Pennsylvania Same Sex Married Couples No Longer Have to Pay Inheritance Tax

On May 20, 2014, U.S. District Court Judge John Jones III declared that Pennsylvania's laws banning same sex marriage was unconstitutional.  Besides the practical implication that same sex couples in Pennsylvania may now get married, it also means that when one spouse dies, the survivor can now inherit tax free.  

Previously, only a heterosexual surviving spouse could inherit assets of the deceased spouse tax free.  Additionally, for same sex couples, if one partner left money to another, that would be taxed at a 15% rate - the same as if the person were a total stranger.

If you are in a same sex marriage (that was licensed in another state) you may wish to consider revising your estate planning documents as a result of this ruling.  Additionally, if you have recently lost a same sex spouse, you may wish to consider amending the Pennsylvania inheritance tax return to request a refund.   

Same Sex Marriage Now Legal In New Jersey

Effective today, same sex marriage is now legal in New Jersey after Governor Chris Christie dropped his plans to appeal the ruling of Superior Court Judge Mary Jacobson.  On September 27, 2013, Judge Jacobson had ruled that New Jersey must allow same sex marriages in the wake of the Supreme Court's decision in United States v. Windsor.

Previously, New Jersey had only allowed Civil Unions and it recognized same sex marriages from other jurisdictions as Civil Unions.  The Governor elected to drop his appeal after receiving very clear signals from the New Jersey Supreme Court that his appeal would not be successful. 

Remaining at issue is whether or not all Civil Unions in New Jersey would automatically be treated as same sex marriages.  The New Jersey legislature had sought to pass a bill to that affect several months ago, but it was vetoed by the Governor.  (The bill included a provision that couples could opt out of the automatic conversion to marriage if they did so within 30 days.)  As it stands, if a couple wishes to be recognized as a married couple, they should not rely on this automatic conversion, but should instead proceed with a marriage ceremony.

I would like to remind individuals who were married in another state that they should consider refiling their income tax returns for the past few years if there is a tax benefit to do so.

IRS Issues Ruling on Tax Filings for Same Sex Couples

Yesterday the Internal Revenue Service issued an important ruling in the wake of the Windsor case in which the Supreme Court ruled that the Defense of Marriage Act was unconstitutional.  Specifically the IRS stated that it will recognize all same sex marriages regardless of where the couple was married. 

The Supreme Court did not specifically address what would happen if a same sex couple got married in one state and then moved to another state that did not recognize the union.  Now it is clear that the IRS will respect the marriage regardless of where the couple moves afterwards.

The IRS also stated that starting with the 2013 tax year, all married couples (same sex or opposite sex) must either file as married or married filing separately.  Additionally, same sex married couples may elect to file an amended income tax return for the 2010, 2011, or 2012 calendar years.  You should seriously consider amending the return if one spouse worked and the other didn't or if there are other significant tax advantages. 

It should be noted that the IRS rules only applies to married couples, not civil unions.  New Jersey and two other states currently allow only civil unions.  The most likely outcome of this is that the civil union laws will eventually fall by the wayside in favor of same sex marriages as separate is once again inherently unequal.

Affect of United States v. Windsor on NJ Same Sex Couples

After scrutinizing the United States v. Windsor decision yesterday a little more thoroughly, it occurs to me that same sex couples in New Jersey are still a state of limbo.  It should be noted that the Supreme Court relied on the fact that the couple in the Windsor case not only were legally married in Canada, but resided in New York, a jurisdiction that recognized the marriage. 

The Supreme Court left open the question as to whether a couple that is in a Civil Union (like in New Jersey) would be entitled to the same benefits as a same sex married couple and it also left open the question as to whether the federal government would have to recognize the marriage of a same sex couple that legally married in one jurisdiction and resides in a jurisdiction that does not recognize the marriage.

While New Jersey recognizes same sex marriages from other jurisdictions in New Jersey, according to the 2007 Opinion of Attorney General Stuart Rabner, it ONLY recognizes them as Civil Unions.  New Jersey does not currently allow same sex marriages.  Therefore, there is a real question as to whether the Windsor case will benefit same sex couples living in New Jersey, regardless of whether they entered into a Civil Union or were married in another jurisdiction.

To take the analysis a little further, the 2007 Opinion of Rabner was not meant to be restrictive, it was actually near the forefront at the time and designed to treat same sex couples as married couples, just using different terminology.  Moreover, New Jersey Statute 26:8A-6(c) specifically states: A domestic partnership, civil union or reciprocal beneficiary relationship entered into outside of this State, which is valid under the laws of the jurisdiction under which the partnership was created, shall be valid in this State.  This statutory language (which was written in 2003, one year before Massachusetts became the first state to allow same sex marriages) would seem to imply that the New Jersey should in fact recognize foreign same sex marriages.

Finally, the New Jersey Supreme Court has already issued an opinion in Lewis v. Harris, 188 N.J. 415 (2006), which held that New Jersey's State Constitution requires that same sex couples be afforded access to a government sanctioned relationship that provides all of the rights and obligations of marriage.  As a result, it is my opinion that if the federal government does not recognize New Jersey Civil Unions or it does not recognize the validity of the legal marriage of same couples living in New Jersey, New Jersey will be required to modify its statutes to allow for same sex marriages.

Perhaps the easiest and best way to test this is for a same sex couple to file a joint federal tax return and see if it is accepted...

Same Sex Couples Entitled to Unlimited Marital Deduction

In a landmark Supreme Court case today, United States v. Windsor, the Supreme Court ruled that the Defense of Marriage Act ("DOMA") was unconstitutional.  DOMA was signed into law in 1996 and defined marriage as between a man and a woman for purposes of federal law.  Importantly, this meant that same sex couples could not file joint tax returns and that a surviving same sex spouse was not entitled to a marital deduction (resulting in higher federal estate taxes).

As a result of this ruling, same sex couples who have married should immediately consider whether they should amend their federal tax returns for the last few years.  Consideration should also be given to whether your estate planning documents should be updated to reflect the change in the law.

The ramifications of this ruling are extremely broad, as it can affect immigration laws, the right to receive health insurance, the right to receive a pension, and Social Security.  All told, there are about 1000 laws that may be affected.

Importantly, it does not require that a state allow a same sex couple to marry.  Accordingly, in states where same sex couples are not allowed to marry, they will have to travel to another jurisdiction to get married in order to receive federal benefits.  (It is still slightly unclear at this point whether the state that the couples lives in must recognize the marriage to take advantage of federal benefits - I haven't had time to read the full opinion yet.  I will point out that New York allows same sex marriages and New Jersey recognizes same sex marriages from other jurisdictions*.  Pennsylvania and Florida have both enacted laws banning such recognition.)

Just a reminder though, strictly from a tax perspective, it does not always make financial sense to get married due to the "marriage penalty".  The marriage penalty is a called a penalty because it creates a higher tax on a married couple when both spouses work.  However, if one spouse works and the other does not, it does create a substantial tax benefit. 

*See post on the Affect of United States v. Windsor on New Jersey Same Sex Couples

Estate Tax Portability Here to Stay

It occurs to me that other than a few minor modifications to the federal estate tax rate, very little has changed with respect to the law as it existed in 2012.  This means that estate tax portability is here to stay.  Portability is the term given when a surviving spouse receives a deceased spouse's unused estate tax exemption (also know as DSUE).  Whether or not portability would last under a new deal was a hotly debated topic. 

For anyone who has had a spouse die in 2012 and has been waiting to see what will happen with the law, it would be highly advisable to file a federal estate tax return (Form 706) to port your spouse's unused exemption amount.  Even if the surviving spouse does not have more than $5,000,000 in assets, it does not mean that his or her assets will not grow, that he or she will not win the lottery or inherit money from a wealthy relative before passing.

Additionally, as mentioned in an earlier post on same sex couples being entitled to the unlimited marital deduction, if you are in a same sex marriage, you should also considering filing a protective Form 706 as the state of the law is in flux right now.

Same Sex Couple Entitled to Federal Estate Tax Marital Deduction?

There was a significant court decision back in June of this year regarding the rights of same sex married couples.  The New York Federal Court concluded that the surviving spouse of a same sex married couple is entitled to an unlimited marital deduction for purposes of federal estate taxes.  Windsor v. U.S., 109 AFTR 2d ¶ 2012-870 (DC N.Y. 6/6/2012)

Prior to this case being decided (and still the law for most of the rest of the country), when one same sex married partner dies leaving assets to the surviving spouse, only the estate tax exemption amount can pass free of estate taxes.  Anything over that would be subject to the federal estate tax.  For a heterosexual couple, when one partner dies, everything that passes to the surviving spouse can go tax free.  (Although there are some limitations if the surviving spouse is not a citizen.)

The Court in the Winsdor case ruled that the so called "Defense of Marriage Act" (or DOMA) effectively allows for a same sex married couple to be taxed when a traditional married couple would not.  They declared that there was no rational basis for this outcome and therefore the law violated the equal protection clause of the Constitution.  It should also be noted that the Obama administration flatly refused to support the DOMA.  The Attorney General's office usually makes an appearance to support all laws that are being challenged.

While the New York Federal Court made an important ruling, one ruling does NOT make it the law of the land.  You should note:
1)  The DOMA is still on the books and stands in the way of allowing the marital deduction for people not living in New York.
2)  The IRS will continue to challenge these rulings and it will likely go to the Supreme Court before it is finally resolved. In fact, there was an article online on CNN about this very topic today.
3)  Not all states allow same sex couples to be married, but if the couple marries in a state that allows it, the couple would then have an excellent argument to try and qualify for this important tax deduction.

While the ruling itself focused on the federal estate tax marital deduction, it can be taken much further.  Other potential benefits include the ability to roll over the surviving spouses IRA or 401(k), portability of the unified credit, the ability to file joint income tax returns and the ability to collect Social Security.

Because of the uncertainty surrounding these matters, it will always be best to pay your taxes and request a refund from the government to avoid any penalties.  When the IRS denies such payment, which they assuredly will, you will then need to make a decision as to whether you want to take further steps to get legally involved in this fight.  For those of you who don't have the inclination to spend a lot of time and money fighting, you should engage in proper estate planning for non-traditional couples.

Estate Planning for Non-Traditional Couples

For purposes of this article, I am going to define a traditional couple as a relationship between a man and a woman who are in their first marriage and the only children are children of the marriage. Estate planning for traditional couples usually consists of having a Will, Financial Power of Attorney, Medical Power of Attorney and Advanced Health Care Directive.

The traditional plan itself usually consists of each spouse leaving money to the other (occasionally in trust for tax planning purposes). On the death of the surviving spouse, everything is left to the children. The surviving spouse is usually executor and trustee of any trusts. If a traditional couple does not create a Will, the state's intestacy scheme will send the money in the same direction - but without any trust or tax planning.

There are typically three types of couples that need planning significantly different from that of traditional couples:

1. Same Sex Couples
2. Couples where at least one party has children from a previous relationship (often called "Blended Families"); and
3. Couples who are in a long term hetero-sexual relationship but are not legally married.

For all non-traditional couples it is even more important to prepare Wills, Financial Powers of Attorney, Medical Powers of Attorney and Advanced Health Care Directives. However, while the documents stay the same, the methodology is very different.

The laws for same sex couples vary widely by state, and the federal government does not recognized the validity of a same sex marriages or civil unions for tax purposes or for most other purposes. If one partner dies without a Will, in most states, the state intestacy law will not direct that the money goes to the surviving partner. Additionally, in many states, the partner will have no rights to administer their loved one's estate or act as a guardian absent written instruction.

Since state law will usually not protect the rights of same sex couples, it is imperative for gay and lesbian couples to prepare a Will, Power of Attorney and Health Care Directive. Additionally, trust and tax planning becomes even more important as does coordination of the couple's other assets. This is particularly true if there are children involved.

Even in states where the law is favorable, same sex couples must plan to minimize the federal estate tax, as the unlimited marital deduction only applies to heterosexual couples. Planning must also be done to minimize state estate taxes and state inheritance taxes if the couple is thinking about moving to another jurisdiction.

For Blended Families, many of the traditional planning techniques do not work because the goal is not always to provide for the spouse first and then for the children. Special planning is needed to ensure that both the needs of the surviving spouse and children from the prior relationship are addressed. This often involves setting up irrevocable life insurance trusts or segregating assets.

For couples who are in a long term relationship but are not legally married, planning is often a sore point. Legally, such couples are pretty much in the same boat as same sex couples unless they living a jurisdiction that has common law marriage. If no planning is done, the surviving partner gets completely cut out.

Ignoring the issue not only leads to litigation, but a more expensive estate administration process and higher taxes. If you are in a non-traditional relationship, I strongly recommend seeing a competent estate planning attorney in a jurisdiction near you to flush out all the issues that affect you.

A Comparison of the Pennsylvania and New Jersey Inheritance Tax Laws

Some states, including New Jersey and Pennsylvania, have an inheritance tax. Other states, like Florida and New York, do not have an inheritance tax. An inheritance tax is a tax on the person who receives money from a decedent.

The inheritance tax rate itself depends upon the relationship between the person receiving the money and decedent. For example:

1. In both New Jersey and Pennsylvania, if the person receiving the money is a spouse (or a charity), there is no tax.
2. If the person receiving money is a sibling, there is a flat 12% tax in PA. In NJ it is a bit more complicated - the first $25,000 is exempt; beyond that there is a tax of 11-16% depending upon on the amount of the bequest.
3. Generally, if the person receiving money is anyone else (besides a child, parent or same sex partner), then there is a 15% flat Pennsylvania inheritance tax and a 15 or 16% New Jersey inheritance tax depending upon the amount of the bequest.
4. The first BIG DIFFERENCE is that Pennsylvania taxes bequests to all lineal descendants and certain lineal ascendants at 4.5%. New Jersey does not charge an inheritance tax to any lineal descendants or ascendants. (Note: Pennsylvania does not charge a tax on the bequest to a parent if the decedent was under 22 years of age.)
5. The second BIG DIFFERENCE is that Pennsylvania has a 15% inheritance tax on bequests to a same sex partner. In New Jersey, as long as the partners are in a civil union or domestic partnership, there is zero inheritance tax. If the partners are not in a civil union or domestic partnership, then there is a 15 or 16% tax, depending upon the amount of the bequest. For more information, see my blog on Estate Planning for Same Sex Couples.
6. In NJ, a bequest to a son-in-law or a daughter-in-law is taxed at the same rate as a bequest to a sibling. N.J.S.A. Section 54:34-2c. In PA, such transfers are taxed at the same rate as a bequest to a child. 72 PS 9116 (Note: If the son-in-law or daughter-in-law later remarries, this does not apply.)
7. In both NJ and PA, step children and adopted children are taxed in the same manner as natural children. New Jersey also allows inheritance tax free transfers to mutually acknowledged children in certain circumstances. N.J.S.A. Section 54:34-2a.
8. The only other significant difference in the rates is that New Jersey exempts transfers that are less than $500. Pennsylvania exempts certain transfers of up to $3,000.

New Jersey and Pennsylvania also have similarities and differences between the types of assets that they will tax. This is not a complete list, but as an example:

1. Neither state taxes life insurance, real property located outside of the state or business interests located outside of the state;
2. Both states will fully tax cash and brokerage assets of individuals who died while domiciled in their state.
3. Both states will fully tax real estate and business interests located inside the state of resident and non-resident domiciliaries.
4. Joint property held with rights of survivorship are fully taxed in New Jersey unless the recipient can prove he or she contributed to the joint property. In Pennsylvania, only the portion of the property owned by the decedent is taxed.
5. IRAs, Annuities, 401(k)s, 403(b)s and other retirement assets are taxed in New Jersey, but not in Pennsylvania, provided the account owner passes away before having the right to withdraw the money free of penalty (generally before retirement age of 59.5) AND provided that a person was named as beneficiary of the retirement plan. In PA, if the owner of the 401(k) has the right to close down the account it will also be subject to a tax, this is generally age 62 or 65.
6. Retirement plans, annuities and other benefits payable by the federal government to a beneficiary are not subject to an inheritance tax in NJ or PA.
7. In Pennsylvania, transfers made within one year of death are taxable, but each such transfer is subject to a credit of up to $3,000 per recipient. In New Jersey, transfers "made in contemplation of death" are taxable for inheritance tax purposes. There is a presumption that transfers made within three years of death are made "in contemplation of death".

Note: An inheritance tax is not to be confused with an estate tax. A state can have either an inheritance or an estate tax, both, or neither. Additionally, many of the assets that are exempt from inheritance tax (such as life insurance) are subject to an estate tax.

The NJ inheritance tax is due within 8 months from the date of death. In PA, the inheritance tax is due within 9 months of the date of death, but there is a 5% discount if the tax is paid within 3 months from the date of death.

The NJ Inheritance tax statute can be found at N.J.S.A Section 54:34-1, et. seq. The PA Inheritance tax statute can be found at 72 PS 9101, et. seq.

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Edited on January 20, 2011 thanks to input from Patricia Picardi.