Tax and Estate Planning Following the DOMA Decision [PODCAST]
This podcast from Bob Keebler covers tax and estate planning following the Defense of Marriage Act decision by the Supreme Court of the U.S. Bob discusses the complexity of moving from a same-sex marriage state to an opposite-sex only marriage state, income tax planning for same-sex married couples, estate and gift tax planning, the marital deduction, gift splitting and portability issues, as well as IRAs and retirement plans. [Email subscribers: Visit AICPA Insights to listen to the podcast.]
Robert S. Keebler, CPA, MST, DEP, Partner, Keebler & Associates, LLP. Bob is a 2007 recipient of the prestigious Distinguished Estate Planners award from the National Association of Estate Planning counsels. From 2003 to 2006, Bob was named by CPA Magazine as one of the top 100 most influential practitioners in the United States. He is the past Editor-in-Chief of CCH's magazine, Journal of Retirement Planning and a member of CCH's Financial and Estate Planning Advisory Board. His practice includes family wealth transfer and preservation planning, charitable giving, retirement distribution planning, and estate administration.
This audio webcast was originally recorded June 28, 2013.
On behalf of the personal financial planning division of the AICPA, this is Bob Keebler to discuss tax and estate planning following the Windsor decision.
Just to talk about the breadth of Windsor, we need to start with a powerful quote by Justice Kennedy. "Congress has enacted discrete statutes to regulate the meaning of marriage in order to further federal policy, but DOMA with a directive applicable to 1,000 federal statutes and the whole realm of federal regulations has a far greater reach.” A thousand statutes, thousands of pages of regulations, all of this has been turned upside down by Windsor, and we have to react to it. It's that straightforward.
What I'm going to do today is not talk about theoretical things. We're not going to talk about what happens next, what other litigation is naturally going to follow. What we're going to focus on are the immediate things we as practitioners should be doing in the world of income tax returns and the world of state tax returns and the world of tax planning.
Items simple like someone died, their spouse received their IRA, now they can roll that IRA over in the right circumstance. And we'll talk about in particular there is a lot of clarity in states like California, perhaps, and not so much clarity if a couple married in California moves to a state that does not recognize state -- same sex marriage. So we'll go through that.
Let's start with Windsor. Windsor and Spyer were married in Canada in 2007. Ms. Spire died in 2009 and left her entire estate to Miss Windsor. Section three of DOMA barred Miss Windsor as the executor from claiming the estate tax exemption for surviving spouses. $363,000 was paid in estate tax and the IRS denied Windsor's request for a refund.
Windsor brought a refund suit, contending that DOMA violated the equal protection clause of the Fifth Amendment. Simply put, the clause abbreviated reads, "No person shall be deprived of life, liberty or property without the due process of law.” DOMA though contained two provisions, one that was directly addressed in Windsor and one that was not addressed.
The provision that was addressed in Windsor was basically the definition of marriage. In determining the meaning of any act of Congress or any ruling, regulation or interpretation, the word marriage means only a legal union between one man and one woman as husband and wife, and the word spouse refers only to a person of the opposite sex who is a husband or wife. That was ruled unconstitutional.
However, DOMA did not -- the court did not address section two of DOMA, powers reserved to the states. Those states should be required to give effect to any public, act, record or any judicial proceeding of any other state respecting a relationship between persons of the same sex that is treated as a marriage under laws of another state or a claim arising from such a relationship. So right now, that's where there is not a lot of clarity.
Some -- a couple is married in California and they move to a traditional marriage state. If that is the case, what happens to these benefits and what happens to federal filings? What happens on the estate side? What happens to the gift tax act?
Now imagine what happens if a couple is living in California. Last year they made a $10 million gift. They're going to go back and gift split and then they move to a traditional marriage state. Does all that get erased? The answer, of course, is a practical matter. They're going to -- we're going to have to work through that and come up with a public policy that makes sense. And we don't quite know what that's going to look like yet.
Now some argue DOMA section 2 is unconstitutional because it's in conflict with the Full Faith and Credit clause of the US Constitution. Now there is a lot of Supreme Court analysis of Full Faith and Credit for over 200 years. So I'm not going to go deep on that. I put this in there just so you can read it on your own. But basically what this means is if a Wisconsin court issues a judgment, a Michigan court is supposed to respect that judgment. DOMA basically says in the case of a same sex marriage that -- section two of DOMA says you're not required to respect that.
We'll see what the court does with this over time. Nobody quite knows. President Obama made some comments yesterday that speaking as President, not as a lawyer, he believes that basically if you're married in one state under the laws of say California and you move to another state, your marriage continues to be respected. It will be interesting to see as we work through this.
The IRS does have regulatory power on some of these issues, and certainly executive orders may be given also. Now -- but this is clearly an outstanding issue which is going to have to be addressed by the court at a later point in time.
Let's talk about the impact of Windsor. First of all, easy things; estate tax. Somebody died. You represented the executor. You filed the return. You did not take the marital deduction. They lived -- they were married in a same sex marriage state and they -- the person died in a same sex marriage state. That should be fairly straightforward.
Now on the other hand, we also get into income tax issues, filing joint return, filing separate returns. Undoubtedly, the IRS -- this is very similar. It's different but it's similar. I think the IRS will react to this in a very similar way that they did with the Madoff crisis. When the Madoff Ponzi scheme blew up, the IRS issued revenue prox and revenue notices to deal with that. Basically, what they were trying to do is bring clarity to a subject that desperately needed it. That's what we have here.
In the meantime, though, we are going to have to look at filing protective claims to make sure statutes do not run. ERISA and RIA, again, it applies to over 1,000 federal statutes, but it's critical to understand that under ERISA there are rights. There are certain property laws, rights terminate at death, and under RIA between a marriage, certain property law rights are created with respect to pension plans. So we have to be thinking through that.
In the world of Medicaid, on a list-serv with elder lawyers and they have been busier than ever trying to figure out how this impacts Medicaid planning, nursing home planning. Keep in mind that if you have a husband wife in the traditional sense and I go in the nursing home, my wife is required to pay for my nursing home care. Now there is a tremendous body of law there. It's not quite that simple, but the bottom line is she cannot just walk away from that. It's part of her responsibility as the community spouse.
Now this is going to affect certainly in states that are same sex marriage states, this is going to be affect responsibility for paying for that. Now as a matter of fact, think about this. Undoubtedly there are individuals in same sex marriages that are currently in nursing homes and now the spouse, even though DOMA prevented that in the past, now the spouse may be responsible for paying for the nursing home care. This is going to take a while to work through the complexity.
If you -- here is where it's easy. A same sex marriage state and you live in a same sex marriage state. Someone died -- they were married and they died in a same sex marriage state. The rules there are basically the same for the traditional marriage we as practitioners have worked with since the enactment of the estate tax, since the enactment of the income tax. However, where it gets tricky, if you will, is when a couple is married in a same sex marriage state and they move to a traditional marriage state. Income tax issues, then there are issues in a divorce.
How does -- a couple gets married in California. They move, to let's say, Florida, and they get divorced. Does 1041 give them -- 1041 is a federal statute that says when you exchange property in a divorce there is no gain or loss. We spoke about the Medicaid issues or RIA. Basically, after a year of marriage, what happens under RIA is you have a right to a portion of your spouse's pension. Okay? So what happens under RIA?
A couple is married in California and then they move to Florida or move to Texas and a spouse dies. Now do all those rights under RIA evaporate when they move? These are going to be very difficult things the court needs to deal with, the same thing with community property.
The couple is married in Connecticut, a same sex marriage state. That's a bad example. Connecticut would be a common law state. But California -- coming back to California, they are married in California. They have clear community property. They get married when they're 25 years old when they had no property. Later they become divorced or a spouse dies. When they're living in a traditional marriage state, how is that going to play out? We don't know the answer to these things, and we don't necessarily need to know those right now.
Now from an income tax planning standpoint, filing status, same sex married couples living in a same sex married state, then what you're going to have is you will be able to fire married. There is no doubt about that. You're married for federal purposes. If, however, you have a same sex couple and they are living in a traditional marriage state, now we get into this intersection of state and federal law.
There are states that have -- obviously there are states that are not going to respect same sex marriages from other states, but what are we going to do from federal tax purposes? That is unknown. I think there are least three or four classifications here. Let's walk through them.
A couple is married in California. They live in California. That's easy. A couple is married in California and they move to a traditional marriage state. That requires analysis. They are married in California and then they move to a same sex marriage state that has a statute preventing you from going to another state to get married. That could be a classification too. And finally, they are living in a traditional marriage state. They have a house. They both have jobs. They get on a plane and they go to a same sex marriage state to get married or they go to Canada to get married, like Miss Spire and Miss Windsor did.
Now in that instance -- and then they return to their traditional marriage state after their marriage. In that instance, you have a whole 'nother dynamic there. So it may take some time. My kneejerk reaction on this is the IRS within 12 weeks will come out with some direction that will help us.
In the meantime, we may need to do some protective claims. Now the California/California situation, the Connecticut/Connecticut situation, for open years you probably are going to file amended returns. Now there could be a marriage penalty when both spouses are working. This could be interesting.
Think about, for example, under the new law today with the 3.8% surtax and with the additional 5% tax on capital gains when your income is over $400,000 for a single person. If a couple was single, they would have $800,000 they could protect from the extra 4.6% and from the 5% tax. If they're married, they're only allowed to protect $450,000, so there is a marriage penalty there.
By the same token, there is a marriage penalty with the 3.8% surtax and there are rate penalties along the way too. What this means is will the government, the IRS -- when something changes constitutionally it's not like it changed on Wednesday. It changed ab initio and is the IRS -- we don't know this. Is the IRS going to make those individuals go back and file a joint return and take away the benefits from single status? That is a great question. If they do that, there certainly would be -- I think most people would believe that is fair. On the other hand, there will be other people that are certainly damaged by that where they will have to pay substantial amounts back to the government.
Further, the issue becomes -- and I think the government would waive penalties in those instances. That's what would have to happen. There are going to need to be protocols to make all this work.
Now a couple is married in a same sex state and they are living in a traditional marriage state. Basically, I think you're filing protected claims and standing on the sidelines. I would be very cautious here. Now if you want to be very aggressive, you could work with counsel and you could actually file the returns, knowing that that might end up in litigation. I think the IRS will deal with this, and you're probably better to file the protective claim and stand on the sidelines to see what type of revenue procs or revenue rulings the IRS issues.
Now married jointly filing -- who do you represent? Do not lose track of the fact that there are responsibilities that go along with married filing jointly. I think most people look at that as a fairly benign thing. This is not a same sex issue or a traditional marriage issue. This is just an issue when people start filing jointly because in many ways the tax issues of one party now become the tax issues of the couple. Innocent spouse, for example, civil tax issues, criminal tax issues. We just need to be careful when you're advising someone. Do you have them file married separate or do you have them file married joint?
On the gifted estate tax issues, basically keep in mind we might be able to do some amended estate tax returns or returns that are in process. The easy ones will be same sex state -- same sex marriage state 2A and they either died in a same sex marriage state. The more difficult ones will be when someone was married in a same sex marriage state and moved to a traditional marriage state or lived in a traditional marriage state, got on a plane, went to California and went to Connecticut, went to New York and got married and then returned home.
Now portability. What about portability? Again, Windsor is not effective as of Wednesday -- this past Wednesday. Windsor is effective -- DOMA is gone because it was unconstitutional according to the court. What that means though is now we have 2011 and 2012 deaths where the period to file a return to grab portability has disappeared. I think you're going to have to try to go back and get 9100 relief on those returns.
IRA rollovers, the rule is real simple. We have seen this for over 10 years. In a traditional marriage, the husband dies at 56 years old. His wife is also 56. She comes to you and you say, "Do not roll over the IRA until you turn 59-and-a-half and then roll it over.” There is no time limit on when a spouse can do an IRA rollover, so the issue becomes you have that New York couple. One died four or five years ago. The surviving spouse in all likelihood, I see no reason why they could not now roll over that IRA. So those are going to be things we have to tackle with some caution. I don't think you have to run into that too fast unless the surviving spouse is ill and you'd like to get it rolled over quickly.
Gift tax returns, we'll go through some of that. We'll talk about gift splitting and how that works. Now for open years, file amended returns. I think even if you are in a traditional marriage state but your clients were married in a same sex marriage state, you probably want to file amended returns or at least protective claims. The problem with a protective claim is -- with filing an actual return is there can be preparer penalties if you do not have the authority to do that.
The thing is on a protective claim, you reduce that risk. You hold the statute of limitations. You very smartly stand on the sideline instead of having to go through the rigor of litigation. You can stay on the sideline to see how eventually the IRS and the courts address these issues.
Closed years, there may be potential refunds. There was an excellent article in Kleinberg about a year and a half ago that went through the case law dealing with whether as a constitutional matter if a tax was deemed unconstitutional, could you later go and get a refund, even though the tax statutes had a statute of limitations that closed that.
These are very complex constitutional issues. I think you find someone with deep expertise on that and have them work with you and your client to evaluate what you do.
Keep in mind there is a marital deduction for gift tax purposes and you are also allowed to make gift-splitting elections. However, if you've already filed returns, you can't necessarily go back and then do gift splitting. However, I think you may be able to get 9100-3 relief or some other type of relief that might allow you to erase the return you filed and enter a new return where you show gift splitting. These are big, complex issues.
Now basics of the transfer tax law; $14,000 annual exclusion. You represent a couple. They were married in a same sex state and one party has been making gifts of $14,000 a year or maybe make it $20,000 a year to a series of nephews and nieces. In that instance, maybe you can go back and gift split so that both parties are using their annual exclusion.
We have a $5 million gift estate tax exclusion now indexed. GST is the same way. Keep in mind marital deduction. One party dies and they put property outright or in trust for the other party, they are going to receive a marital deduction. Obviously, that has total clarity if a couple is married in, for example, New York and they died in New York or if they were married in New York and they died in Connecticut or California, a same sex marriage state. The clarity may not be as crisp when they're living in a traditional marriage state.
Community property issues come into this. Portability -- again, I brought it up before, but keep in mind if you represented someone that died in 2011 -- you helped administer the estate, you filed the income tax returns, but you saw no need to file the state tax return because they were under $5 million, but they were in a same sex marriage, now what you'd like to do is go back and try to grab portability. Try to file a return, and maybe you have to ask for a PLR to get the government's permission on this. But you would like to go back and file that return just to protect the surviving spouse.
Keep in mind transfer tax deductions -- the marital deduction is unlimited. However, you do get into some requirements. Spouses are married. The donee spouse is a US citizen, and there are other tests that you are familiar with. This is nothing that you haven't dealt with for years.
On slide 22, I just remind all of us that there are slightly different rules for non-US citizen spouse, just so that when we're working through this with clients, we're cognizant of that.
Gift splitting, we know the lay of the land with gift splitting; fairly straightforward. All gifts made by one spouse can be treated as made half by each spouse. But you can't have gift split gifts to your spouse unless there is an ascertainable standard.
Now each spouse must be a citizen or resident of the United States. The individual is considered as a spouse of another individual only if they are married to the individual at the time of the gift and they do not remarry during the year. So, for example, if husband and wife were married -- they were married on January 2 but the wife was very ill. She was dying. She died on January 4 after the gifts were made and then on December 31 the husband remarries, that's going to come into this. But that's not a same sex issue. That's just the gift splitting rules.
The executor can sign for a deceased spouse. You may be able to go back and file gift splitting on returns where -- earlier returns where basically the couple was in the eyes of DOMA not eligible for gift splitting. You may be able to get some relief on that.
Consenting spouse doesn't have to file a federal estate tax return in limited -- or federal gift tax return in limited incidences. I laid that out on slide 26. That's when only one spouse made gifts during the year and the total value of the gifts to any one donee is less than $28,000 -- two times the annual exclusion.
Okay, here is the issue. There is a due date. Consent to gift splitting can be signified at any time after the close of the calendar year in which the gift was made. However, consent may not be signified after April 15 following the close of such year unless before such day no return has been filed. This couple has never filed any type of return. Then they can go back and gift split. However, if they filed a return, they are not allowed to go back and gift split.
However, I think this is a very unusual situation because DOMA prevented them from filing their return to gift split. Now DOMA is held to be unconstitutional. It would seem logical that the IRS would grant some relief.
Basically, the statutory deadline on gift splitting, you may be able to get 9100-3 relief. I think that's important to pay close attention to. Keep in mind, just like the income tax, when you gift split there is joint and several liability for the gift tax. So be careful who you are representing and that both parties truly understand what they are doing when they gift split.
Portability issues, again, all portability is, it's just saying if one party dies, the surviving spouse is allowed to receive what's left of their unified credit. And for 2011, in a same sex marriage, no one would have thought -- I mean, maybe people did file protective claims, but in general you may not have thought about filing a return to grab portability. For 2012, some of those returns may still be open and the returns certainly filed in the first six or seven months -- for people that died in the first seven months of 2012, those statutes will have lapsed. The estate tax return has to be filed within 9 months, 15 months with an extension.
If you are between the 9 and 15 months, that is a regulatory extension and the IRS can certainly allow you to fix that. If you're beyond the 15 months, you're going to have to get a private letter ruling on that and whether or not the IRS will entertain that, we don't know. Hopefully, the IRS comes out with a blanket, comprehensive revenue proc that just walks us through what to do.
Keep in mind what that does. It's going to move to the surviving spouse the $5 million exemption if someone died in 2011, or $5,120,000 for 2012 gifts. Now finally, remember an election to file basically must be made on a timely estate tax return. I do think they'll have to give us 9100 relief for these situations. Okay?
Now IRAs and retirement plans, a couple of things we really need to know. First of all, when one spouse dies, the surviving spouse can roll that over. In my mind, there is no time limit on when a rollover has to occur. So it's not like I die today and my wife has to roll that over within 60 days or 100 days or 5 months or 6 months. There is no test like that.
For many clients, we've had husbands die in their mid-50s and we've told the wife, "Do not roll that over in your own name until you are at least 59-and-a-half.” So you might have had somebody die five or six years ago and their surviving spouse simply has an IRA. They're treating it as an inherited IRA in a non-spousal capacity because of DOMA and now they would be able to go back and potentially roll that over into their own name. Really, that does give you advantages because you're allowed to delay the required minimum distribution until the spouse reaches April 1 following the year they turn 70-and-a-half.
Okay. So again, any IRAs that go outright will also qualify for the marital deduction, so there are some nuances there. Spousal rollover, again, only available to a surviving spouse. This is going to get tricky though if you're living in a traditional marriage state. Again, I think there are three general classifications there. You were married in a same sex marriage state and you live -- parties died in a same sex marriage state, like California, you would be okay.
Parties moved after being married. They actually lived there. They resided in California and they moved to another state. That could be a problem. I think the deeper problem is they're living in a traditional marriage state. They get on a plane. They go to a same sex marriage state. They have the ceremony in the same sex marriage state and they return home. Again, these are going to be all issues we need to work through over time. So there is just a lot here.
We've covered a lot of ground. What I would like to do is just close. We have to watch what the IRS does. That's going to be the biggest thing. Watch what the IRS does. In the meantime, file your amended returns. File your protective claims, but watch your due dates. Certainly if somebody died, where the statute of limitations on their estate tax return is going to expire in a few days, you need to get that protective claim or amended return in place.
In closing, this has been Bob Keebler on behalf of the AICPA's Personal Financial Planning Division. Stay tuned to your weekly AICPA PFP News and Financial Planning Digest to get up-to-date news and resources on this and other important issues. Contact the PFP team if you have any questions at financialplanning@AICPA.org. Thank you for joining us today.