Advantages for same-sex spouses in the tax code

This post is hopefully the first of what I hope will be several on this topic (though it may be a few months before I have time to return to it). I’ve been thinking lately about some of the ways in which Registered Domestic Partners and Same-Sex Spouses can take advantage of the tax code and their unique relationship status for their benefit. I’m certainly not saying that same-sex partners get a great deal under the current laws, but I have begun to see that a few opportunities do arise from the fact the Federal government has chosen to not recognize members of these relationships as spouses.

While taking a Graduate level course in estate taxation, I was recently introduced to Internal Revenue Code Section 2702.  This section was introduced to deal with “abusive” trusts that were being established to avoid Gift Tax on the transfer of assets to family members. Without going into too much detail, effectively what was happening was individuals were giving members of their family a “remainder interest” in property, while maintaining an “income interest” for themselves, by creating a trust that was set up to last for a specific period of time, say 15 to 20 years. When a gift is given, but the transfer doesn’t take immediately, the value is reduced to account for the fact that an asset you don’t receive immediately is worth less than an asset you do receive immediately. The IRS has tables to determine the value, and they’re based on the assumption the asset produces income. For items like land or art, there is no “income” from the item, so the tables produce ridiculously low values for what the asset will be worth when it is transferred in the distant future. This is considered an “abusive” strategy and Section 2702 prohibits family members from engaging in such transactions. But, if you wanted to give your same-sex spouse, or the descendants of your spouse, a gift under these terms, you’re free to do so. You can take advantage of the fact the IRS doesn’t legally recognize you as “family.”

This got me thinking, and I quickly came up with two more situations (more common situations!) where not being legally recognized as “family” could work to the advantage of same-sex spouses.

Like-kind exchanges (or 1031 exchanges) are a way to sell appreciated property without recognizing gain. There are special rules and restrictions that apply to like-kind exchanges between “related parties.” But once again, the IRS can’t legally consider same-sex spouses to be “related parties.”

Finally, the most common situation that same-sex spouses could benefit from is by having one spouse file as Head of Household. Filing Head of Household gets you better tax treatment than just filing single, and many couples with kids have tried to come up with various ways that one partner can file Single while the other files Head of Household — or both file Head of Household (because the combined benefits of two people filing this way is better than the rates for a married couple filing jointly). Most heterosexual couples will find the criteria very tricky for getting the Head of Household status…but not so for same-sex spouses. This is a great way to equalize treatment in separate property states. In community property states (like California), it’s a little tricker to pull this off, but it can be a very valuable benefit.

Now I must admit I’d much rather be able to simply help my same-sex spouse clients to file a Married Filing Joint return. The benefits of being treated equally I’m sure far outweigh the financial benefits of some loopholes in the tax code. But until that happens, I’m happy to find every loop hole I can to help same-sex partners get every benefit legally available.

Who knows? Maybe those opposed to same-sex unions will be so outraged when they find out about these “benefits” that they’ll realize what a waste of time and energy it is to try and create two separate classes of legal unions between people who love each other.

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5 Responses to Advantages for same-sex spouses in the tax code

  1. Jim says:

    Have the latest changes regarding the Supreme Court decisions had any effect on this? Nice article.

    • class5tax says:

      Hi Jim, thanks for the compliment. Can you be a little more specific about the Supreme Court decisions you’re referring to? At this point, I’m unaware of any recent decisions by the Supreme Court on the issue of same-sex marriage.

      I suspect you’re referring to the Obama administration decision not to defend the Defense of Marriage Act (or DOMA, which as you probably know is what prevents same-sex spouses from having their marriage legally recognized at the federal level). The administration’s decision does not undo DOMA, and in fact the administration will still enforce DOMA. But it does mean that if a lawsuit is brought against DOMA on constitutional grounds–which is now almost certain to happen–the Justice Department will not defend the law. However, Congress is free to provide lawyers to defend the law, and some members of Congress have already announced their intention to do so.

      So at this point, nothing much has changed. Inevitably, DOMA will be overturned–the only question being whether it is a near-term result of the recent Obama administration decision, or a longer term event. The overwhelming support for marriage equality among people under 40 make me quite confident in using the term “inevitably.” When that does happen, then presumably any marriage recognized by a state will also be recognized by the Federal government. At this point I honestly don’t have enough information about what will happen to Registered Domestic Partnerships in that scenario.

      But for the time being, the above information is still accurate and reflects current law.

  2. […] a quick follow-up to an earlier post about some of the few advantages for same-sex spouses in the tax code. This one generally only applies to same-sex spouses and Registered Domestic […]

  3. […] least for what you can really learn about a topic from blogs. (See here for the main overview, and here, here, and finally here.) More guidance is available in IRS Publication 555, but as we’re […]

  4. […] Top 10 loopholes for same-sex spouses in the tax code Same-sex couples face many forms of legal discrimination, particularly around the issue of recognition of marriage. However, because the tax code was not written with same-sex spouses and Registered Domestic Partners in mind, there a number of loopholes that offer benefits to same-sex spouses. In many situations, it is possible–through careful planning in some cases–for same-sex spouses to get better tax treatment than spouses whose marriage is recognized by the federal government.  Continuing a theme from recent posts, here’s a collection of my favorite benefits I’ve found for same-sex spouses in the tax code…some new and some already covered. […]

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