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.

  1. High income earners? If both spouses earn six-figure incomes (or higher), you’ll probably benefit from better tax brackets than married couples filing jointly. This also applies if there is one high earner in a community property state (e.g. California). More on that here.
  2. Did you take a large loss on stock or other assets? If you don’t want to sell other stock at a large gain to offset a large loss, capital losses can carry forward year over year for a very long time, with only $3,000 allowed as a deduction each year on a Joint return. If same-sex spouses held the asset as joint or community property, they can EACH take the $3,000 allowance, effectively doubling the deduction available.
  3. Do you own rental property? Married couples filing Jointly are limited to a $25,000 loss on rental property, and this is only allowed as a deduction if the Joint AGI is less than $150k. For a same-sex married couple who each file Single, a jointly owned property can generate deductions of up to $25,000 EACH, and this deduction is available for each spouse whose individual AGI is less than $150k. In a community property state, this effectively allows a same-sex couple to deduct up to $50,000 annually on rental property, and not lose this deduction completely until combined AGI exceeds $300,000.
  4. Both spouses taking grad school classes? There is a “per return” limit on education credits and deductions of $2000 and $4000, respectively. Same-sex spouses effectively double that limit by each filing a Single return
  5. Want to sell an asset to a family member without recognizing gain? This is normally very tricky to do thanks to very restrictive “related party” rules in the tax code. But for purposes of the tax code, your same-sex spouse, and family related to you through the same-sex spouse, aren’t legally related to you. So like-kind exchanges with family members are fair game. (These are complicated, so consult a professional before taking any action in this area.)
  6. Got kids? It’s usually possible for one spouse to file Head of Household while the other files a Single return. The end result of this strategy is the couple gets far more favorable tax brackets than they would if they filed with Married Filing Joint status.
  7. Got kids (part II)? Same-sex spouses get much higher income limits for claiming the Earned Income Credit. A married couple filing Joint can no longer claim EIC once their combined income reaches $50,000. But for same-sex couples who must file Single, this limit can be significantly higher, over $80,000 in some cases. And if there’s more than one child, the couple can claim a substantially higher amount of Earned Income Credit by splitting up the dependent deductions.
  8. Got kids (part III)? One of the most generous credits in the tax code is the Adoption Credit. This credit generally provides for a dollar-for-dollar tax credit of up to $13,170 (for 2010) for qualified adoption expenses. Essentially, it’s a direct reimbursement of adoption expenses. One caveat is that the credit is not available to individuals who adopt their spouse’s child. But of course that doesn’t apply here. The government will pay the adoption costs for a same-sex spouse or RDP to legally adopt their child (up to the annual maximum, of course).
  9. Need to transfer some wealth and avoid estate & gift taxes? There are ways to use trusts to transfer large amounts of wealth while only recognizing a small amount in the transfer. Some of these methods (explained in IRC Section 2702) are banned as “abusive” when practiced between family members…but the federal government doesn’t recognize your spouse, or your spouse’s family, as your family, so this opens up a variety of legal techniques for transferring huge amounts of wealth without transfer taxes.
  10. OK, I’ve been trying to finish up the “Top 10” for about a week now. Since it was actually a client that brought #8 to my attention, I’m going to open this up to the community and see if anybody else has run across a benefit in the tax code because the federal government doesn’t recognize your relationship.
  11. (Alternate #10) And if I don’t get a suggestion for #10, there’s always the fall-back of the 50% reduction in self-employment taxes for same-sex spouses. I don’t include this in the actual “top 10” because it’s almost certain to be challenged by the IRS…but it sure looks like a loophole to me. We’ll probably have to wait for the courts to decide whether this one works or not.

So while it’s good news that DOMA appears to be on its way toward the dust bin of history…the down side is same-sex couples may soon lose out on some valuable tax breaks. So enjoy them while they last. And feel free to pass this on to your conservative friends as yet another reason they shouldn’t oppose gay marriage.


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