Nobody looks forward to tax day, but for same-sex partners, April 15th can be particularly daunting. From completing federal tax returns to figuring out whether a spouse’s health insurance benefits are exempt from taxation, gay and lesbian couples face a number of complicated tax issues.
This article discusses the basics of how states and the federal government treat same-sex couples for tax purposes. But keep in mind that many factors can affect your tax situation -- from the state you call home, to how much money you make, to how much property you expect to own when you die. If you can afford it, it’s smart to consult a tax pro who can help you find your way through the tax laws in your state and the particular issues that affect you and your partner.
Filing Federal Income Tax Returns
If you and your partner are married or registered as domestic partners or civil union partners in a marriage-equivalent state, you are in an awkward situation where federal taxes are concerned. Because the federal government does not recognize your marriage, you must file your federal taxes as single individuals. You should, however, note on your federal return that you are actually married, but filing as a single person due to federal tax law. This can help in other situations -- such as applying for a joint mortgage -- where you want to show that you consider yourself married for all legal purposes.
If you and your partner have a child, one of you can claim that child as a dependent when you file your federal return. You might also qualify for the child tax credit -- currently $1,000 if your gross income is less than $75,000. In addition, if you provide more than half of the child’s support, you can file as head of household, which will usually lower your tax bill. If you and your partner have two children, each of you might be able to claim one child as a dependent and file as head of household. A qualified tax professional can explain your options.
Filing State Income Tax Returns
For same-sex couples, the rules for filing state tax returns depend on where you live.
States That Recognize Same-Sex Partnerships. If you live in a state that recognizes your same-sex marriage or marriage-equivalent registration, you must file state tax returns as a married couple, following all the tax rules that apply to marriage.
Heterosexual married couples can easily file state tax returns by importing numbers from their federal returns, but because you had to file fedrally as singles, completing your state returns can be tricky. Most tax professionals suggest that you prepare a “dummy” or "pro forma" federal return, completing it as though you were married for federal tax purposes. Then you can plug those figures into your state return. After that, you destroy the dummy return. But some states, such as California, have their own instructions for dealing with the federal/state dichotomy, so be sure you check what's recommended in your state before you prepare the dummy return. Whatever you end up having to do, it’s an extra headache and expense for gay and lesbian spouses.
States That Don’t Recognize Same-Sex Partnerships. In states that don’t recognize same-sex marriage or offer domestic partnerships or civil unions with marriage-like benefits, you must file your state taxes as single individuals.
Understanding Estate Tax
Only very wealthy couples need worry about federal estate tax. In 2012, the federal government imposes a tax on your estate only if it is worth more than $5,120,000 when you die. For those estates that are subject to this tax, however, the financial hit is significant.
Under federal tax law, all property left to a heterosexual spouse passes tax-free, as long as the spouse is a U.S. citizen. Same-sex partnerships are not eligible for this exemption. If you think your estate may be subject to tax when you die, consult a tax or estate planning professional to set up legal methods for reducing or avoiding estate tax.
Watch Out for Gift Taxes
As with estate taxes, heterosexual married couples are exempt from federal gift tax rules, but same-sex spouses are not.
What is the gift tax? As an individual, you may give away up to $13,000 per year -- with a lifetime maximum equal to the estate tax exemption of $5,120,000 -- without owing federal gift taxes. After you exceed that limit, any gifts you make are subject to federal gift tax. Heterosexual spouses are exempt from this rule; they can give any amount to each other, tax-free. This exemption does not apply to same-sex spouses.
For example, if Ellen and Peter are married, Peter can give Ellen $60,000 per year, and this will not count towards Peter’s $5,120,000 lifetime total. But if Ellen and Paula are married and Paula gives Ellen $60,000 one year, $47,000 of that amount counts against Paula’s lifetime total.
How the gift tax may affect you. If you exceed the lifetime gift tax exemption, you will have to pay taxes on any future gifts. The tax can be significant -- perhaps as much as 50% of the value of the nonexempt gifts. If you are very wealthy, you should be alert to this possibility, especially if you are considering adding your partner to the title of your home. If your partner doesn’t pay you, the federal government will consider the transaction a gift of half the value of your home, and your federal gift tax exclusion will be reduced by that amount. Again, we recommend you consult a tax professional if you believe you might be subject to these tricky tax rules.
Employment Benefits Are Taxed
When heterosexual spouses and their children receive health benefits through one spouse’s job, the value of the benefits is exempt from federal taxes. But if you are in a same-sex partnership and you are able to obtain benefits through your employer for your spouse or domestic partner, the cost of the benefits will be deducted from your paycheck post-tax, so they are taxable income to you.
Divorce and Taxes
If you live in a state that recognizes your union -- either as a marriage, civil union, or domestic partnership—and your relationship ends, the settlement you make with your partner may involve paying your ex money, either as a property settlement or as alimony or spousal support. If you were heterosexual and married, those financial transactions related to your divorce would be tax-free events. But because your relationship is not a federally recognized marriage, you aren’t eligible for the broad exemptions from taxation that are bestowed on straight spouses who divorce. This means the payments could be considered a gift from you to your ex, or could be classified as income on your partner’s taxes.
It’s not even clear that same-sex couples can avoid taxes on child support, which is neither taxable nor deductible in a heterosexual divorce, because the technical rule only exempts payments to a former “spouse.” This is an unfair situation, but what to do about it is not clear. Talk with a local tax professional who is familiar with the rules for same-sex couples in your state.
For More Information
This is just a summary of the tax issues affecting same-sex partners. For more information, we recommend that you read Making It Legal: A Guide to Same-Sex Marriage, Domestic Partnerships & Civil Unions, by Frederick Hertz with Emily Doskow (Nolo).