THE GAY TAX

Tax and estate planning is never simple, but it’s particularly complicated for same-sex marriages and civil unions. Here’s how federal law treats them differently.

By Michael Kosnitzky

ILLUSTRATION BY PETE RYAN

I recently finished representing the wealthier partner in a domestic partnership in his “divorce.” He and his male partner have an adopted child and had conducted substantial tax and estate planning. My task was to resolve matters associated with the division of their assets and to untangle their post-relationship business activities.

I’ve represented many wealthy gays and lesbians embarking on domestic partnerships or, more recently, marriage, but this was my first same-sex divorce. The men acted just as vicious towards one another as do spouses in many heterosexual divorces I’ve seen. What was very different, however, was the division of assets, the payment of post-relationship support and the resolution of economic interests. Why? Because of how federal law disadvantages same-sex couples.

Under the Federal Defense of Marriage Act, the U.S. government only recognizes marriages between a man and a woman. Even if a same-sex couple’s marriage is recognized by the state in which they live, the couple does not receive marriage benefits under federal tax laws. This preferential treatment for straight couples has profound consequences for same-sex ones.Gay and lesbian couples cannot file a joint tax return, for example. And under federal law, a straight married spouse can transfer unlimited assets to the surviving spouse at death without incurring a dime in estate tax. Same-sex couples cannot receive this huge financial advantage. Unless the law changes, a gay person whose spouse or civil partner dies in 2013 leaving the survivor his or her estate will have to pay federal taxes of $550,000 for every $1 million subject to estate tax at the maximum rate. A straight spouse would pay nothing.

Same-sex partners can utilize some estate-tax planning strategies available to straight married couples. They can, for example, place assets in an irrevocable trust for the benefit of the surviving partner rather than bequeathing them outright to him or her, which would cause the assets to be included in both the decedent partner’s taxable estate and, eventually, the survivor’s taxable estate. Transfers to an irrevocable trust generally result in a gift tax when the value of the gift exceeds the unused amount of the grantor’s allowed exclusion, now $5.12 million. Some trusts, however, transfer only future increases in the market value of the transferred assets, so the assets are not immediately taxed. These are called grantor retained annuity trusts, or GRATs.

But other so-called “life estate” planning techniques are unavailable to same-sex couples. For example, heterosexual married couples can create life estate trusts, including what are called QTIP and QDOT trusts, which provide distinct tax advantages. The QTIP trust allows surviving spouses to use trust property estate and gift tax-free during their lives. The QDOT trust allows non-U.S. citizen surviving spouses to postpone paying any estate taxes on assets above the exemption amount. In addition, married heterosexual couples can combine their personal estate tax exemptions; under current law, the second spouse to die can leave heirs property worth up to $10.24 million free from federal estate tax. Gay and lesbian couples can’t do that.

Married straight couples also have advantages over gay couples in divorce: They can transfer assets incident to a divorce tax-free, and alimony can be tax-deductible for the payer. Same sex couples generally have a taxable event when receiving assets in a divorce, and their support payments are not tax-deductible. So same-sex couples should consider a domestic partnership agreement, which is similar to a prenuptial agreement.

Attempts to repeal the Defense of Marriage Act, or have it declared unconstitutional, are working their way through the court system and will perhaps one day succeed. Until then, same-sex couples, as well as families who treat the members of those couples as part of their family for estate planning purposes, need to understand how gay married couples and same-sex civil unions are discriminated against under federal law — and plan accordingly.

A partner at Boies, Schiller & Flexner, Michael Kosnitzky chairs the law firm’s Tax and Middle Market Practice Group.

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