Two recent U.S. Supreme Court decisions affecting same-sex marriage have opened the floodgates for all couples to strategically marry and divorce in order to significantly reduce their federal taxes.
The first was the so-called “Windsor” decision in 2014 which states, “the Constitution delegated no authority to the Government of the United States on the subject of marriage and divorce.” According to New York City attorney Carlyn McCaffrey, this makes it clear that “it is purely within the realm of states to define marriage.”
This past summer, the high court determined in the Obergefell case that marriage is a fundamental right of all individuals. As such, McCaffrey says “Any two people who want to get married- a man and woman, a man and a man or casual acquaintances- can do so."
According to McCaffrey, nearly 200 sections of the Tax Code “give neither taxpayers nor the IRS the option of disregarding state law marital status for federal tax purposes.”
The only time the federal government can refuse to recognize two individuals as married is if there is a specific public policy reason and a statute that enforces this. For instance, federal law allows officials to ignore marriages that are conducted just to enable someone evade federal immigration rules.
On the other hand, explains McCaffrey, sometimes federal law treats you as married even though you claim you are not. For instance, in New York State two people who are living together can hold themselves out as “married” without going through a formal ceremony. Although they are recognized as such for purposes of New York law, they cannot also claim they are “single” for purposes of federal disability. That’s because two single individuals would get a higher benefit than a married couple.
IRS in a Bind
For decades the Internal Revenue Service has maintained that it has the power to declare a marriage or divorce- a “sham” if it appears to have been conducted for the sole purpose of avoiding taxes. But McCaffrey and her son, John, who is also an attorney, researched the case history on this and concluded that the IRS is on shaky ground.
Back in the 1970s, for two years in a row, David and Angela Boyter took a late-December vacation to a foreign destination and got divorced. Since your marital status on of December 31st determines how you file your income tax return, they were able to file as “single” each year. This enabled them to pay far less in income tax than they would have owed as a married couple. Shortly after they returned to the United States, they got re-married.
The IRS maintained that the Boyter’s divorces were “shams,” only undertaken so that they could avoid paying their taxes. The Boyters sued in tax court and lost on other grounds. But in the McCaffreys’ analysis, the IRS’ main argument was flawed because it was based on regulations that cover corporations. You can hardly apply corporate law to human beings.
No Federal Law
More importantly, Supreme Court decisions in the Windsor and Obergefell cases make it clear that the federal government has no power to either define “marriage” or rule on the validity of it. According to McCaffrey, in order for the IRS to have the power to argue that two people entered into a marriage just to avoid taxes, Congress would have to pass a specific law to this effect, as it did regarding immigration policy.
The sticky part would be to come up with a federal definition of “marriage.” State law varies widely on this. For instance, some states recognize common law unions, while others do not. State law also differs on the age at which someone can wed and whether they can marry a close relative.
“The [federal] government can’t decide to treat you as unmarried just because you didn’t intend to have sexual relations or combine your finances” or engage in any other activities that are commonly thought of as indicators of marriage, says McCaffery. It also cannot pass judgment on your motivation for getting married.
Play the Newlywed Game to Reduce Estate Tax
Under the law, if one spouse dies without using all or any of their estate tax exemption, the unused amount passes to the surviving spouse. Thus, a wealthy person could marry someone who is on their death bed and thereby double the amount of assets the wealthy individual can leave to their own heirs free of estate tax. “If somebody finds someone who is dying [and who agrees to marry them], they can give away an extra $5,430,000 tax-free,” says McCaffrey.
A similar advantage applies to the gift tax.
Marry a Friend
When you die, you can leave an unlimited amount of assets to your spouse without any estate tax consequences. If you combine this with the Generation-Skipping Transfer Tax (GSTT) rules, things get really interesting. The GSTT applies to assets left to grandchildren as well as to unrelated persons who are more than 37½ years younger.
“Suppose that an elderly person with a live-in caregiver wants to make a bequest in thanks for their help,” says McCaffrey. The caregiver is at least 38 years younger than the older person.
“If he left her $100,000 it would cost his estate $40,000 in estate tax. Then there would be a second $40,000 in generation-skipping transfer tax.” In other words, it would cost him $80,000 to leave $100,000 to this person because she is: a) more than 37½ years younger, and b) not a spouse.
Now suppose that in a private ceremony in his hospital room he marries her. (Or him.)
The result: no tax at all because an unlimited amount of assets can be left to your spouse!
All Gain, No Tax
Another nifty incentive to marry revolves around investment gains. Under the law, every dollar you report making on investments can be offset by every dollar you lose. The key is that as a couple, you get to pool your gains and losses. As McCaffrey explains, “If you have a $100,000 gain. and you find someone with a $100,000 loss and you get married on the last day of the year, you can use your new spouse’s loss to offset your gain.”
The end result? Zero tax on your investment profits.
Playing the Year-End Split
On the other hand, there are a number of well-known “marriage penalties” in the federal income tax code. For instance, say you are married and each spouse earns $232,425. This gives you a joint income of $464,850, putting you in the highest income tax bracket. As a couple, says McCaffrey, your tax bill would be $339.905.70.
“If you divorce on Dec. 31, [the two of you] would pay a total of $301,027.90, saving $38,877.80.” Then- if you want- you can get re-married the next year.
The personal exemption is another marital “gotcha.” Consider a family comprised of mom, dad and three kids. Each is allowed a $4,000 deduction- a total $20,000.
However, if mom and dad happen to be married, they start losing this deduction once their joint income hits $309,900.
If they are unmarried on last day of the year, they can have earnings of up to $516,500 ($258,250 each) before the deduction phases out.
The McMansion Divorce
Untying the knot by December 31st creates a big tax savings for couples buying an expensive home.
Whether you are married or single, the tax code allows you to borrow up to a million dollars and deduct every penny of interest you pay on your mortgage.
In other words, if both partners file their taxes as “single” they can each borrow up to $1 million and deduct the interest.
McCaffrey sums it up this way: “Divorce doubles the interest deduction for your mortgage.”
A-M-T for Two
The Alternative Minimum Tax kicks in when a married couple’s combined income hits $83,400.
For a single filer, the AMT applies at an income level of $53,600. Thus, two unmarried equal earners are not subject to the AMT until their combined income reaches $107,200.
Not Just for the Rich
Let’s say you are a single mother with three children and had income of $17,800 last year. Not only will you owe zero income tax, McCaffrey points out that “the government will pay you $6,143” thanks to the earned income tax credit (EITC).
Now assume that during the year you married someone who also happens to have an income of $17,800. Same apartment, same kids. How much EITC does the government pay you? $3,538. Marriage cost you more than $2,600.
“You can’t afford to get married!,” exclaims McCaffery.
Not for Everyone
As the McCaffrey’s write:
Obergefell and United States v. Windsor, suggest that the private fundamental right to marry and the equal protection clause may put valid marriages and divorces beyond the authority of the IRS to disregard. This should be true even for those marriages entered into with the primary purpose of realizing a tax benefit explicitly authorized by Congress and those divorces obtained for the primary purpose of avoiding the tax penalties the Code often imposes on married individuals.
None-the-less, don’t expect to suddenly see a spike in Vegas-style quickie marriages and divorces and time soon. McCaffrey is the first to admit that “people don’t necessarily act purely in economically rational ways. In my practice, I haven’t seen many people do it.”
Still, she says, “Tax-motivated marriage and divorce is probably a lot easier to accomplish. People need to be made aware of this opportunity.”
You’ve got to admit it is tantalizing. As Billings Learned Hand, a U.S. District Court judge, wrote in a 1934 decision involving the IRS:
Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one's taxes. (2)
1. Your spouse must be a U.S. citizen.
2. Helvering v. Gregory, 69 F.2d 809 (1934).