Tax Considerations in Light of <i>Windsor v. U.S.</i>

Theoretically, the Windsor outcome means that other same-sex spouses who paid estate taxes on assets inherited because they were widowed are entitled to seek refunds. However, the U.S. Supreme Court has agreed to hear the appeal of the case, along with the appeal of another same-sex rights case, concerning the legality of a California voter-approved ban on same-sex marriage. Until the Supreme Court hands down its decision in these cases, the fate of marriage equality remains in limbo

If and when the federal government starts to treat same-sex married partners in the same way it does opposite-sex married partners, tax-lowering opportunities that the latter have enjoyed for years will become available to the former. Not only will estate taxes be affected by this change in policy, but also income and gift taxes. Waiting for the day that these questions are settled once and for all to make any claim to these benefits may prove costly, however. By acting now, some couples may be entitled to secure rights that will be granted retroactively if decisions like Windsor are upheld.

The mechanism for protecting same-sex married couples' rights at this time, while the legal situation is still unsettled, is known as a “protective claim.” A protective claim is an application filed with the IRS asserting that taxes paid should be refunded if an as-yet undecided issue is ultimately decided in the taxpayer's favor. An example of such an undecided issue would be an expected change in a tax regulation; another is the one presented in Windsor, in which certain laws affecting taxes may ultimately be declared unconstitutional.

Making a Claim

The rules for making such a claim with regards to income taxes, for example, are described in IRS Publication 556 (Rev. May 2008), titled “Examination of Returns, Appeal Rights, and Claims for Refund.” A protective income tax claim must be filed within three years of filing a return, or within two years of when the tax was paid, whichever is later. Once it has been filed, however, the claim will not be deemed untimely even if the ultimate issue is not resolved for many years. The protective claim stops the clock. For instance, if a same-sex married couple paid higher taxes on their income in 2011 than they would have paid had they been able to file jointly, they could seek a refund in 2013 if the Supreme Court were to affirm the Second Circuit's Windsor decision in that year. However, if they want to recover a tax overpayment made on March 10, 2010, and the Supreme Court does not rule on the issue until May 2013, our theoretical couple would be unable to recover unless they had filed a protective claim within three years of the date on which they paid their taxes.

• A protective income tax claim can be made in two ways: 1) as a formal claim; or 2) as an amended return for credit or refund (using Form 1040X, which can be found at www.irs.gov/pub/irs-pdf/f1040x.pdf). The claim does not need to state an amount of the expected refund, and it does not have to demand immediate payment. To be valid, it need only:
• |
  • Be in writing;
  • Include the taxpayer's name, address, Social Security number or individual taxpayer identification number (along with any other contact information);
  • Explain the contingency that affects the claim (in our case, the potential final declaration that DOMA's Section 3 is unconstitutional);
  • Alert the IRS to the essential nature of the claim;
  • State for which tax year(s) a refund is being sought; and
  • Be signed by the taxpayer.

Although not required, a computation of what the new refund should be is helpful. Taxpayers should write “Protective Claim” on the top of the form, then mail it to the address listed in the instructions for Form 1040X, under “Where To File.” Claimants should also make sure they obtain proof that the IRS has received the claim. And, as with all tax documents, copies of the claim and supporting papers should be kept in the taxpayers' files.

Once the claim is received, the IRS can act on it when the contingency that prompted the claim's filing is resolved. In the case of same-sex married spouses, that resolution would presumably come when the Supreme Court renders an ultimate decision on the validity of DOMA's Section 3. When the contingency has been resolved, the IRS will then approve or deny the claim. If the taxpayers are unhappy with the IRS's action, they may appeal the decision or seek aid from the courts.

Conclusion

The benefits of being deemed married when estate or gift taxes are involved are pretty universal, but not all married partners will benefit from filing their income taxes jointly. For example, if one spouse has a high income and the other's is very low, the low-earning spouse may not have to pay any income tax, or may pay only a small percentage, as a single filer. But adding that income to the high-earner spouse's might move the couple into a higher overall tax bracket. Still, for many same-sex married parties, a protective claim seeking the return of income tax overpayments through a joint filing is an appropriate way to avoid leaving money on the table. Time is of the essence, however, and taxpayers in this second group should be encouraged to act now to take advantage of the marital tax benefits that may become available to them in the near future.

When the U.S. Court of Appeals for the Second Circuit handed down its decision in Windsor v. U.S., it gave new hope to the many same-sex married couples in New York that their marriages might someday be afforded the same recognition as the marriages of opposite-sex couples. The emotional benefits of such an acknowledgement are undoubtedly substantial, but the financial benefits are equally compelling.

Edith Windsor had sought the return of the federal estate taxes she was compelled to pay because the United States was blind to her lawful marriage to Thea Spyer. The couple's home state of New York deemed their marriage valid. Had her marital status been recognized by the federal government, Windsor would have inherited her spouse's assets tax free, as would the widow of a man. The Second Circuit's ruling in Windsor v. U.S. confirmed the district court's finding that Section 3 of the Defense of Marriage Act (DOMA) ' the provision that declares that the federal government will not legally recognize the marriages of same-sex couples, whether those marriages were legal where performed or not ' is unconstitutional. As an unconstitutional law, it is therefore unenforceable. The Internal Revenue Agency (IRS) was ordered to return to Windsor the estate taxes she paid, which were in excess of $350,000.

Effects of Windsor on Taxes

Theoretically, the Windsor outcome means that other same-sex spouses who paid estate taxes on assets inherited because they were widowed are entitled to seek refunds. However, the U.S. Supreme Court has agreed to hear the appeal of the case, along with the appeal of another same-sex rights case, concerning the legality of a California voter-approved ban on same-sex marriage. Until the Supreme Court hands down its decision in these cases, the fate of marriage equality remains in limbo

If and when the federal government starts to treat same-sex married partners in the same way it does opposite-sex married partners, tax-lowering opportunities that the latter have enjoyed for years will become available to the former. Not only will estate taxes be affected by this change in policy, but also income and gift taxes. Waiting for the day that these questions are settled once and for all to make any claim to these benefits may prove costly, however. By acting now, some couples may be entitled to secure rights that will be granted retroactively if decisions like Windsor are upheld.

The mechanism for protecting same-sex married couples' rights at this time, while the legal situation is still unsettled, is known as a “protective claim.” A protective claim is an application filed with the IRS asserting that taxes paid should be refunded if an as-yet undecided issue is ultimately decided in the taxpayer's favor. An example of such an undecided issue would be an expected change in a tax regulation; another is the one presented in Windsor, in which certain laws affecting taxes may ultimately be declared unconstitutional.

Making a Claim

The rules for making such a claim with regards to income taxes, for example, are described in IRS Publication 556 (Rev. May 2008), titled “Examination of Returns, Appeal Rights, and Claims for Refund.” A protective income tax claim must be filed within three years of filing a return, or within two years of when the tax was paid, whichever is later. Once it has been filed, however, the claim will not be deemed untimely even if the ultimate issue is not resolved for many years. The protective claim stops the clock. For instance, if a same-sex married couple paid higher taxes on their income in 2011 than they would have paid had they been able to file jointly, they could seek a refund in 2013 if the Supreme Court were to affirm the Second Circuit's Windsor decision in that year. However, if they want to recover a tax overpayment made on March 10, 2010, and the Supreme Court does not rule on the issue until May 2013, our theoretical couple would be unable to recover unless they had filed a protective claim within three years of the date on which they paid their taxes.

• A protective income tax claim can be made in two ways: 1) as a formal claim; or 2) as an amended return for credit or refund (using Form 1040X, which can be found at www.irs.gov/pub/irs-pdf/f1040x.pdf). The claim does not need to state an amount of the expected refund, and it does not have to demand immediate payment. To be valid, it need only:
• |
  • Be in writing;
  • Include the taxpayer's name, address, Social Security number or individual taxpayer identification number (along with any other contact information);
  • Explain the contingency that affects the claim (in our case, the potential final declaration that DOMA's Section 3 is unconstitutional);
  • Alert the IRS to the essential nature of the claim;
  • State for which tax year(s) a refund is being sought; and
  • Be signed by the taxpayer.

Although not required, a computation of what the new refund should be is helpful. Taxpayers should write “Protective Claim” on the top of the form, then mail it to the address listed in the instructions for Form 1040X, under “Where To File.” Claimants should also make sure they obtain proof that the IRS has received the claim. And, as with all tax documents, copies of the claim and supporting papers should be kept in the taxpayers' files.

Once the claim is received, the IRS can act on it when the contingency that prompted the claim's filing is resolved. In the case of same-sex married spouses, that resolution would presumably come when the Supreme Court renders an ultimate decision on the validity of DOMA's Section 3. When the contingency has been resolved, the IRS will then approve or deny the claim. If the taxpayers are unhappy with the IRS's action, they may appeal the decision or seek aid from the courts.

Conclusion

The benefits of being deemed married when estate or gift taxes are involved are pretty universal, but not all married partners will benefit from filing their income taxes jointly. For example, if one spouse has a high income and the other's is very low, the low-earning spouse may not have to pay any income tax, or may pay only a small percentage, as a single filer. But adding that income to the high-earner spouse's might move the couple into a higher overall tax bracket. Still, for many same-sex married parties, a protective claim seeking the return of income tax overpayments through a joint filing is an appropriate way to avoid leaving money on the table. Time is of the essence, however, and taxpayers in this second group should be encouraged to act now to take advantage of the marital tax benefits that may become available to them in the near future.