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updated: 3/4/2013 10:18 AM

Wealthy gay couples seen paying more taxes if unions legal

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Bloomberg News

Top-earning gay couples who married in states where the law permits it may soon be paying more in income taxes as the U.S. Supreme Court considers the legality of same-sex unions.

Right now, couples' finances are often complicated by the division between federal and state law: They're able to handle their finances and tax-filing jointly under their state's law while the federal government -- which doesn't recognize the marriages -- treats them as though they are single.

For gay couples where both earners are making salaries of $400,000 a year or more, the ruling may mean thousands of dollars in higher income taxes if the court accepts the legality of these unions. Such high-earning couples already may have added costs when they file their taxes, share employee benefits such as health insurance and transfer assets.

"There will be a whole new raft of planning for people," said Alex Popovich, a wealth adviser at New York-based JPMorgan Chase & Co.'s private bank unit. "There's so many different nuances."

The Supreme Court will consider gay marriage for the first time this month in two cases. One is a dispute over a California ballot measure banning the practice. The other is a challenge to a 1996 federal law called the Defense of Marriage Act, which defines marriage as solely a union between a man and a woman. The court is expected to rule in the cases by June.

Estates, Benefits

The rulings may not legalize gay marriage nationally, meaning that same-sex married couples who move to states that don't recognize their union would still face challenges with their finances, estates, employee benefits and other rights.

More than 1,000 federal rights and benefits involve marital status, said John Olivieri, a partner in the private clients group at White & Case LLP in New York.

Not every couple would be hurt, and most would see some advantages in other parts of their personal finances. Wealthy gay married couples would be able to delay estate taxes if their unions were legalized, for instance. Still, there are detriments to being married from a federal tax standpoint.

A disadvantage for high-earning couples on the income-tax side is the marriage penalty. Currently, two partners each earning $400,000 a year in taxable income don't pay the top rate of 39.6 percent, which starts at income above that amount for singles and at $450,000 for married couples.

'Kind of Brutal'

If the federal law is overturned and the same-sex spouses file jointly, their combined income is $800,000, of which $350,000 would be subject to the highest federal rate. "That's kind of brutal," Olivieri said.

Gay couples who are legally married in a state will experience pros and cons if the Supreme Court finds the act, known by its acronym DOMA, unconstitutional and have to plan for them, he said.

"The biggest impact for DOMA being repealed especially for wealthy same-sex couples is the availability of the federal estate-tax marital deduction," said Lisa Siegel, senior wealth planner at Wells Fargo & Co.'s private bank unit. "That completely changes estate planning for same-sex couples."

The case being heard by the Supreme Court involves New York resident Edie Windsor, who sued the federal government over a $363,000 estate-tax bill imposed after her spouse died. Same-sex spouses aren't treated as married for federal tax purposes, which means when one spouse dies their assets don't transfer to the survivor free of estate taxes.

Surviving Spouse

The effect of the marital deduction for heterosexual married couples is to defer federal estate taxes owed until the death of the surviving spouse.

"For an older couple with significant wealth -- and especially if one spouse has a lot more wealth than the other -- from a tax perspective it will make a lot of sense to get married" if the federal law is overturned, said Popovich of J.P. Morgan Private Bank.

Same-sex married couples would be able to use several types of marital trusts not currently available to them and benefit from so-called portability rules under federal estate-and-gift tax laws, said Siegel of Wells Fargo Private Bank.

The portability provision lets a widow or widower retain the unused portion of a deceased spouse's lifetime exclusion from estate and gift taxes. That amount in 2013 is $5.25 million for individuals or $10.5 million for married households.

"That's a very big deal, especially now since you have $10.5 million to work with," said Siegel, whose clients include same-sex couples.

Income Trusts

On the other side of the ledger, gay couples would lose the ability to pass assets via grantor retained income trusts, or GRITs, if the Supreme Court overturns the defense-of-marriage law, said Olivieri of White & Case.

Congress in 1990 barred the use of GRITs for immediate family members because people were using them to discount assets and reduce gift taxes owed. Gay couples have been able to take advantage of the trusts because they aren't considered related under federal law, Olivieri said.

Same-sex couples also would lose a planning technique for stock sales if the federal law changes, JPMorgan's Popovich said. Gay partners currently can sell shares to their spouse, recognize a loss to offset gains and keep the security in the family, he said. Opposite-sex couples have to sell in the market and then wait 30 days before buying back the same stock because they are related, according to Internal Revenue Service rules.

Market Involvement

"It can be a really powerful way to keep your market involvement and recognize your loss," Popovich said.

Same-sex couples would have more options for their retirement savings upon a partner's death if the federal law is overturned, Olivieri said. The survivor would be able to roll over the deceased spouse's individual retirement account into their own, he said. Currently the so-called spousal rollover for IRAs is not available to same-sex married couples.

"The big advantage there is the surviving spouse doesn't have to start taking money out until he or she turns 70.5," he said. "Depending how old you are that could be a huge benefit. If you're 50 that could mean 20 years of tax-free growth."

Worker Benefits

Same-sex couples in states that let them marry would be entitled to joint-and-survivor annuity payments required for spouses with pension plans if the law is overturned, said Todd Solomon, a partner in the employee benefits practice group at McDermott, Will & Emery LLP in Chicago. They would automatically become each other's beneficiaries on 401(k) accounts unless giving consent for someone else to be listed, he said.

Health-insurance costs also would change for gay couples, Solomon said. They currently can't receive the tax advantages of being married for employer-provided medical benefits. While they may be able to add their partner to their company's plan, payments for their spouse generally must be made on an after-tax basis. The employer contribution is also treated as taxable income.

"That's a pretty harsh tax result," he said.

Same-sex couples have the right to marry in nine states -- New York, Washington, Maryland, Massachusetts, Vermont, Iowa, Connecticut, New Hampshire and Maine -- and the District of Columbia.

More Consistency

There probably will be more consistency for same-sex married couples around health-care decisions, parenting rights and immigration rules if the law is overruled, said JPMorgan's Popovich. It also would be easier for same-sex married couples to title properties jointly and transfer assets in a divorce settlement without triggering taxes, he said.

Same-sex couples who are legally married in their state will be subject to the pros and cons of hundreds of laws if the defense-of-marriage is overturned, said Dennis Ventry, a professor at the University of California Davis School of Law.

"In some circumstances they may be financially worse off," Ventry said. "That's not what they're excited about. They're excited about being treated like everybody else."

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