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EXCLUSIVE: Landmark DOMA Ruling Creates Complex Financial Waters For Gay Couples To Navigate

Wendy Spires

24 July 2013

Geoff Seaman, wealth strategist at BNY Mellon, speaks exclusively to Family Wealth Report about the financial complexities for same-sex married couples thrown up by the Supreme Court’s recent ruling on the Defense of Marriage Act.

The issue of same-sex marriage continues to be a hot topic in the US , with politicians, religious leaders and social commentators at both ends of the spectrum loudly banging their respective drums on the issue. But a recent Supreme Court ruling on same-sex marriage means that it is financial advisors who should really be getting hot under the collar. Those who do not risk their LGBT clients’ plans falling into disarray on a number of fronts, Geoff Seaman, wealth strategist with BNY Mellon, told Family Wealth Report in a recent interview.

By even the most conservative estimates, one in every ten people is gay. This figure underscores just how chunky the LGBT segment must necessarily be and it follows that most wealth managers will have a significant contingent of clients who are gay – many of whom might be in or considering a same-sex marriage. The recent Supreme Court ruling, which effectively struck down the Defense of Marriage Act, has wide-ranging wealth management implications which advisors ignore at their peril, Seaman explains.

First, some background: DOMA was enacted as a federal law in 1996 and prevented same-sex couples from being treated as spouses in the eyes of federal law while allowing states to treat their resident as they saw fit for state and local law purposes.  This affected the financial affairs of same-sex couples with an overlay of complexity impacting not just their income taxes, but also the gift and estate tax implications of transfers between these couples.

At the end of last month, the Supreme Court ruled, in the case of the United States vs Windsor, that Section 3 of DOMA was unconstitutional as a Fifth Amendment violation. In essence, the ruling determined that same-sex married couples are entitled to the same benefits and obligations as heterosexual married couples in jurisdictions that recognize same-sex marriages.

While Supreme Court recognition of this fact and the extension of federal benefits to same-sex spouses is certainly to be welcomed, and was indeed met by jubilation by the LGBT community, the ruling has however created an absolute minefield of additional complexities for advisors to navigate for their clients.

Pros and cons

The effective defeat of DOMA with regards to the right of gay married couples to be married in the fullest sense of the term is certainly a victory for equality, but it may well produce mixed results for the finances of gay couples. Among the positives are the income tax benefits available in some states, access to healthcare through a spouse’s employer without taxation and certain pension rights. Retirement, along with wealth transfer, is however where real complexities may arise. In short, the state where a same-sex married couple decides to retire to can be very important indeed to their finances.

In “qualifying” states, same-sex married couples may be able to realize “significant value from being able to defer taxation until after the second spouse dies”, explains Seaman. Additionally, if one of a couple has had children in a previous relationship there’s also the option of “gift splitting” which means that the financially stronger spouse can give away $10 million to their children, as opposed to $5 million before being taxed.

So far, so good, but as ever the devil is in the detail and it is the differences between the states which can throw up problems. The 14 jurisdictions where legislation currently allows for same-sex marriage are: California, Connecticut, Delaware, Iowa, Maine, Maryland, Massachusetts, New Hampshire, New York, Vermont, Washington and Washington, DC, and Minnesota and Rhode Island will also join this group at the start of August. In stark contrast, Texas has in place a constitutional amendment banning same-sex marriage .

Snowbirds beware: a hypothetical scenario

To illustrate the problems that can occur, Seaman outlined a hypothetical scenario of a same-sex couple who marry in New York and later move to Florida , having made use of the unlimited gifting provision while they were in New York to mitigate inheritance tax. To the extent that they made use of this provision before moving, the federal government will allow the gifting exemption for transactions that took place in New York. However, if the couple moves to Florida and then try to make use of the provision it may not work since Florida does not technically recognize that the spouses were indeed ever married. The end result is a large portion of the deceased’s assets may now be subject to tax before the survivor’s death.

This kind of de facto invalidation of a same-sex marriage once state lines are crossed also of course applies to those marrying outside the US; indeed, the aforementioned Edie Windsor had married her partner in Canada. Gay marriage either has or is soon to be written into the statute books of a number of nations and so same-sex couples moving to the US need to also be very careful where they choose to reside.

Although the prospect of losing the Unlimited Marital Deduction is something that will predominantly preoccupy retirees, it is also an issue for those much younger since actually reaching retirement age is far from a given and death can of course strike at any time. Same-sex married couples who are still in work also have a host of other tax implications to cope with, such as the fact that an employee who is transferred from one jurisdiction to another may find that certain employee benefits applicable to their spouse now again become taxable as imputed income.

But it is with wills and estate planning that same-sex married couples have to be really careful, said Seaman, explaining that there are an array of things such couples need to do “just so they can make sure their wishes and their planning are carried out”. At the top level, domestic partners are not considered be heirs of law and therefore surviving partners are not qualified to serve as an administrator unless a will exists to that effect. Getting more granular, retirement accounts and life insurance policies can also throw up issues because of beneficiary designation defaults that see someone other than the surviving spouse as the deceased’s heir – and that’s before we even consider possible interference from family members who might wish to undermine the validity of the marriage wholesale.

“Contentious things can happen in the family where they don’t accept the relationship…people who come in and possibly try to defeat their wishes,” said Seaman. “So you’ve got to tie things up tight if you don’t know where you’re going to be living.”

Tie things up tight

Helping same-sex married couple to “tie things up tight” in light of the DOMA ruling will no doubt keep financial advisors and lawyers busy now and in the coming years, particularly as it is as yet unclear how the change will play out at both a state and federal level. The IRS has said that it is still analyzing the ruling, the key point to be determined being whether it will treat a same-sex couple as married for tax purposes dependent on whether they live in one of the jurisdictions that views then as being married.  Commentators have pointed out, however, that federal bodies have typically used the jurisdiction of residency and not the jurisdiction where the marriage took place as the determiner of married status.

One thing that is certain however is that same-sex married couples should certainly not let the DOMA ruling make them think that a lesser degree of financial planning is necessary now – if anything the need for proactive approach is arguably now greater than ever if same-sex couples want to get the maximum financial benefit from their married status. Some 1,000 federal statues will be impacted by the DOMA ruling – a number which really underscores the need for specialist expertise.

Knowing which of the more than 1,000 statues will ultimately benefit – or harm – the wealth of a same-sex couple will be a huge task due to the sheer scope of the legislation. Among the areas the DOMA ruling encompasses are income tax benefits; estate and gift tax benefits; qualified pension plans; IRA rollovers; gift splitting and the taxation of health care benefits; and it may also have a retroactive impact. President Obama has made his intentions clear, however, vowing that he wants the ruling’s implications to be applied as widely as possible “swiftly and smoothly”. The fact that it was announced that medical, dental and housing allowances are to be applied to same-sex couples almost straight after the DOMA ruling emerged attests to how “swiftly” changes will be coming in, but just how “smoothly” these will occur remains the question. Family Wealth Report predicts some interesting times ahead for those advisors with gay clients on their books, and by that we must surely mean all.