Ruling poses tax issues for same-sex couples
LOS ANGELES (MarketWatch)--In June, the U.S. District Court in New York handed Edith S. Windsor a victory worth more than $363,000.
In a bold and dramatic move, U.S. District Court Judge Barbara S. Jones ruled that the Defense of Marriage Act is unconstitutional.
That wasn't just a social statement. It heralds a powerful change in tax procedure, as well. On the basis of that ruling, all legally performed marriages, even those between same-sex couples, are entitled to the same tax treatment under federal law.
The verdict is being appealed by the Bipartisan Legal Advisory Group of the U.S. House of Representatives. Expect this case to reach the Supreme Court before the issues are resolved.
Meanwhile, the IRS was instructed to refund to Edith Windsor the estate taxes paid on behalf of the estate of Thea Spyer, Windsor's wife.
California attorney and enrolled agent Mel Kreger says that this verdict opens up exciting tax opportunities for same-sex couples and domestic partners. It's time to file protective claims to protect the right to tax refunds.
First, a little background. Several states allow same-sex marriage or recognize marriages performed in other states or countries. Some states also recognize registered domestic partnership arrangements for tax or legal purposes. Therefore, same-sex couples may be able to file joint tax returns in those states.
The federal government doesn't recognize these marriages. For IRS purposes, same-sex couples must file as if they are not married. Each spouse files a tax return as single or head of household, depending on a variety of issues. IRS made concessions for same-sex couples in community property states, in deference to state property laws.
Estates taxes ranged from 45% to 55% in the past decade, plus state taxes. Suppose you could avoid those taxes?
Federal law allows for a marital deduction from estate taxes. All property included in the gross estate that passes to the surviving spouse is eligible for the marital deduction. The property must pass "outright."
Having won their case in U.S. District Court, attorney Richard J. Bronstein, co-chair of the tax department of the New York firm of Paul, Weiss, Rifkind, Wharton & Garrison plans to file a state claim for refund of estate taxes paid. The New York Department of Taxation and Finance will probably not issue a refund. But this filing will protect Windsor's right to her refund when the dust settles.
Consider a 'protective claim'
Generally, for federal tax purposes, a taxpayer may request a refund of taxes paid if he files a claim for the refund by one of two dates, whichever is later: within three years of filing the tax return or amended return, or within two years of having paid the tax (or having had it garnished or levied by the IRS). States may have a different time frame.
Suppose the IRS denies your claim? One option is that you take your case to court. This can cost much more than the average person can afford to spend. It can also be scary and complicated. But once someone else has already done that, we can all take advantage of it.
When you request the refund, you won't get it yet, since the reason you're entitled to the refund is still being litigated. Clearly, this won't be resolved in time for you to file your amended return. What can you do?
You file a protective claim.
Enrolled agent Lynn Freer, president of Spidell Publishing Inc., said that when you file a protective claim, your right to that refund is protected regardless how long the litigation takes. No need to refile your claim every three years.
What taxes qualify for the protective claim?
Estate taxes, income taxes, even gift taxes. In fact, any time you feel you overpaid a tax you can file for a refund, if you have a good reason.
Bronstein said that amending the personal income-tax return may not be worth the effort for some same-sex couples. If one or both spouses was able to file as head of household, that places them into a lower overall tax bracket. Also, with lower, separate income levels, higher itemized deductions may be possible for medical expenses and employee business expenses.
Alison Flores, an attorney with H&R Block's Tax Institute, said less affluent couples are apt to benefit by refiling jointly. H&R Block has started to explore the tax issues to see how to help their clients.
How to file a protective claim
File the federal and state income-tax return or estate-tax return and pay the taxes in full. Your refund will include interest--at a higher rate than banks are currently paying.
Next, file an amended return to request a refund. For estate taxes, refile Form 706, writing "protective claim" at the top of the form's first page. For personal income taxes, file a Form 1040X and write "protective claim" at the top of page one.
Your reason is this: Based on Windsor v. United States, you would like to protect your right to a refund if the case is ultimately decided in Windsor's favor.
If you want to get fancy, Kreger points out you could even copy the language from Windsor's complaint, which is available at the American Civil Liberties Union's website or use the language directly from Judge Jones' decision.
Include all the computations showing how you arrived at the increased refund. Keep copies of everything you send to the tax authorities. Be sure to send it to the correct address and get proof that it was received.
Is it worthwhile?
Clearly, if you have paid estate or gift taxes, there's no question about the value of the amended return. But what about the income-tax return? How hard is it to figure out if you will get a refund?
Not as hard as you think. Flores points out that same-sex couples already have to prepare a joint IRS tax return in order to file their joint state return. So the joint return is already on a computer somewhere. Ask your tax professional.
You can tell at a glance if you will get a refund by filing a joint federal return. Look at your tax filings since 2008 (if you filed on extension) to see if the statute of limitations for refunds is still open.
Flores points out some issues to consider when filing. By the time the case will be resolved, the couple may have moved, gotten divorced or perhaps one spouse may even have died. You don't want to miss getting the refund when it comes your way several years from now. Be sure to file changes of address with IRS and the state any time anything changes until Windsor v. the United States is finally decided. You may have a fortune at stake.
Eva Rosenberg, EA, is the publisher of , where your tax questions are answered for free. Eva is the author of several , including Eva teaches tax courses at IRSExams.com and .