Unknotting Windsor: The Potential State Tax Implications of the Same-Sex Marriage Decisions

 The Supreme Court is expected to release its ruling onUnited States v. Windsor andHollingsworth v. Perry this Thursday morning. Awaiting the decision, Bloomberg BNA interviewed Nicole Pearl, a partner at McDermott Will & Emery LLP who has extensive experience in tax planning for gay, lesbian and unmarried couples, asking her about the decisions’ possible impact on calculation of tax, amended returns or refund opportunities, and any potential interplay between the two cases.

Interplay Between Windsor and Hollingsworth

BBNA: While Windsor and Hollingsworth deal with different issues (taxes vs. Prop. 8), they ultimately examine the same underlying issue—the definition of marriage and equal protection under the law. Are the cases interdependent? Is a result in Hollingsworth necessary to resolve Windsor?

Pearl: While these two cases are related, they are not interdependent. 

In Windsor, the Court is looking at Section 3 of DOMA which defines marriage as between one man and one woman for purposes of federal laws.  Striking down this Section of DOMA would cause the federal government to recognize same sex marriages that are validly performed in any state (i.e., in any state where same-sex marriage has been legalized). It would not, however, force states that currently do not allow same sex marriages to recognize same sex marriages performed in other states (this is Section 2 of DOMA which is not at issue in Windsor), and it would not force every state to allow same sex couples to marry. In other words, Windsor only addresses federal recognition of same-sex marriages that were validly performed under state law.

If Section 3 of DOMA is found to be unconstitutional, then all couples who have legally married in their state of residence will be treated the same as their heterosexual married counterparts. This means that they will be able to file joint federal tax returns, will qualify for spousal benefits under social security and other federal programs, will be entitled to preferred immigration status, and so on.  Couples that live in states that do not allow same sex marriage will be in nearly the same position as before – still no legal right to marry. However, because couples can go to other states to marry or can move from state to state once married, there are several issues that will still be hanging out there even assuming that the Court strikes down Section 3 of DOMA. These include the following:

• What if a couple from NY (or any other state that allows same sex marriage) moves to another state that does not recognize their marriage? Will they still qualify as married for purposes of federal law? The answer to this may be different for income tax purposes than it would be for estate tax purposes. Also, some of the same problems that exist today will continue to exist for this couple. For example, can they divorce in their new state of domicile if that state does not recognize their marriage? Would the prior state still have jurisdiction to dissolve their marriage? State laws often allow out of state residents to marry there. However, their courts generally lack jurisdiction to hear any divorce case involving out of state residents. The practical effect of this wrinkle is that couples could marry, but not divorce.

 What if a couple from TX (or any other state that prohibits same sex marriages) goes to NY or some other state to get married? TX would not recognize their marriage, and would not be forced to do so, even if Section 3 of DOMA is held to be unconstitutional. Would the federal government recognize this marriage? Would the result be different if they actually have some tie to NY (e.g. a vacation house there that they spend a considerable amount of time at each year)? The answers to these questions are likely to come from Regulations issued by the IRS or other governmental agencies or from future legislation or court cases.

Hollingsworth involves Proposition 8, a voter-passed referendum that barred same-sex marriages in California performed after November 2008. In this case, the Court could tackle the larger issue of whether it is unconstitutional to prohibit same-sex couples from marrying. However, most analysts do not believe that the Supreme Court will make such a broad ruling at this time or with this case. The far greater likelihood is that the Supreme Court will punt on this case. It will either decide that the intervenors lacked standing to bring the appeal or the court will fashion a narrow conclusion that stops short of reaching the big Equal Protection Clause issue. The Supreme Court could adopt the reasoning of the Ninth Circuit opinion which found Prop 8 to be unconstitutional because it removed a right that had already been granted (unlike most states where same-sex couples have never had the right to marry so it was not a right that was being taken away). It is also conceivable that the Court could find that a “separate, but equal” system, such as CA’s domestic partnership registry, somehow is more egregious from a constitutional standpoint than a state that simply prohibits any type of legal recognition for same-sex relationships. At this point, this is all conjecture until we see the actual Opinion (which I understand could come as early as tomorrow).

Calculating Tax

BBNA: Many states which have legalized same-sex marriage have had to restructure their calculation of individual income and death taxes because they begin with the calculation of federal gross income, which bars same-sex couples from filing joint returns. Many states require same-sex couples to file pro forma federal returns as if same-sex marriage was legal under federal law. How would the ruling in Windsor change the states’ base calculation mechanisms? 

Pearl:If Section 3 of DOMA is struck down by the Court, then couples would no longer have to prepare a “fake” or pro forma joint federal return. Instead, they would be allowed to file both joint federal returns and joint state returns. This could be a benefit or a detriment to the couple, depending on their circumstances. For two wage earning families, same-sex couples filing joint returns are likely to pay more federal income taxes than they did before. However, for families where one spouse earns all of the income, their taxes are likely to go down.

United States v. Windsor deals with a same-sex spouse’s ability to claim the unlimited spousal deduction on an estate tax return. How would a ruling against DOMA affect state estate taxes and the gift taxes, specifically? A ruling in Windsor is not likely to affect state taxes. The Section of DOMA at issue in this case really only involves federal recognition of marriages. Assume, for instance, there was a state that had a state estate tax and did not recognize same sex marriage. Even if Section 3 of DOMA was struck down, this state would not be forced to recognize a marriage that was performed in another state for purposes of the state estate tax marital deduction. If we get a broad ruling in the Hollingsworth case, that may force the state to recognize the marriage for all purposes (including the state estate taxes).

BBNA: What would be the impact on the estate and gift taxes if the Supreme Court simply remands the case, or decides to dismiss the case on jurisdictional grounds? What other sweeping changes would states have to make to their tax codes if the Supreme Court rules in favor of Windsor? 

Windsor should have very little impact on the states. Hollingsworth, on the other hand, could force the states to recognize same sex marriages if the Court gets to the merits of the case and issues a fairly broad ruling that applies outside of California.

Federalism and Uniformity

BBNA: Chief Justice Roberts focused on issues of federalism during the oral arguments. What are some of the potential effects on state tax codes if the definition of marriage is ruled to be a federal issue, no longer up to the states to police?

Pearl: Marriage has typically been a state issue. The states defined how and when you were married, and the federal benefits that went along with marriage were conferred on those couples that were deemed to be married under state law. As far as I am aware, DOMA was the first time that the federal government began to regulate the definition of marriage. Traditionally, there has also been a lack of uniformity among states concerning marital status. For instance, common law marriages are permitted in some states, but not in others. Every state has their own laws about how you can terminate a marriage, and in some old cases, the rules governing when you can remarry after divorce. 

I’m not sure either case here would affect state tax codes (although, of course, I will give the disclaimer here that I have no idea how the justices will rule, and much of this analysis depends on their actual decision). The decision in Windsor, regardless of how the Court rules, is not likely to affect the states at all, especially those states that do not now permit or recognize same-sex marriages.   The Hollingsworth decision is more likely to affect the states if the Court reaches the merits of the case and finds it unconstitutional to deny marriage rights to same-sex couples. In that case, any rights conferred by the states to married couples would likely have to apply equally to same-sex and heterosexual couples. But, again, this assumes that the Court reaches a broad decision that applies to all 50 states. It is more likely that their decision will either be based on standing issues, or will otherwise be limited in scope to California (or any other state that first allowed and then took away a right of same-sex couples to marry) or possibly other states that grant “separate but equal” rights to same-sex couples in the form of domestic partnerships or civil unions.

Amended Returns and Refund Opportunities

BBNA: How would a finding of DOMA as unconstitutional affect the tax returns same-sex couples have filed in the past? Would there be an opportunity for amended returns and refunds, and what sort of issues might these amended returns cause? 

Pearl: It is hard for me to imagine a situation in which these decisions applied only prospectively. If something is unconstitutional today, then presumably it would have been similarly unconstitutional a few months or a few years ago. 

This would allow same sex couples who have created a legal marriage in any state to go back and amend any income, estate or gift tax returns in which the statute is still open (generally 3 years from the date of filing). This would allow couples to go back as far as their 2009 returns (assuming that they were filed on extension in 2010). Of course, there is no duty to amend tax returns so couples can decide based on their particular circumstances whether this would make sense for them. 

This also gives rise to further questions. For instance, are couples that registered as domestic partners or formed civil unions in their states of domicile because they were not allowed to marry in those states allowed to go back and amend their returns? Would they even be considered to be married under federal law, or would they have to take some further step in order to legitimize their marriage (e.g. obtain a marriage license). 

Nicole M. Pearl is a partner in the law firm of McDermott Will & Emery LLP and is based in the Los Angeles office. Nicole focuses her practice on estate planning, wealth transfer planning, marital property agreements, business succession planning and post-death administration. Nicole has extensive experience in estate and tax planning for gay, lesbian and unmarried couples. She regularly speaks on this topic.

By Melissa Fernley

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