Wealthy Same-Sex Spouses Get Tax Break, but Multinational Couples Still Must Plan Ahead
Yesterday’s historic U.S. Supreme Court decision struck down a law preventing the federal government from recognizing same-sex marriages (the Defense of Marriage Act or “DOMA”). In this case, the estate of a married lesbian had to pay over $363,000 in estate taxes. The widow sued the federal government for a tax refund claiming that her wife’s estate is entitled to the unlimited marital deduction for transfers made to her, the surviving spouse. Since the marital deduction is unlimited, spouses can transfer unlimited amounts of wealth between each other (whether by gift or inheritance), as long as they are legally married. Until now, the IRS has used DOMA to disallow the marital deduction for same-sex couples by simply not recognizing their marriages. Without the marital deduction, lifetime gifts between spouses and inheritances received by a surviving spouse are all subject to tax at rates up to 40%.
As you can imagine, a lot of estate tax planning involves maximizing the benefit of the marital deduction, even in situations where the surviving spouse isn’t necessarily supposed to inherit everything with no strings attached (e.g. former spouses, children from prior relationships, family businesses, etc.). Without the availability of the marital deduction, current law permits “only” the first $5,250,000 (adjusted for inflation) of assets to be transferred tax free. Wealthy Same-Sex Couples have been keenly aware of this issue, but most Multinational Couples (i.e. one or both spouses is not a U.S. Citizen) don’t realize that the unlimited marital deduction is still not available for transfers to a Non-Citizen Spouse. Instead, transfers to Non-Citizen Spouses can only be reduced by an “annual exclusion” of just $143,000 per year (adjusted for inflation).
In other words, gifts made from time to time by one spouse to their Non-Citizen Spouse and the inheritance ultimately left to a Non-Citizen Spouse are all subject to a 40% transfer tax after applying the annual exclusion and after the $5,250,000 lifetime exemption is used up. Furthermore, property held jointly with a Non-Citizen Spouse is presumed to be transferred 100% to the surviving spouse, as opposed to only 50% when the surviving spouse is a citizen, potentially doubling the amount subject to tax. There is not even an exception in the case that the Non-Citizen Spouse is a permanent resident or has spent most of their life in the U.S. However, there are certain planning strategies and legal structures that can help Multinational Couples reduce this tax burden if set up in advance. Multinational couples of any sex should plan ahead to avoid having unnecessary taxes reduce their wealth by up to 40% when the time comes to pass it on.
1. Non-citizens who are not “domiciled” in the U.S. have only a $60,000 lifetime exemption, as opposed to the $5,250,000 exclusion.
2. This article is not meant to discourage or encourage, marriage or U.S. citizenship.