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CCH provides special CCH Tax Briefings on key topics at CCHGroup.com/Legislation.

• CCH Tax Briefing: 2012 Tax Year-in-Review
• CCH Tax Briefing: President Signs Eleventh-Hour Agreement to Avert Fiscal Cliff
• CCH Tax Briefing: Analysis of Post-2012 Net Investment Income and Additional Medicare Taxes
• CCH Tax Briefing: Analysis of Comprehensive Repair/Capitalization Regulations
• CCH Tax Briefing: Post-Election Tax Policy
• CCH Tax Briefing: Year-End Tax Planning

Tax Filing Status Varies for Single, Married, Same-Sex Couples: CCH Examines Latest State, Federal Guidelines

(RIVERWOODS, ILL., January 2013) – One of the first steps for all taxpayers beginning to prepare income tax returns is listing their filing status. The details for those filing as single and married filing separately or jointly are often established well ahead of tax season, but it may be that the complications are just about to begin, notes CCH, a Wolters Kluwer business and a leading global provider of tax, accounting and audit information, software and services (CCHGroup.com).

While federal law remains unchanged when it comes to a couple’s tax filing status, same-sex couples who are married, joined by civil union or registered as domestic partners may need to do a little research on their state tax return filing status options – especially if listing dependents or claiming tax deductions on co-owned possessions. 

“When a same-sex couple has joint property or has children or where spouses are earning significantly different income and paying different bills, it can get very complicated trying to allocate and report this separately for tax purposes,” said CCH Principal Federal Tax Analyst Mark Luscombe, JD, LLM, CPA.

Changing Tax Status Guidelines

Although federal law does not recognize same-sex marriages or civil unions, a growing number of states do. For example, in November, voters in Maine, Maryland and Washington approved ballot referendums to legalize same-sex marriages. And although certain states allow same-sex married couples to file a state tax return jointly or as married filing separately, those same couples are still required to file separate income tax returns at the federal level. Separate federal returns have to be filed as either single or head of household.
  
According to the IRS, same-sex partners who are married under state law may not file using a “married filing separately or jointly” filing status because federal law does not treat same-sex partners as spouses. 

“Rather than automatically checking a box, it’s important to understand what your tax filing status is, how it may have changed and if you’re entitled to different tax breaks if you have a choice of filing status,” added Luscombe. “The tax implications of different marital decisions aren’t always crystal clear.”

According to Luscombe, more than 60 provisions of the Internal Revenue Code relate to marital status and can either work for or against these taxpayers.

Because of the tax status differences between state and federal returns for same-sex married couples, many have to calculate their taxes twice, using different rules for their federal and state filings.

For their federal returns, each individual must use the “single” or possibly “head of household” status. On their state return, the couple can file jointly or as “married filing separately.” As a practical matter, this usually means computing a second federal return that won’t be filed but with the correct state filing status, then transferring amounts from that second return to the state return.

State Tax Considerations

Currently, nine states and the District of Columbia allow same-sex marriages: Connecticut, Iowa, Maine, Maryland, Massachusetts, New Hampshire, New York, Vermont and Washington. All of these states allow same-sex couples to file joint state income tax returns. One additional note: New Hampshire has no broad-based income tax, but does allow joint filing for taxes levied on interest and dividends. 

An additional 10 states with civil union or domestic partnership laws have varying rules: California, Colorado, Hawaii, Illinois, Maine, Nevada, New Jersey, Oregon, Washington and Wisconsin. Four of these states allow same-sex couples to file state income tax returns jointly: California, Illinois, New Jersey and Oregon. However, four other states do not allow joint filing for these couples: Colorado, Hawaii, Maine and Wisconsin. Nevada and Washington do not have state income taxes.

A provision under the Defense of Marriage Act of 1996 (DOMA), which defines marriage as a union between a man and a woman, stipulates that individual states are not required to recognize same-sex marriages performed under another state’s law. Currently, only Maryland, New York and Rhode Island recognize same-sex marriages performed in other states. None of these states allows such same-sex couples to file joint state tax returns.

“Generally, only in states where same-sex partnerships are recognized for income, inheritance, and gift tax purposes and allowed to file income tax returns jointly, do partners realize some of the tax advantages of being a couple,” said Luscombe.

For example, in New Jersey, the surviving domestic partner is exempt from the state’s inheritance tax. But that’s not the case in every other state. Oftentimes, such as with estate and gift taxes, state rules are based on federal rules. As a result, same-sex couples often not only have to prepare separate federal income tax returns under current federal law but also, because their joint state tax return requires numbers to be pulled from the corresponding federal joint return, they must prepare a pro forma joint federal tax return so that they can calculate the numbers to complete the state joint income tax return.

One area where state and federal government tax status guidelines match up is in the case of registered domestic partners who are stepparents of children. The IRS says that if a registered domestic partner is the stepparent of his or her partner’s child under the laws of the state where the partners live, then the registered domestic partner is the stepparent of the child for federal income tax purposes.

Federal Tax Considerations

As stated above, the DOMA defines marriage as a union between a man and a woman. This precludes same-sex partners from being recognized as spouses under the Internal Revenue Code.

The tax consequences of this can be good or bad, depending on a number of factors.

For example, the income levels for joint filers in the 10- and 15-percent tax brackets are twice as high as they are for single filers, providing married couples some relief, which same-sex couples can’t take advantage of as single filers.

But, above that level, some married couples may find themselves paying more in taxes, depending on who earns the income and the credits and deductions available to them.

Couples who must file separately can use this to their advantage, for example, by shifting interest income from a joint brokerage account to the lower income earner and moving joint deductions, such as eligible charitable contributions, to the higher income earner.

Income shifting for same-sex partners, however, may be limited in states with community property laws that recognize domestic partnerships, including California, Nevada and Washington. Community property rules generally require that earned income be split equally between marriage partners for both federal and state taxes. The IRS has issued internal guidance indicating that the community property rules of the state will be applied to domestic partners where the state applies the rules to domestic partners. The fact that the IRS does not recognize same-sex partners makes this even more confusing: they must file separately, but it appears that they will be required to claim the income 50-50.

“Many people will want to have a tax professional help them with these returns as it is complicated, and it’s a good idea to provide an explanation with both partners’ tax returns when they’re filed,” said Luscombe.

Lower income couples not recognized as married under federal law may also be able to lower their taxes by filing separately. For example, the separate incomes of two parents each with children could make them eligible for credits such as the Earned Income Tax Credit (EITC). However, their combined income as a married couple could mean they would no longer qualify for the EITC, which for 2012 provides a refundable credit of up to $5,891.

Earned Income Tax Credit

Two unmarried wage-earners who each have children and are just making it with the help of the EITC – a refundable credit and a tax provision encouraging work over welfare – often face a tax dilemma after “tying the knot.”

For example, Kim and Doug each earn $25,000 and the couple lives apart. Each has one child and can file as head of household, which will entitle each to an $8,700 standard deduction for 2012 taxes. Unmarried, each is entitled to a 2012 EITC of $1,901. Combined with the $1,000 child credit each is entitled to, this eliminates their federal income tax obligations and even produces a payment to each one from the Treasury of more than $1,500. If they had filled out the proper employment tax forms, they could have received that refundable credit throughout the year in their paychecks.

If these two low-wage workers decide to get married, they’ll receive a higher standard deduction as joint filers rather than heads of households.

However, at $11,900, it’s nowhere near double the amount (2 x $8,700) they were each entitled to as single parents. Worse, with $50,000 in wages, the couple no longer qualifies for the EITC. 

The bottom line is that the couple owes $569, losing out financially as a result of getting married.

Partner, Spouse Recognition

Not being recognized as a couple for federal tax purposes could be an advantage when selling appreciated property. For example, because a same-sex couple is not seen as related under federal tax law, one partner can sell an asset to a second partner under a deferred gain sale. That partner can then sell it to a third party with the initial partner not realizing the gain for many years into the future, based on the terms of the sale from the first to second partner.

There also are some clear disadvantages for couples who are not able to file jointly. For example, a spouse is automatically a “dependent” for tax purposes, providing a $3,800 exemption for 2012 to joint filers. Being recognized as a spouse also means that benefits, such as employer-paid healthcare coverage, which covers the worker, their children and/or their spouse, is tax-free.

For same-sex couples – particularly those with children – not being able to recognize this benefit as tax-free is quickly confusing.

“The taxpayer would need to determine what portion of the coverage should be allocated to themselves and their children and how much to their partner, and then pay taxes on that portion,” said Luscombe. “There’s no easy or clear-cut formula for doing this.”

Tax laws for pensions and inheritances also favor traditional marriages as a surviving spouse in a two-sex marriage can inherit a husband’s or wife’s estate without any federal estate tax. However, in any other relationship, federal estate taxes would apply.

Marriage Penalty Relief, Child Tax Credit and More

The American Taxpayer Relief Act of 2012 (ATRA) extends all existing marriage penalty relief.

Previously, the 2010 Tax Relief Act extended the marriage penalty relief that was linked to the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA): the10- and 15-percent tax brackets, the standard deduction and the EITC.

At one time, there were two obvious contributing sources to the marriage penalty. First, the standard deduction allowed on a joint return was less than twice the amount of the standard deduction for single filers. Second, a couple could move into a higher tax bracket when their incomes were combined on their joint return. Add together two incomes that each might be taxed at 15 percent and you could get a joint income taxed at 28 percent.

Now, the standard deduction for joint filers is twice that of singles, and the 10- and 15-percent tax brackets are twice as high for joint filers, as well. But beyond the 15-percent bracket, the classic “marriage penalty” lingers on.

For example, in 2012 Lisa and Larry each have a taxable income of $75,000, toward the top of the 25-percent bracket for single filers. As domestic partners who file singly, each pays income tax of $14,786. If they tied the knot and the tax laws were not affected by marriage, their tax would be twice that amount, or $29,572. But that’s not how it works.

Filing jointly, Lisa and Larry report taxable income of $150,000. The 25-percent tax bracket for joint filers ends at $142,700, so the top $7,300 of their joint income is taxed at 28 percent, leading to a total tax bill of $29,779 – a “marriage penalty” of $207.

Distribution Determines Penalty…or Bonus

It’s important to note that in the example, it’s the distribution of income – 50/50 between the two spouses – that produces the penalty.

If Lisa were a single professional with a taxable income of $150,000, she would owe $35,460. So she would reduce her income tax and reap a “marriage bonus” of $5,681 if she were to marry a charming but penniless drifter.

“When the income tax was first established, the typical family included only one wage-earner,” Luscombe said. “As a result, some people, especially those in ‘traditional’ families with a principal wage-earner, benefit from the same structures in the tax code that penalize others, such as those in dual-income situations.”

The 2013 tax year brings additional tax provisions that may carry a marriage penalty or bonus. The new thresholds under the ATRA for top ordinary income and capital gain rates are $400,000 for single and $450,000 for joint filers. The thresholds for the phase-out of itemized deductions and exemptions are $250,000 for single and $300,000 for joint filers. Also in 2013, the new Medicare contribution taxes kick in at thresholds of $200,000 for single and $250,000 for joint filers. All of these carry the potential for additional marriage penalty or bonus issues depending on the distribution of the income between the couple.

Judicial Developments

The DOMA has faced a number of constitutional challenges in the courts and several courts have declared it unconstitutional. The Supreme Court has accepted a couple of cases addressing the DOMA and may rule on its constitutionality in 2013.

About CCH, a Wolters Kluwer business

CCH, a Wolters Kluwer business (CCHGroup.com) is a leading global provider of tax, accounting and audit information, software and services. Celebrating its 100th anniversary in 2013, CCH has served tax, accounting and business professionals since 1913. Among its market-leading solutions are the ProSystem fx® Suite, CCH Integrator™, CCH® IntelliConnect®, Accounting Research Manager® and the U.S. Master Tax Guide®. CCH is based in Riverwoods, Ill. Follow us on Twitter @CCHMediaHelp. Wolters Kluwer (www.wolterskluwer.com) is a market-leading global information services company. Wolters Kluwer is headquartered in Alphen aan den Rijn, the Netherlands. Its shares are quoted on Euronext Amsterdam (WKL) and are included in the AEX and Euronext 100 indices.

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