Paul L. Caron
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Monday, July 11, 2011

WSJ: Tax and Other Headaches for Same-Sex Couples

Wall Street Journal, Headaches for Same-Sex Couples, by Kelly Greene:

Same-sex couples can get married in five states and the District of Columbia—and in New York starting July 25. But the happily-ever-after part doesn't necessarily extend to their personal finances.

Such couples still can't file a joint federal tax return, share retirement benefits, shield each other's assets from estate taxes or benefit from many other tax breaks provided through federal law.

As a result, same-sex couples who marry have to stay on guard, doing even more financial and legal planning, in some cases, than those who don't choose to tie the knot. ...

As of 2008, there were an estimated 565,000 same-sex couples across the U.S., including about 32,000 who were married and 80,000 registered as reciprocal beneficiaries or domestic partners or united in civil unions. ... Connecticut, Iowa, Massachusetts, New Hampshire, Vermont and Washington, D.C., now issue marriage licenses to same-sex couples. California did so for part of 2008, and those marriages remain valid. Four states allow civil unions among same-sex couples, and seven, plus the District of Columbia, grant some state-level spousal rights through domestic partnerships.

The problem: Under the Defense of Marriage Act of 1996, passed by a Republican Congress and signed by President Bill Clinton, the federal government doesn't recognize same-sex marriage—even if it is blessed by a state government. So it's important to weigh what same-sex families stand to gain—or not—by getting married. ...

Anything involving federal taxes for same-sex couples can turn into a quagmire quickly.

Since they still have to file their federal income-tax returns as individuals, many same-sex couples wind up filling out tax forms no fewer than four times: Separately with the federal government, then a "dummy" joint federal return, and finally a married-filing-jointly state return based on the pretend federal one, says Nicole Pearl, an estate-planning partner at McDermott Will & Emery in Los Angeles.

Filing separate state and federal tax returns can get complicated fast. California, Nevada and Washington, for example, allow same-sex couples to register as domestic partners and are also so-called "community property" states, which generally treat income and property acquired during marriage as belonging equally to both partners, no matter who earned it. Since same-sex domestic partners can't file joint federal tax returns, each is required to report half of the combined community income earned by the individual and his or her partner on the individual's single federal return.

Simply writing half of your income on a single return could trigger an audit, says Melissa Labant, a tax expert with the American Institute of CPAs. Say the couple earns $10,000 in interest income, reported on a 1099 form. That means each individual would have to report $5,000. However, "if the $10,000 on the 1099 doesn't match up with the amount on the tax return, it will kick out an examination letter," she warns.

To avoid the problem, you could report $10,000 in income, she says, "then on the next line down, you'd note the amount reported on the partner's tax return. The bottom line would say $5,000." ...

There is one way to take advantage of the federal government's lack of recognition of same-sex marriage: Such couples can set up a "grantor-retained income trust," a type of trust that family members aren't allowed to create for one another. You put an asset into a trust and retain the right to income from it. You have to pay gift tax on that asset, but the Internal Revenue Service would subtract a standard rate of return from the asset's value, and you would owe tax on that discounted amount—whether the asset produces income or not.

https://taxprof.typepad.com/taxprof_blog/2011/07/wsj-tax-and-.html

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