Same-sex couples should watch for three tax-code gotchas that can set them up to lose money or even break the law.
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These traps loom particularly large for couples wed in Massachusetts, Connecticut, Iowa, New Hampshire, Vermont and the District of Columbia, where such marriages are legal. Similar problems can also trip you up in the states that provide domestic partnerships, civil unions or benefits, or recognize same-sex marriages performed in other states.
Behind each tax problem is a conflict between state and federal law. In such states as Massachusetts, married same-sex couples enjoy the same legal status as married heterosexuals. But a federal law called the Defense of Marriage Act requires the Internal Revenue Service to treat legally married same-sex couples as legal strangers, despite the Obama administration's recent decision not to defend the law against court challenges.
1. Accidentally Breaking the Law
Your first hurdle comes in the filing status box on your federal tax return. It's illegal to file false or misleading returns. Misidentify your relationship, and you've broken the law.
"At this point, it's illegal to file a joint return federally if you're a same-sex couple," says Tina Salandra, whose New York City firm, Numerical LLC, specializes in tax issues faced by gays and lesbians.
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No matter how your home state views your relationship, you must file a separate federal tax return from your spouse and identify yourself as either being "single," or as "head of household" if you have a dependent.
Some tax preparers recommend placing an asterisk next to the filing status box and adding a note or cover letter explaining the situation. For example, you might attach a copy of your marriage certificate and explain that even though you are filing as a single taxpayer, you are in fact married to a person of the same sex and that filing as such does not mean you are disavowing your marriage.
Not everyone agrees. "This is kind of worthless," Salandra says. But the law firm Lambda Legal argues that such letters protect you from the charge that you disclaimed your marriage's validity on your tax return. This could be an issue in applications for mortgages or spousal insurance benefits.
2. Falling Prey to The Gift Tax
"There's no limit to what legally married (heterosexual) spouses can give to each other," Salandra says. But you can be subject to the federal gift tax if you give your same-sex spouse more than a certain amount in your lifetime.
These "gifts" would not be taxed in a heterosexual marriage. They can include a jointly owned house or car, joint investments or even a joint bank account, says Wendy Hartmann, a tax and estate attorney with the Los Angeles firm of Bennett & Erdman. Taking an elaborate vacation where one of you pays most of the bills can also cause problems. The donor pays the gift tax, currently 35 percent.
"Married (heterosexual) couples never have to think about that, but same-sex couples get trapped in this all the time," Salandra says.
Present law allows you to exclude up to $5 million over your lifetime, but that exclusion will drop to $1 million in 2013 if Congress doesn't act. You can use your entire exclusion if you add your spouse's name to a real estate title or jointly purchase other high-value assets.
Even if you haven't hit your lifetime exclusion, you must still file a federal gift tax return if you give more than $13,000 to one person in a year. A gift of $113,000 to your same-sex spouse, for example, would require you to file a return reporting the gift of $100,000 and invoking your exemption.
Despite the hassles, the current law offers opportunities. "The high gifting exclusion can offer tremendous benefits to same-sex couples who may want to add their partners to the title of appreciating assets, or simply make cash gifts to a partner," Hartmann says.
3. Getting the Tax Prep Blues
Same-sex couples could face triple the fee heterosexuals pay for tax preparation, Hartmann says. That's because tax preparers may have to create four returns:
- Two returns: one for each spouse filing as single with the IRS.
- One return to file jointly with your home state.
- One hypothetical joint federal return, which is needed to prepare the joint state return.
Even bigger bills may go to some same-sex couples in California, Nevada or Washington. A new IRS rule allows registered domestic partners and legally married same-sex couples in those community property states to split their income. This may provide tax advantages or produce new liabilities.
All of this complicates tax preparation. "It's critical for every couple to recognize the potential issues and to seek the right advice," Hartmann says.
To avoid unexpected costs, pay attention and plan ahead, tax preparers advise.
"It is starting to be impossible for the average person to keep up with tax law," Salandra says, "but same-sex couples, in particular, can benefit more from being aware of tax laws than the average taxpayer."