In April, this column discussed the challenges of trying to change one's domicile from a state that imposes an income tax (e.g., New York) to a non-taxing state like Florida (like Florida). In the article, I wrote: "It's what a lot of people dream about -- to live in a state where the sun always shines and you (legally) don't have to pay state income tax."
However, it now appears that this statement does not apply to everyone.
In a landmark decision handed down last month, the U.S. Supreme Court ruled in United States v. Windsor that Section 3 of the Defense of Marriage Act ("DOMA") is unconstitutional. For federal law purposes, Section 3 defined marriage as "the union of a man and a woman." Windsor involved a same-sex couple who had been together for more than 40 years. The couple resided in New York State and were legally married in Ontario, Canada in 2007 (the marriage was subsequently recognized by New York State). One of the spouses died in 2009, leaving her entire estate to the other spouse. Because the marriage was valid under New York State law, the surviving spouse sought to claim the federal unlimited spousal deduction in determining the estate tax. The Internal Revenue Service ("IRS") denied the deduction, finding the marital deduction did not apply to same-sex marriages (per DOMA), regardless of whether or not such a union was recognized under state law. The denial of the deduction resulted in a $363,053 estate tax liability. If federal tax law had afforded the couple in Windsor the same status as different-sex married couples, the estate would not have owed any federal estate tax.
The Court concluded that DOMA's attempt to supersede New York's recognition of same-sex marriage constituted "a deprivation of the liberty of the person protected by the Fifth Amendment." The Court went on to say that DOMA served no legitimate purpose other than to injure a class of people whom the state chose to protect. As a result of the decision, the estate in Windsor was entitled to a refund of the $363,053 federal estate tax it had previously paid.
While the Court's ruling was viewed as a victory for same-sex marriages, it notably does not require states to permit or even recognize same-sex marriage. In fact, it appears the Court carefully limited the scope of its decision to affect only those taxpayers who reside in a state that recognizes same-sex marriage. In other words, only married same-sex couples living in a state that recognizes such unions are considered married under federal law.
The conflicting treatment (i.e., based on the state in which a couple resides) will likely have significant federal and state tax implications since the IRS currently takes the view that marriage is determined by applicable state law. For example, it appears post-Windsor that where a same-sex married couple "resides" may determine whether one spouse can leave the other spouse an unlimited amount of assets -- i.e., the marital deduction -- at death without incurring an estate tax (the issue argued in Windsor). It is possible that the application of Windsor, causing the different tax treatment of residents, could be challenged or clarified, resulting in equal treatment of all married couples regardless of where they live.
Currently there are 13 states, plus the District of Columbia that recognize same sex marriage. In addition, Illinois and New Jersey are currently considering legislative measures that would grant marital recognition to same-sex couples. The majority of states, including Florida, do NOT recognize same-sex marriages. As a result, same-sex "Snow Birds" may want to reconsider their retirement plans or, at a minimum, the state in which they are deemed to "reside." The obvious next question is -- what is the definition of "reside"? Does it mean domicile or does it mean literally live for more than a certain number of days? Unfortunately, today there does not appear to be a definitive answer.
Conclusion
Absent clarification/changes by the IRS, the Windsor decision could result in significant estate tax savings for same-sex married couples depending on the state in which they reside (or, if you are a "glass half empty" type of person, residing in the "wrong" state could result in significant estate taxes). For example, same-sex married "Couple A" is deemed to reside in New York State -- one of the 13 states that recognize same sex marriage. If Spouse 1 dies during 2013 and leaves Spouse 2 all of his/her assets valued at $10 million, Spouse 2's federal estate tax liability should be zero.
Assuming the same facts about "Couple B," except that they reside in Florida instead of New York, Spouse 2's federal estate tax liability should be approximately $1,900,000 ($5,250,000 is tax exempt, with the remainder taxed at 40 percent). Because Couple B resides in Florida, a state that does NOT recognize same-sex marriage, Couple B is NOT entitled to the unlimited marital deduction, thereby creating Couple B's large federal estate tax liability.
The tax implications of Windsor are very much evolving. We expect that over the coming months, the IRS and/or Courts will provide guidance on many important open tax questions (e.g., the definition of reside). In the meantime, if the Windsor decision has the potential to affect you and your spouse, I recommend you speak with your tax adviser as soon as possible.
David Seiden is a leading authority on state and local tax ("SALT") matters. He is a partner with the accounting and consulting firm Citrin Cooperman, where he leads the firm's SALT Practice. He can be reached at (914) 517-4447 or dseiden@citrincooperman.com.
Citrin Cooperman is a full-service accounting and business consulting firm with offices in New York City; White Plains, NY; Norwalk, CT; Livingston, NJ; and Philadelphia.