On June 26, 2013, the United States Supreme Court decided in United States v. Windsor that Section 3 of the federal Defense of Marriage Act, which had defined marriage for federal purposes as a legal union between one man and one woman, was unconstitutional. The states were still able to decide whether to recognize same-sex marriage and they did not need to recognize the decisions of other states. This resulted in much uncertainty for determining the most suitable estate plan for same-sex spouses in both recognition and non-recognition states.
Then, on June 26, 2015 (notably two years to the day of the Windsor decision), the United States Supreme Court ruled in Obergefell v. Hodges that same-sex couples have the same right to marry as opposite sex couples. This meant that all states must grant marriage licenses to same-sex couples. In addition, all states must recognize a valid same-sex marriage from another state. As a result, the estate planning options for same-sex spouses are now equal to those for opposite sex spouses and estate planners can confidently move forward with planning for same-sex spouses. As with opposite sex spouses, there are numerous tax and non-tax related variables that go into estate planning for same-sex spouses. Therefore, it is imperative that same-sex spouses consult with an estate planning attorney to discuss their unique situation. Below are a few key topics that same-sex spouses in Wisconsin should consider when creating or updating their estate plan:
Income Taxes. Same-sex spouses should consider the federal and state income tax changes. The Windsor and Obergefell rulings result in same-sex spouses now being treated as “married” for federal and state tax purposes. The IRS issued guidance in 2013 stating that the IRS would recognize all marriages validly contracted in states that recognize same-sex marriages even if the couple lived in a state that did not recognize same-sex marriages. As a result, same-sex spouses have available to them the same income tax filing statuses available to opposite sex spouses. The IRS also allowed, but didn’t require, same-sex spouses to amend federal tax returns for tax years that are still open under the statute of limitations. We would expect that the state tax authorities would issue similar guidance in the next couple months. However, we will have to stay tuned for such guidance and to see whether states will allow same-sex spouses to amend state tax returns.
Gift Taxes. In addition to income taxes, same-sex spouses are now treated as married for gift tax purposes. A taxable gift arises when an individual makes a gift to another individual that does not qualify for an exclusion or exemption. Historically, opposite sex spouses could make gifts to each other during their lifetimes with no gift tax consequences, whereas gifts between same-sex spouses could be considered taxable gifts. Therefore, prior to Windsor and Obergefell, estate planners advised same-sex couples to be cognizant of making taxable gifts to each other. For instance, prior to Windsor and Obergefell, if a same-sex spouse re-titled his house in his name and the name of his spouse, he could be making a taxable gift to his spouse, whereas there would be no gift tax consequences for the same gift between opposite sex spouses. Now, same-sex spouses may generally make gifts to each other during their lifetimes and such gifts will not be treated as taxable gifts.
Estate Taxes. Similarly, same-sex spouses are now treated as married for estate tax purposes. Any gifts to a surviving same-sex spouse upon the death of the first spouse, will qualify for the unlimited marital deduction for estate tax purposes (i.e., will not be subject to estate tax) at the time of the first death. Previously, an estate plan for same-sex spouses may have required that the surviving spouse’s share of the assets of the first spouse to die be held in a lifetime trust to avoid the assets of the first spouse to die being subject to estate tax twice (at the time of the first death and the second death). However, now assets that pass to a same-sex spouse at the time of the first death will not be subject to estate tax at the time of the first death. In addition, the relatively new federal estate tax concept of portability is now available to same-sex spouses. This means that at the time of the first death, the surviving same-sex spouse may elect to add the remaining federal estate tax exemption (i.e., the amount and individual can pass to beneficiaries at the time of his or her death without paying estate tax) of the first spouse to die to his or her own federal estate tax exemption. For instance, the current federal estate tax exemption is $5.43 million (subject to annual increases for inflation). If the first same-sex spouse dies in 2015 and leaves all of her assets to her spouse, she will not use any of her $5.43 million federal estate tax exemption. Then, the surviving spouse can make the portability election and add the deceased spouse’s $5.43 million federal estate tax exemption to her own $5.43 million federal estate tax exemption. As a result, the surviving spouse will be able to pass up to $10.86 million to beneficiaries at the time of her death without paying any estate tax.
IRAs. In addition to considering the tax consequences of their estate plan in light of Windsor and Obergefell, same-sex spouses also need to consider their beneficiary designations for individual retirement accounts (“IRAs”). Traditionally, if an IRA owner named his opposite sex spouse as the primary beneficiary of his IRA, upon the owner’s death, the spouse was able to rollover the IRA into an IRA in her name and treat the IRA as her own. The benefit was that the surviving spouse was not required to begin taking required minimum distributions from the IRA until the surviving spouse reached age 70 ½. Alternatively, an IRA that was payable to a non-spouse beneficiary (including a same-sex spouse) would be rolled over into an inherited IRA for the non-spouse beneficiary, who had to begin taking required minimum distributions over his or her life expectancy immediately, thereby losing the benefit of income tax deferral. Under Windsor and Obergefell, same-sex spouses may now decide to name their spouse as the primary beneficiary of their IRAs, so that the surviving spouse can take advantage of the tax deferral.
Marital Property. Lastly, same-sex spouses living in Wisconsin now need to consider marital property. The Wisconsin marital property laws provide that all property of spouses is presumed to be marital property, with a few exceptions. Prior to Obergefell, marital property only applied to opposite sex couples. After Obergefell, marital property will now also apply to same-sex spouses in Wisconsin. Therefore, same-sex spouses should consider executing a Marital Property Agreement to clarify the classification of their assets as marital property or individual property, as has been historically done by opposite sex couples. A Marital Property Agreement can help avoid any complexities upon the first death with tracing assets to determine marital versus individual property. A Marital Property Agreement typically “opts-in” to or “opts-out” of marital property. There are tax benefits to opting-in to marital property. First, any property which is marital property generally receives an income tax basis equal to its fair market value at the time of the death of the first spouse to die. Then, when the second spouse dies, the assets receive a second step-up in basis to the fair market value on the date of the second death. Therefore, if assets, such as marketable securities, appreciate in value between the time of the initial investment and the time of the second death, the assets can be sold after the second death and there should be no capital gains tax payable on any appreciation up to the time of the second death.
There continue to be many tax and non-tax related issues that go into determining the best estate plan for spouses. However, Windsor and Obergefell give same-sex spouses the same options to deal with these issues as opposite sex spouses. Importantly, the rulings will allow same-sex spouses to avoid unnecessarily complex estate plans that were drafted with such complexity simply because the spouses did not have the same rights given to opposite sex couples. Based on the substantial changes in the laws and the equality now afforded to all spouses, it is now more important than ever for same-sex spouses to create a new estate plan or review their current estate plan to ensure that it reflects these changes.
If you have any questions, please contact the author or your Certus attorney.