The U.S. Internal Revenue Service, already under unprecedented scrutiny, must make another tough call -- whether to recognize the same-sex marriages of taxpayers whose home states don’t consider the unions legal.
Underneath that big decision are dozens more stemming from the June 26 U.S. Supreme Court ruling that invalidated the federal government’s definition of marriage as between one man and one woman. The IRS, which said last week it would “move swiftly,” must set rules for amending prior years’ returns and weigh potential penalties for under-withholding.
Each decision may mean thousands of dollars in costs or benefits to couples across the country who are trying to figure out what the court’s ruling will do to personal finances that long were structured to avoid running afoul of the IRS.
“It’s a simple statement and then there’s all these complexities,” said Nanette Lee Miller, a partner at Marcum LLP in San Francisco who leads the accounting firm’s practice for same-sex couples.
The IRS will make those determinations under a congressional and political microscope because of the extra attention it gave to small-government groups’ applications for tax-exempt status. The IRS has also been stretched thinner because of its expanding responsibilities under the 2010 health-care law and federal budget cuts. Agency employees will be on unpaid furlough July 5 as the result of the budget cuts.
“No matter what they do, it’s such a volatile issue, they’ll end up getting a challenge,” said David Herzig, a tax law professor at Valparaiso University in Valparaiso, Indiana.
The Supreme Court’s 5-4 decision in an estate-tax case turned the attention of same-sex married couples from the legal system to federal agencies, particularly tax enforcers.
For same-sex couples living in Washington, D.C., or the 13 states that allow and recognize their marriages, the path forward is relatively clear. They will file tax returns just like heterosexual spouses do.
The IRS’s major decision comes for residents of the other 37 states. Will it rely -- as it has in some previous cases --on states’ own definitions of marriage? Or will it set a nationwide definition requiring all same-sex married couples to file as married taxpayers? What will happen to couples in civil unions or domestic partnerships?
“The court’s decision, for a decision of this magnitude, is relatively short,” Joanne Youn, a member in the employee benefits practice at Caplin & Drysdale in Washington, told Bloomberg BNA. The justices refer to more than 1,000 federal laws pertaining to marriages and “they don’t go into details.”
A single nationwide rule would make the most sense, said Patricia Cain, a tax-law professor at Santa Clara University in California. Without it, taxpayers could find ways to game the system, establishing a temporary domicile in whatever state fit their tax needs that year.
“The IRS has the power to construe the Internal Revenue Code, so for them it’s ‘What does the word spouse mean?’” she said. “Nonconsistency would be an administrative hassle.”
President Barack Obama said it was his “personal belief” that same-sex couples should get the same federal benefits as married couples regardless of where they live. He said he had asked federal agencies to research the legal issues involved.
Such a ruling, though, might cause challenges for the IRS, which has argued in other contexts that state law controls the definition of marriage, Herzig said.
“You may solve this problem, but you may open up another problem,” he said.
For many same-sex couples, decisions from the court and the IRS that give them more rights might also cost them money.
Couples with roughly equal incomes typically pay a marriage penalty under the tax code, because more of their income is subject to higher marginal tax rates. Same-sex married couples in that situation may technically owe penalties for under-withholding for 2012 and 2013 if the IRS doesn’t provide relief.
Some same-sex couples have been able to take advantage of their separate status, claiming multiple adoption tax credits or multiple capital loss deductions unavailable to opposite-sex married couples.
Couples with unequal incomes would get a marriage bonus and would be most likely to try to file amended returns -- if the potential benefit exceeds tax preparation fees. Typically, the IRS allows taxpayers three years to redo their tax returns.
“One of the biggest issues is what to do retroactively, and the IRS has to outline what is mandated, what is not mandated,” said Elda Di Re, a partner at Ernst & Young LLP in New York. “One would think that the IRS will allow there to be filing refunds but not mandate filing to pay additional tax.”
The IRS may also need to address potential payroll tax refunds for companies that paid the taxes on health insurance for employees’ same-sex spouses, which isn’t taxable for married couples.
The companies would then need to figure out how to distribute any payroll tax refunds to employees and ex-employees. Companies may also need to decide whether to seek reimbursement from employees who get tax refunds this year related to their spouses’ benefits, and who got past help from their employers with additional income to cover those tax costs, which could disappear retroactively after the Supreme Court ruling.
Among the other issues are the tax treatment of alimony payments in past gay divorces and what happens to recently inherited individual retirement accounts, which now will pass to gay spouses under different tax rules than to unmarried partners. Some of the same questions would apply in estate tax cases, such as the one the Supreme Court decided.
Couples will navigate these transitional issues and then, at least in states that recognize same-sex marriage, have to spend much less money on accountants and tax lawyers.
“For same-sex couples, we’re always concerned with creating inadvertently taxable gifts or taxable compensation,” said Phyllis Epstein, an attorney at Epstein, Shapiro & Epstein in Philadelphia. “And a lot of those concerns are gone.”
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