Memorandum to Our Clients and Friends Regarding the Recent Supreme Court Decisions holding the Defense of Marriage Act Unconstitutional as to Same-Sex Couples who were Validly Married under State Law and Reinstating a right to Same-Sex Marriage in California

On June 26, 2013, the United States Supreme Court struck down Section 3 of the Defense of Marriage Act (DOMA), which previously had required same-sex spouses to be treated as unmarried for purposes of federal law. The decision in Windsor v. United States, U.S., No. 12-307, 6/26/2013, found DOMA unconstitutional based on a violation of due process and equal protection.

In a second case decided the same day, the Supreme Court dismissed for lack of standing the appeal of a Ninth Circuit decision that had held California Proposition 8 to be unconstitutional. That Proposition, which was passed by the voters of California in November 2008, banned same-sex marriages in that state. The Supreme Court’s dismissal of Hollingsworth v. Perry, U.S., No. 12-144, 6/26/2013, resulted in the reinstatement of a right to same-sex marriage in California.

These two decisions do not by any means resolve the many planning issues confronted by same-sex married couples, but they provide such couples several planning opportunities.

DOMA was passed by Congress and signed into law by President Clinton in September 1996. It contained two primary sections. Section 2 provided that no U.S. state or other authority is required to recognize a same sex marriage that is treated as a valid marriage under the laws of any other state or other authority. Section 3 stated that for all purposes of federal law, the word “marriage” means only a legal union between one man and one woman, and the word “spouse” refers only to a person of the opposite sex who is a husband or a wife.

Section 2 limits the application of the Full Faith and Credit Clause of the U.S. Constitution, so that states that have banned same sex marriage, either by constitutional amendment or statute, are not required to recognize a same-sex marriage or other union entered into or validly recognized by any state that has authorized such marriages or unions. In the years after the enactment of DOMA and before the Windsor and Perry decisions, same-sex marriage had become available in 9 states and the District of Columbia (with an additional 3 scheduled to take effect later in 2013)¹ and several states had authorized civil unions or domestic partnerships.² Because of Section 2 of DOMA, same-sex marriages validly entered into in these states (or in foreign countries that authorize such marriages) are not recognized by the 6 states that prohibit same-sex marriage by statute, or by the 29 states that have constitutional bans.

The effect of Section 3 was to deny to same-sex spouses up to 1,049 (according to the General Accounting Office) federal statutory provisions that were based upon DOMA’s federal definition of marriage, among these income, estate, gift and generation-skipping transfer (“GST”) tax exclusions, deductions and benefits, veterans benefits, employer-provided health and pension benefits, and rights relating to the immigration status of non-citizen spouses.

New York residents Edith Windsor and Thea Spyer were partners for over forty years. In 2007 they were legally married in Canada, which had recognized same sex marriage starting in 2005. Although New York State did not enact its own statute legalizing same-sex marriage until July 24, 2011, its courts had held that same sex marriages validly entered into in other jurisdictions should be recognized in New York. When Spyer died in 2009, the IRS applied Section 3 of DOMA and refused to acknowledge the couple’s marriage or the right to an unlimited marital deduction for property passing to a surviving same-sex spouse, imposing over $363,000 in U.S. estate taxes. Windsor paid the tax due and sued for a refund, challenging Section 3 of DOMA in federal district court as a violation of rights under the equal protection guarantees of the Fifth Amendment. (The Windsor case did not concern Section 2.) She won both in the district court and in the Second Circuit on appeal.

The Perry case arose out of the enactment of a constitutional amendment in California banning same-sex marriage, after it had been legalized by a decision of the California Supreme Court. Following the enactment of the ban, two same-sex couples who no longer were able to marry sued in federal district court, challenging Proposition 8 as a violation of their rights to due process and equal protection under the U.S. constitution. The plaintiffs were successful both at the district court and in the Ninth Circuit on appeal. (The state officials named as defendants in the district suit refused to defend the suit on appeal in the Ninth Circuit and before the Supreme Court and the original backers of Proposition 8 stepped in to defend the ban.)

The Supreme Court accepted both cases on appeal and conducted two days of hearings in late March 2012. In a 5-4 decision written by Justice Kennedy, the Court held in Windsor that Section 3 of DOMA is an unconstitutional “deprivation of the liberty of the person protected by the Fifth Amendment.” In a 5-4 decision written by Chief Justice Roberts, the Perry case was dismissed for lack of standing, holding that the Proposition 8 backers did not have the authority under state law to defend the ban.

Two important considerations should be remembered in considering the impact of Windsor on same-sex married spouses. First, Justice Kennedy limited the Windsor decision to same-sex couples who have entered into a lawful marriage; the decision does not appear to grant federal recognition for same-sex partners who are not married but who have entered into a civil union or domestic partnership.³ Second, it is not clear whether same-sex couples who marry in a state or country that authorized their marriage but who reside in a state that does not recognize their marriage will be able to avail themselves of all of the 1,000-plus federal benefits of marriage that are now available to same-sex spouses who live in one of the 13 states or the District of Columbia that recognize their marriage. The Obama administration has already begun reviewing the regulations of governmental agencies to determine to what extent federal benefits and programs can recognize the marriages of same-sex couples resident in a state that does not recognize such marriages absent Congressional action.

For those same-sex married couples living in jurisdictions that do recognize their marriage, the impact of Windsor cannot be overstated, and the array of federal tax and other property benefits now afforded them through marriage has been greatly expanded. Highlighted below are just a few important planning opportunities for same-sex spouses in light of the Windsor and Perry decisions.

The Unlimited Marital Deduction. There is an unlimited marital deduction from estate and gift tax for transfers between U.S. citizen spouses that take effect during lifetime or at death. Section 3 of DOMA prevented Thea Spyer’s estate from making use of the unlimited marital deduction at her death, thereby subjecting Edith Windsor’s inheritance to significant U.S. estate taxes. With the overturning of Section 3, gifts or bequests between validly-married same-sex spouses no longer are subject to U.S. gift or estate tax.⁴ Planning for property ownership has become easier, now that same-sex spouses can title real and other property in joint tenancy (subject to state and local property laws). In addition, if the difference in age between the spouses is significant (i.e., more than 37 ½ years), the spouses are treated as being in the same generation for GST tax purposes, thereby eliminating any GST tax exposure for gifts or bequests from the older spouse to the younger.⁵ Furthermore, in certain situations, the deceased spouse’s unused applicable exclusion amount (“DSUE Amount”) can be used by the surviving spouse if not fully utilized prior to death. Estate planning documents that did not foresee the availability of an unlimited marital deduction for transfers to a same-sex spouse or use of the DSUE Amount should be reviewed with counsel to determine whether proper tax planning could offer a more tax efficient distribution of the spouses’ assets to their descendants and other beneficiaries.

Gift Splitting. Married couples may combine their annual and lifetime gift tax exclusions, so that when a taxable gift is made to a third party by one spouse, the gift can be treated on the spouses’ U.S. gift tax returns as having been made one-half by each spouse, with the result that the total amount of gifts made by each spouse is reduced. Prior to the Windsor decision, same-sex spouses were prohibited from “gift splitting.” Now, married same-sex couples are allowed to split their taxable gifts to children and other donees, so that (for 2013) up to $28,000 in taxable gifts per couple can be given by one spouse to the couple’s beneficiaries without requiring the spouses to make use of any of their applicable exclusion amount.

Income Taxes and Withholding. Same-sex married couples residing in states that recognize their marriage must now file their federal income tax return as married taxpayers, and should consult with their tax advisors whether to file jointly or separately. If they have not yet filed their 2012 income tax return, they will be required to file that return either as married filing jointly or married filing separately. In addition, such couples should consult their tax advisors on updating their filing status on Form W-4 to reflect their marriage (if they receive a Form W-2 at the end of each tax year), or revise any quarterly estimated tax payments that they pay (if they are self-employed).

Amend Prior Tax Returns. Same-sex married couples should consider whether they should amend any previously-filed federal income, gift or GST tax returns to take advantage of the spousal benefits provided in the Windsor decision. (This also applies to state income tax returns in California due to Perry). Depending upon the same-sex married couple’s particular circumstances, amending previously-filed income tax returns may increase or decrease the couple’s collective income tax liability for the subject tax year. Also, surviving same-sex spouses should consider whether to amend the estate tax return of their deceased spouse. Although one generally can amend a previously-filed federal tax return for three years after the date of filing, it is not yet clear what position the IRS will take with respect to same-sex couples, and whether amending such returns will be voluntary or mandatory, given that a statute declared unconstitutional is void from inception. Will this mean that married same-sex couples should be permitted to amend their tax returns going back to the year of their valid marriage or only for the 2010, 2011 or 2012 tax years? The Netherlands was the first country to legalize same-sex marriages in 2001, and Massachusetts was the first state in the United States to legalize same-sex marriages in 2004, so a liberal authorization allowing or requiring the amending of all returns filed by a married same-sex couple could result in significant tax filings. Answers to these questions must await further guidance from the IRS and the Treasury Department. At the least, same-sex married couples should consider whether to file protective claims for refunds for any of 2009 and subsequent years during which they were lawfully married.

Group Health Insurance Plan Costs. Many employers offer health insurance coverage to their employees and the spouses of their employees. Before the Windsor decision, the cost of an employee’s health insurance coverage provided to a same-sex spouse was treated as taxable income to the employee. The tax consequences have now changed in the case of an employee with a same-sex spouse residing in a state where a same-sex marriage is recognized. It still remains to be seen whether income taxes paid by such employees in prior years (or during this year) will be refunded. In addition, absent further guidance from the IRS, the Windsor decision did not change the tax consequences with respect to an employee whose same-sex marriage is not recognized in the state where he or she resides. Similarly, the cost of health insurance coverage provided to a domestic partner of an employee continues to be treated as taxable income to the employee.

COBRA Benefits. The Consolidated Omnibus Budget Reconciliation Act (“COBRA”) provides an opportunity to many employees and “qualified beneficiaries,” including a spouse, to continue with employer-provided health insurance coverage for a limited period after certain “qualifying events,” including an employee’s death, termination of employment or, with respect to a spouse, the divorce or legal separation from an employee. In light of the Windsor decision, a same-sex spouse of an employee could now be eligible to be covered by COBRA, whether in the event of divorce from the employee or the employee’s termination of employment. However, in the absence of further guidance from the IRS, it is not yet clear whether the IRS will allow a COBRA election to (i) a same-sex spouse of an employee who already has made a COBRA election, or (ii) a former same-sex spouse who previously has divorced from an employee.

Enrollment Elections. Many employers grant their employees with a right to make an election, or to revoke an existing election in a group health plan, during a coverage period in case of a change in legal marital status. Employees with same-sex spouses who reside in a state that recognizes same-sex marriages should check with their employer regarding these opportunities in light of the Windsor decision.

Pension, Profit-Sharing and 401(k) Plans. With respect to survivor benefits, pension and other qualified plans generally do not permit a married employee to designate a beneficiary other than a surviving spouse without the written consent of that spouse. Employees in a lawful same-sex marriage should revisit their current beneficiary designations as a result of the Windsor decision. Additionally, employees in a lawful same-sex marriage may now be required to take a qualified joint and survivor annuity in the absence of a written consent from a same-sex spouse that allows for alternative distribution methods (e.g., single life annuity). Furthermore, plan participants with same-sex spouses who have begun taking their required minimum distributions should consult with their plan administrator, as the required minimum distribution rules are generally more liberal for participants who are married than for unmarried participants. Finally, in light of the Windsor decision, a surviving same-sex spouse is now allowed to rollover the deceased spouse’s retirement account into his or her own individual retirement account (as opposed to “inherited IRAs”), which could result in deferral of minimum distributions until mandated by the surviving spouse’s age.

Transfers Incident to Divorce. For same-sex couples who are able to divorce under the laws of their state of residence (discussed in further detail below), transfers of property required to be made upon divorce from one spouse to the other are no longer treated as taxable gifts. In addition, same-sex couples who divorce may now take advantage of a court-issued order that meets the requirements of a “qualified domestic relations order” (“QDRO”) under the Employment Retirement Income Security Act of 1974 and/or the Internal Revenue Code of 1986, as amended, to divide and assign the participant spouse’s retirement benefit or 401(k) account.

Citizenship and Permanent Residency. A same-sex spouse of a US citizen is now afforded the opportunity for citizenship and permanent residency based upon his or her marriage (regardless of the state of their residency), and a U.S. citizen spouse may now sponsor his or her same-sex non-citizen spouse for residency or citizenship. As always, persons who are considering acquiring U.S. residency or citizenship should carefully consider the tax and other implications thereof well before taking irrevocable steps to change their residency or citizenship.

These are just a sample of the most important estate planning benefits gained by same-sex couples from the Windsor and Perry decisions. It is important to consider the effects of domicile, as neither case requires a state with its own version of DOMA to recognize a same-sex marriage lawfully entered into in another state. Below are two important state-specific considerations to keep in mind.

1. Domicile in a state that does not recognize same-sex marriages may affect the ability of a same-sex couple to divorce. Most states do not allow a couple married in that state to divorce when they are no longer residents (Vermont being an exception if the same-sex marriage was entered into in that state). In such a case, an unhappily married same-sex couple could end up unable to divorce without one party moving and establishing residency in a jurisdiction that recognizes their marriage.
2. A state that does not recognize same-sex marriage may cause difficulty in applying the definitions of common terms in legal documents used in estate planning. For example, many states, including New York, require that the “next-of-kin” or distributees of a decedent be made party to probate proceedings, or give favorable treatment to an individual’s next-of-kin in determining who should make health care decisions for, or be appointed guardian of, a disabled individual, or who should be responsible for disposing of the bodily remains of a deceased resident. It is especially important in those states where a same-sex spouse is not validly recognized as the next-of-kin to use careful language in estate planning documents when defining terms that are related to marriage.

While the Windsor decision has brought to same-sex couples federal recognition of their unions and the Perry decision has brought to 13 the number of states (plus D.C.) that offer and recognize same-sex marriage, neither case established a nationwide entitlement to same-sex marriage, leaving that question inevitably to be decided at a future day. In the meantime, while same sex marriage advocates focus on the remaining states with existing bans, seeking legislatively or judicially or through ballot initiatives to convert civil union or domestic partnership rights in states such as Colorado, Hawaii, Illinois Nevada, New Jersey, Oregon and Wisconsin into full-fledged marital rights, or to overturn constitutional bans or statutes, same sex couples should carefully consider their own situation and consult with their tax and legal advisors. And same sex couples who have not yet married should consider whether these developments alter their marriage plans.

If you have any questions about this report, please feel free to call Hume Steyer at (212) 574-1555, David Stutzman at (212) 574-1219, Scott Sambur at (212) 574-1445,  or Stacia Kroetz at (212) 574-1352 of our Trusts and Estates Group.

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¹ These states included, by order of enactment, Massachusetts, Connecticut, Iowa, Vermont, New Hampshire, New York, Washington, Maine and Maryland. Same-sex marriage became available in Delaware on July 1, and will become available in Rhode Island and Minnesota on August 1. California had legalized same-sex marriage, but for only a few months in 2008 before passage of Proposition 8 reimposed a ban on such marriages. Certain foreign countries have also legalized same-sex marital relationships.

² States with current civil union provisions (but not marriage equality statutes) include New Jersey, Illinois, Hawaii and Colorado. Oregon, Nevada and Wisconsin authorize same-sex domestic partnerships.

³ Thus, for instance, New Jersey has legalized civil unions for same-sex couples, but not marriages. It is unlikely that civil unions entered into in that state by same-sex couples will be recognized by the U.S. government as valid marriages.

⁴ Please note, however, that transfers to a spouse who is not a U.S. citizen do not qualify for the unlimited marital deduction.

⁵ Because DOMA had treated married same-sex spouses as non-relatives, spouses with large age differences could be subject not only to gift tax but also to GST tax on gifts from the older spouse to the younger spouse.