30th Jun 2013

On June 26, 2013, the United States Supreme Court ruled that the federal Defense of Marriage Act (“DOMA”)1 is an unconstitutional “deprivation of the equal liberty of persons that is protected by the Fifth Amendment of the Constitution” (U.S. v. Windsor, 2013).  The ruling opened the door for same-sex couples who were legally married by their states of residence to receive federal marital income and estate tax deductions, as well as a multitude of other benefits.

The Windsor Decision

The case arose out of the IRS’s denial of an estate tax deduction claimed by a woman following her partner’s death.  Edith Windsor, age 83, married her partner of more than 40 years, Thea Clara Spyer, in Canada in 2007.  Spyer passed away on February 5, 2009, in New York, which is one of 12 states along with Washington D.C. that allows same-sex marriage.  Following Spyer’s death, Windsor sought to claim the marital federal estate tax deduction, which allows a decedent (Spyer) to transfer unlimited assets to her surviving spouse (Windsor) without incurring any estate tax.2  However, the IRS denied the deduction, citing DOMA, and sent Windsor, as executor of Spyer’s estate, an estate tax bill of $363,053.

In striking down the law, Justice Kennedy wrote, “The federal statute is invalid, for no legitimate purpose overcomes the purpose and effect to disparage and injure those whom the State, by its marriage laws, sought to protect in personhood and dignity.”  Specifically, the Court found Section 3 of DOMA, which provides that same-sex marriages are not recognized for all federal purposes, including insurance benefits for government employees, Social Security survivors’ benefits, immigration, and the filing of joint tax returns, to be unconstitutional.

The Windsor decision is likely to have a significant effect for financial planning purposes for same-sex couples.  Residents of states that allow same-sex marriage will likely experience the quickest changes as a result of Windsor.  Same-sex couples residing in these states will be required to file joint tax returns and will be allowed to claim marital deductions which were previously denied to them at the federal level, including the unlimited marital deduction for estate and gift taxes, which allows spouses to transfer assets between each other during their lifetime or at death without incurring a transfer tax.  Once financial institutions catch up to the Windsor decision, same-sex couples will also benefit from spousal rollovers for retirement accounts, allowing greater income tax deferral advantages.

As is the case with any new legislation or ruling, planners will wait to see how federal agencies, lower courts and, in this case, financial institutions will react and respond to Windsor.  Additionally, state laws regarding same-sex marriage continue to vary and the decedent’s state of residence at the time of death will determine the tax treatment and distribution of the estate.  It remains unclear how states that allow “civil unions” but not same-sex “marriage” will respond to the ruling.

Planning in Times of Uncertainty

Due to the constantly evolving landscape of same-sex marriage laws and estate and gift tax laws in general, an individual’s intentions and desires are always best reflected in documents recognized by state law.  By having a comprehensive estate plan in place—consisting of a Will, Revocable Living Trust and Powers of Attorney for Health Care and Property—an individual can ensure that his or her estate will be distributed in accordance with his or her wishes rather than state or federal law.

Although a Simple Will allows an individual to provide who shall be the beneficiaries of the estate, its flexibility is limited.  Additionally, the Will becomes a public document upon the creator’s death.  Instead, by utilizing a Revocable Living Trust along with a Pourover Will, a couple can ensure that both individual’s estate tax exemptions, for state and federal purposes, will be maximized.  Furthermore, unlike a Will, a Trust helps avoid the probate process, provides asset protection from the liabilities of beneficiaries and is a private document available only to the trustee and beneficiaries after death.3,4

Additionally, Powers of Attorney for Health Care and Property are always the best method for appointing an agent to make decisions regarding an individual’s health and assets if he or she is unable to do so, whether there is a legally defined relationship between the principal and agent or not.  Powers of Attorney are modeled after forms provided by each state, so medical and financial institutions are likely to recognize and be familiar with the documents.  In addition to appointing a health care and property agent, these documents allow an individual to appoint successor agents, define the powers of the agent and, in the case of the Power of Attorney for Health Care, reflect the principal’s wishes regarding organ donation and life-sustaining treatment.

As laws regarding relationships and taxes continue to evolve, it is important for all individuals to speak to an experienced estate planning attorney to understand how decisions will be made, the estate will be administered and taxes will be incurred and paid in case of the incapacity or death of a family member.  Understanding the process and ensuring that your estate planning documents accurately reflect your wishes will provide significant peace of mind to you and your loved ones.

1. Defense of Marriage Act (“DOMA”), enacted September 21, 1996, by President Bill Clinton, whereby the Federal government defined marriage as a legal union between one man and one woman.

2. 26 USC § 2056.  The unlimited marital deduction is only available when the surviving spouse is a U.S. citizen.

3. See the May 2011 Newsletter: Protecting Your Child’s Inheritance.

4. See the April 2013 Newsletter: Probate—What It Is and How to Avoid It.

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