Marriage INequality: Surviving Gay Spouse Had Better Plan for Big Tax Bite

There is a tax time bomb ticking away for California Registered Domestic Partners and Same Sex Married Couples. It's set to go off at midnight, Dec. 31, 2012 and will uniquely impact a class of taxpayers already in perpetual purgatory when it comes to taxes. The stakes are higher than usual this time, for some -- well into seven figures.

It is often said by opponents of same-sex marriage that present-day registered domestic partnership agreements offer the same benefits as an "opposite-sex" marriage. This may be true in some respects, but as far as federal, income gift and estate taxes are concerned, there are vast differences.

For example, in an opposite-sex marriage, when one spouse dies there is generally no estate tax on property passed to the surviving spouse. Gone are the days when a surviving spouse would be thrown into peonage by a rapacious "death tax."

Now, in most cases the property simply transfers to the surviving spouse by operation of law, free of any estate tax. This tax-free transfer of property from one spouse to another is called the "unlimited marital exemption."

There is no marital exemption for same-sex married couples or registered domestic partners, unlimited or otherwise. It does not exist for property transferred in life or at death. For the majority of registered domestic partners and same-sex married couples this does not matter for now.

But it soon will.

For Richer, For Poorer, Til Death Do Us Part
Five million dollars is a lot of money. The vast majority of people will not leave estates that large when they die. So the "good" news is that persons dying before Jan. 1, 2013, who have estates valued at less than $5 million will generally be exempt from estate tax.

This exemption applies to individuals by right of their own personhood and is not affected by marital status. Therefore, most people will not have to worry about paying estate tax if they plan on dying before next year.

But what happens to the people who do have assets in excess of $5 million and/or live past Dec. 31, 2012?

This question is important for registered domestic partners and same-sex married couples because there is no tax exemption for the transfer of property between these partners. For opposite sex surviving spouses, it doesn't matter if the deceased spouse was worth $1 billion dollars: Code Section 1041 allows a tax-free transfer of unlimited property between spouses in death as well as life.

Since the federal government does not recognize same-sex marriages or domestic partnerships, this is not the case for these couples. Assuming no other estate planning, once the $5 million estate and gift tax exemption amount is exceeded, every dollar in the estate is subject to estate tax.

That means that somebody who dies with a taxable net worth of $8 million would be taxed on $3 million, which in turn would generate an estate tax liability of $1,020,000 using the rates currently in effect. This could create a liquidity crisis and force the sale of assets to generate enough cash to meet the estate tax liability. This scenario can be particularly troublesome if the estate largely consists of assets for which the market may be depressed, such as real estate or collectibles.

Mitigating Death Duties
There are some estate planning techniques that can mitigate federal estate taxes for these couples. In the above situation, an Irrevocable Life Insurance Trust might be used to provide enough cash to meet the tax and other obligations of the estate. However, the viability of this and other estate planning options depends on variables such as the age, health, liquidity, etc. of the future decedent.

What is generally not an issue in estate planning for heterosexual partners due to the marital exemption is a huge issue for gay ones. They need to be aware of these tax pitfalls and plan accordingly.

Next, I'll explain why death from a tax perspective is both good news and bad news -- especially for registered domestic partners and same-sex married couples.

David Ellis has been a Certified Public Accountant in Pasadena, Calif., since 1987. Prior to that, he worked for the IRS. His firm, Ellis & Ellis CPAs specializes in matters relating to same-sex couples. His phone number is 626-577-4404; email: [email protected].

This article is submitted by the author with the understanding that it is intended for general informational purposes only. The author is not rendering legal accounting or other professional advice to the reader and assumes no liability whatsoever in connection with the information herein contained. Tax laws are ever changing and subject to interpretation. Readers wishing to learn more about the above topic should consult a qualified tax advisor.