the infamous Defense of Marriage Act that excluded same-sex couples from taking part in many financial and tax-related benefits that are automatically afforded to heterosexual married couples throughout the U.S.
Yet, while the ruling is an extremely positive move in the right direction, it will also lead to some highly complex financial planning needs for gay couples who reside or own assets in the thirty-plus states that do not currently recognize same-sex marriage.
Benefits and Drawbacks of the DOMA ruling
The DOMA ruling brought some valuable protections, as well as recognition, to many same-sex couples. For instance, couples may now file joint federal tax returns, receive survivor’s benefits on pensions, and obtain Social Security benefits based on their same-gender spouse’s work history.
Some of the biggest inroads will be felt in areas such as:
• Estate Taxes – Prior to the recent DOMA ruling, only heterosexual couples could pass wealth to their spouse upon death completely free of estate taxation. Same-sex spouses may now enjoy this privilege as well. This could potentially save thousands—or hundreds of thousands—of dollars in tax liability for a surviving partner. In Edie Windsor’s case, she was able to recoup $363,000!
• Rollover of Retirement Savings – Opposite-sex married couples enjoy certain privileges when it comes to rolling over retirement savings in accounts such as IRAs and 401(k)s. Now, same-sex couples may also be allowed to roll a partner’s funds into their own retirement account without the need to begin taking distributions immediately.
• Gift Taxation – Similar to estate taxes, legally married spouses can pass an unlimited amount of assets to each other throughout life, without the need to pay gift tax. Now, many same-sex married couples can also do the same. Prior to the victory over DOMA, if one partner in a same-sex marriage purchased a home and then added his or her partner to the deed, a gift tax based on half of the home’s purchase price would have been due.
• Social Security
The victory over DOMA also means that same-sex couples will be more secure in terms of their partner’s Social Security benefits. For example, the surviving spouse in a same-sex marriage will now be allowed to claim Social Security benefits if his or her deceased partner earned more. In this case, the surviving partner will be able to claim either their own Social Security benefits—based upon his or her own earnings history—or claim 50 percent of the deceased partner’s benefit amount.
• Medicaid – The ruling will also have an effect on eligibility for expanded Medicaid benefits. As Medicaid qualification is based on both the size and total income of a household (in relation to federal poverty guidelines), the effect on married same-sex couples could be mixed—depending on the couple’s total amount of income and assets.
• Medical Decisions – In the states that recognize same-sex marriage, the DOMA ruling also means that one’s partner could be treated as the next of kin for purposes of making medical decisions, as well as the sharing of medical information under HIPAA.
From a tax and financial standpoint, the DOMA victory is huge. However, one of the most important aspects to the ruling is that, even though federal benefits are now available to partners who are legally married in states that recognize same-sex marriage, it does not force the states that don’t sanction it to honor such benefits. In other words, a couple could have rights to federal benefits but not to state benefits.
For example, if a couple is married in California, but they later move to Texas, the partners may not be eligible to receive tax-free wealth transfer upon death—or many of the other tax and financially related privileges that heterosexual couples automatically have access to.
The Challenges Still Ahead
While this victory over DOMA signals a positive movement for those in the LGBT community, it may also make financial planning for same-sex couples a bit more complicated—especially for those who live in (or own assets in) more than one state.
For example, prior to the DOMA ruling, partners in a same-sex marriage were not required to list (for tax purposes) the property or assets that were held by their significant other. Now, however, the recognition of marriage at the federal level will require the listing of all assets and property considered to be community property under state law.
This can have an especially detrimental effect on those couples who own substantial assets—and could signal the loss of one or both partner’s homestead exemption, depending on their state of residence and their property ownership/titling.
Given some of the potential financial drawbacks, it is important that couples contemplating marriage carefully consider all angles prior to heading to the altar. It also means that couples will really need to weigh their options in terms of what will work out best financially going forward. For example, even though married same-sex couples are now able to file federal taxes jointly, doing so could actually mean taking an even bigger tax hit—especially for high-income earners.
This also means that same-sex couples who are married should add an extra layer of “just in case” protection when it comes to their tax and financial affairs. These protections may include setting up a domestic partnership agreement, creating health-care proxies, and titling real-estate and financial assets jointly.
For this reason, it is essential that all tax and financial planning be done by a qualified professional who has knowledge of tax and financial planning concepts, as well as which strategies would be the best fit for couples and individuals with diverse planning needs.
Grace S. Yung, CFP, is a certified financial planner practitioner with experience in helping domestic partners plan their finances since 1994. She is a principal at Midtown Financial LLC in Houston.
See other MoneySmart columns:
Critical Illness Insurance (July 2013 OutSmart)
Filling in the gaps.
Implementation of Obamacare (June 2013 OutSmart)
How LGBTs can prepare.
The Aging Population (May 2013 OutSmart)
How LGBTs folks can prepare for living longer.
Staying on Top of the Fiscal Cliff (April 2013 OutSmart)
How to maximize your investments, even if your paycheck is smaller
Finding the Funds …to make your IRA contribution (March 2013 OutSmart)
Have You Made Your 2012 IRA Contribution Yet? (February 2013 OutSmart)
There is still time!
What’s Different for 2013? (January 2013 OutSmart)
Considerations for Texas and your future investments.
LGBT Partners… (December 2012 OutSmart)
Working around the denial of your government benefits
Future Tax Rules Can Further Penalize LGBT Investors (November 2012 OutSmart)
But there is still time to act
Protecting your Wallet and your Heart (October 2012 OutSmart)
How and when to keep assets separate—even when you’re madly in love
Domestic Partner Tax Deductions in Home Ownership (September 2012 OutSmart)
With today’s historically low interest rates, it’s certainly a great time to either purchase or refinance a home.
Dying Intestate (August 2012 OutSmart)
Could you be leaving the state in charge of distributing your assets?
Protecting the Things that Matter (July 2012 OutSmart)
How those in the LGBT community can use life insurance planning strategies
When ‘I Do’ Becomes ‘I Don’t Anymore’ (June 2012 OutSmart)
Ensuring both partners’ fair share with a Domestic Partnership Agreement
Retirement (May 2012 OutSmart)
Using annuities can provide lasting income for both domestic partners: When depending on a partner’s retirement income, annuities can offer the perfect solution
Financial and Tax Planning Issues for Domestic Partners (April 2012 OutSmart)
Is Uncle Sam getting a bigger chunk of your income and wealth?
The Real Cost of Long-term Care (February 2012 OutSmart)
How LGBT caregivers are paying the price
Gay Money Matters (part 1) (February 2010 OutSmart)
Domestic Partners: Estate and Tax Planning
Gay Money Matters (part 2) (February 2010 OutSmart)
Protecting your assets . . . even when the rules don’t