The United States Supreme Court's widely heralded decision in United States v. Windsor struck down the section of the Defense of Marriage Act (DOMA) requiring that same-sex spouses be treated as unmarried for purposes of federal law. It is unclear whether the Supreme Court's decision applies nationwide or just in certain states. But, where applicable, the Windsor decision requires the IRS to recognize same-sex marriages for tax purposes and permit same-sex spouses to file joint tax returns--something they have been unable to do until now.
Only Couples Living in States Recognizing Same-Sex Marriage May File Jointly
At the moment, it appears that, as far as federal taxes go, the Supreme Court's decision applies only to same-sex spouses who were married in (and live in) a state recognizing same-sex marriages (the state of marriage and residence don't have to be the same). This is because the IRS has long relied on the state marriage laws in effect in a taxpayer's state of residence to determine whether he or she is married for tax purposes.
Currently, 11 states and Washington, D.C. recognize same-sex marriage: California, Connecticut, Delaware, District of Columbia, Iowa, Massachusetts, Maine, Maryland, New Hampshire, New York, Vermont, and Washington. Effective August 1, 2013, two more states will recognize such marriages: Minnesota and Rhode Island. Same-sex spouses who live in these states will be recognized as married by the IRS. For an updated list of states recognizing same-sex marriages, see the Human Rights Campaign website.
It appears that same-sex spouses living in states that don't recognize same-sex marriage will continue to be treated as unmarried by the IRS. For example, a same-sex couple who were married in New York, but later moved to Texas, would be treated as unmarried by the IRS. However, this needs further clarification and could change.
In any event, same-sex spouses whose marriages are recognized by the IRS will have the option of filing a joint tax return, something the vast majority of married people already do. Filing jointly will reduce income taxes for some same-sex spouses, but increase them for others. Windsor also has important tax implications for same-sex spouses who own, or plan to own, real estate. Same-sex spouses will now be eligible for some of the most important tax breaks for homeowners.
Home Mortgage Deduction for Same-Sex Spouses
One of the greatest tax benefits of home ownership is the tax deductibility of interest (subject to certain limits) on a home mortgage.
Before Windsor: All same-sex spouses had to file separate tax returns, because their marriages were not recognized by the IRS. This meant that same-sex spouses who co-owned a home and had a mortgage together needed to split the home mortgage deduction between them. This split had to be based on the percentage of the mortgage interest payments each spouse paid--for example, if one spouse paid 75%, and the other 25%, they could each deduct that amount on their separate tax returns.
However, the home mortgage interest deduction is an itemized personal deduction that is only available if a taxpayer's total itemized deductions exceed the standard deduction. Splitting the mortgage deduction in two could result in one or both spouse's itemized deductions being lower than the standard deduction, making it impossible for either or both spouses to deduct any mortgage interest.
After Windsor: Same-sex spouses who own a home and have a mortgage together, and live in a state recognizing same-sex marriage, will be able to claim the home mortgage interest tax deduction jointly on their joint tax return, like any other married couple. The same-sex spouses will not need to split the deduction.
$250,000/$500,000 Home Sale Exclusion
The IRS provides homeowners with a generous tax exclusion when they sell their principal residence: the $250,000/$500,000 home sale tax exclusion. Up to $250,000 of the gain from a single homeowner's sale of a principal residence is tax free (for married homeowners filing jointly the amount is $500,000). To qualify for the home sale exclusion, the property must have been used as a main home for two out of the prior five years before the sale. In addition, a surviving spouse may claim a $500,000 exemption if the home is sold within two years of the death of the other spouse.
Before Windsor: Because same-sex spouses could not file a joint tax return, they were each limited to the $250,000 exemption for single taxpayers (rather than a combined $500,000 exemption). Each spouse needed to qualify separately to take advantage of the $250,000 deduction. This meant that each spouse had to have his or her name on the home's title, and the home sale proceeds had to be split between the spouses based on their ownership interests. Moreover, each spouse had to separately satisfy the two-year use requirement. In addition, if one spouse died, the other could not claim the $500,000 exemption for surviving spouses.
After Windsor: Because they may file jointly as married, same-sex spouses living in a state recognizing same-sex marriage now qualify for the $500,000 exclusion. Only one spouse's name need be on the title and only one spouse need satisfy the two-year use requirement. Moreover, if one spouse dies, the surviving spouse qualifies for the $500,000 exemption if the home is sold within two years.
Gifting or Leaving Real Estate and Other Property to a Spouse
The tax law is very beneficial to married couples when it comes to estate taxes. A spouse may leave his or her entire estate to their surviving spouse tax-free, regardless of the value of the estate. A spouse may also gift any amount of property to the other spouse tax-free while they are alive.
Before Windsor: Because the IRS did not recognize same-sex spouses as married, they did not qualify for spousal exemptions to the estate taxes. This is what motivated Edith Windsor to sue the IRS. When her same-sex spouse died, Edith Windsor inherited a $4 million estate, including a co-op in Greenwich Village. However, the IRS would not permit her to take advantage of the unlimited spousal exemption because of DOMA. As a result, Edith Windsor had to pay $363,053 in estate taxes.
After Windsor: Same-sex spouses living in a state recognizing same-sex marriage are eligible for the same spousal exemptions as heterosexual married couples. As a result, Edith Windsor will be entitled to a $363,053 tax refund (plus interest).
This consequence of Windsor will only benefit wealthy same-sex spouses. The estate and gift tax exemption is currently $5.45 million per individual (2016) -- so high that most same-sex or heterosexual spouses will not need to worry about estate taxes. However, very wealthy same-sex spouses now qualify for "portability" which allows a surviving spouse to use any unused portion of the deceased spouse's exemption, giving the surviving spouse an exemption up to $10.9 million.