Tax Considerations for Same-Sex Marriages

With same-sex marriages now legal in California as well as Massachusetts, couples will need to plan their finances and taxes very carefully. Federal law, however, does not recognize same-sex marriages. This provides same-sex couples with some administrative burdens at tax time, and some tax planning opportunities as well.

Same-sex couples will need to file as unmarried persons for federal tax purposes, and as married for state tax purposes. This means that same-sex couples will need to file either three or four tax returns: two single federal returns plus a joint state return; or two single federal returns plus two separate state returns.

Filing Status Options

The biggest challenge, for tax planning and preparation, will be managing two different filing statuses. Same-sex married persons will be unmarried for federal taxes and married for state taxes.

Federal law does not recognize same-sex marriages under the Defense of Marriage Act. Even if a couple is legally married in CA or MA, or has entered into a registered domestic partnership or civil union, these couples cannot file as married persons on their federal tax returns. They will have to file individual tax returns. Their filing status can be either single, or possibly head of household if they support a qualifying person such as a child or parent. A domestic partner will not qualify for the head of household based solely on supporting his or her partner financially, however.

For state tax purposes, married couples will file as married in their state. Here the filing status options are to file jointly or separately. Because some tax breaks have different limitations, state tax liabilities will likely be different than if the couple filed single returns. For example, there's a $3,000 cap on net capital losses per year. If both spouses have capital losses, their state loss could be different than their federal losses. There's a wide range of dollar limits and phase out ranges that would need to be considered in optimizing a state tax return. As such, I recommend that married same-sex couples focus on managing their federal tax situation foremost.

Tax Planning Suggestions

Here's some things to watch out for when dealing with the federal side of the tax return:

Health insurance benefits will be tax-deductible for the employee, but not for a covered same-sex spouse. If both spouses work, it would make sense for each spouse to obtain coverage through their respective employers. If one spouse isn't covered by a group plan, consider purchasing an individual policy instead of getting coverage through a group plan. This will preserve the tax-deductible status of the health insurance premiums at the federal level.

Consider shifting income to the spouse with the lower income. Investment income such as dividends, interest, and capital gains might be taxed at a lower rate. Each spouse will report his or her own wages, however. So income shifting really means deciding who will do the saving and investing.

Consider shifting deductions to the spouse with the higher income. Mortgage interest, property taxes, and charity would yield greater tax savings for the spouse with the higher income. Some deductions cannot be shifted, such as IRA contributions, college tuition and medical expenses. Those deductions remain with the taxpayer and cannot be deducted by the other partner.

Maintain separate bank accounts. To get a tax deduction, a person will need to prove that he paid for the expense. Paying for tax-deductible expenses out of a joint account could result in lost deductions if a return were audited and the taxpayer couldn't prove that he actually paid for the expense. To eliminate this audit scenario, the person who gets the deduction should pay expenses out of his own bank account.

Use financial software. Juggling three or four sets of tax returns, each with their own rules and limits, will prove challenging. You can stay on top of the numbers by using financial software such as Quicken or Microsoft Money. When setting up your software, you'll want to account for your income and expenses separately, that way the reports generated at tax time for will help you prepare your federal and state tax return more efficiently.

More information:

• Tax Tips for Gays, Lesbians and Same-Sex Couples from About.com
• Registered Domestic Partners and Tax Information for Registered Domestic Partners (pdf, 17 pages) from the CA Franchise Tax Board
• Same-Sex Marriages from the MA Department of Revenue