The Winds(or) of Change are Blowing: Estate Planning for Same-Sex Couples in Tennessee

Same-sex marriage is a phenomenon of our time, currently available in 14 states and the District of Columbia,[1] as well as in 20 countries.[2] Traditionally, in the U.S. each state has been free to create its own definition of “marriage,” within the bounds of federal Constitutional limitations. Both Tennessee’s Constitution, as amended in 2006,[3] and the federal Defense of Marriage Act (DOMA), enacted in 1996,[4] define “marriage” as between one man and one woman. On June 26, 2013, the U.S. Supreme Court issued its decision in United States v. Windsor[5] (Windsor), dramatically changing the legal landscape for same-sex couples nationwide.

No More DOMA?

Section 3 of DOMA provides that, for federal purposes, “the word ‘marriage’ means only a legal union between one man and one woman as husband and wife, and the word “spouse” refers only to a person of the opposite sex who is a husband or a wife.”[6] Edith Windsor and Thea Spyer, residents of New York, were married in Canada and the marriage later was recognized by New York. Spyer died in 2009, leaving her entire estate to Windsor. In accord with DOMA, the Internal Revenue Service (IRS) treated the couple as unmarried for U.S. estate tax purposes, denying Spyer’s estate the unlimited estate tax marital deduction and resulting in approximately $360,000 in federal estate tax. Windsor, as personal representative, sued for a refund, asserting that Section 3 of DOMA was unconstitutional on Fifth Amendment due process and equal protection grounds. The U.S. Supreme Court agreed, requiring the federal government to recognize the marriage since it was both validly entered into and legally recognized in the state of the decedent’s domicile.

Windsor does not address directly the treatment of a marriage that is legal in the state of “celebration” but not recognized in the state of domicile, as Windsor does not explicitly strike down Section 2 of DOMA, which purports to protect each state’s right not to recognize other states’ marriages that violate its public policy:

No State, territory, or possession of the United States, or Indian tribe, shall be required to give effect to any public act, record, or judicial proceeding of any other State, territory, possession, or tribe respecting a relationship between persons of the same sex that is treated as a marriage under the laws of such other State, territory, possession, or tribe, or a right or claim arising from such relationship.[7]

Federal Agency Responses to ‘Windsor’

In response to Windsor, various federal agencies have issued pronouncements regarding treatment of same-sex married couples under federal law.

OPM. On July 17, the Office of Personnel Management issued a memorandum providing eligibility for federal benefits for same-sex married couples and their families, including insurance, retirement and flexible spending accounts.[8]

Defense. On Aug. 14, the Department of Defense announced that by early September it would begin offering health care coverage, housing allowances and survivor benefits to legally married spouses of military personnel and other employees without regard to gender.[9]

Treasury/IRS. On Aug. 29, the Department of the Treasury and IRS ruled that all legal same-sex marriages will be recognized for federal tax purposes.[10] The rulings provide transitional guidance for past tax years not yet beyond the relevant statute of limitations, and explicitly do not apply to civil unions, registered domestic partnerships or other formal relationships not classified as a marriage under state law.

Labor. In August, the Department of Labor Wage & Hour Division’s Fact Sheet #28F regarding Family Medical Leave Act (FMLA) rights was updated to include in the definition of “spouse” persons in same-sex marriages recognized in the state where the employee resides.[11]

Veterans. On Sept. 4, the Obama Administration announced that the Department of Veterans Affairs would begin providing same-sex spousal benefits, notwithstanding a federal statute that limits such benefits to veterans’ spouses of the opposite sex.[12]

Federal departments and agencies requiring only that a same-sex couple’s marriage be valid where performed (a “state of celebration” standard) include OPM, Defense and Treasury/IRS. Labor requires that the couple also reside in a state that recognizes the marriage (a “state of residency” standard) and, as of submission of this article, the Social Security Administration is processing benefits only for same-sex couples who reside in recognition states.[13]

Federal Tax and Retirement Benefit Planning

Because the IRS has adopted the less rigorous “state of celebration” standard for federal tax status, married same-sex couples residing in all states must be advised of the effects of these new federal tax rules.

Income Tax. For tax year 2012, a married same-sex couple may elect single or married filing status. Effective Sept. 16, 2013, married same-sex couples must file either “married filing separately” or “married filing jointly.” The IRS ruling allows married individuals to amend a federal tax return for any year open under the statute of limitations and during which they were validly married.[14]

Same-sex surviving spouses will be allowed a “spousal rollover” for IRA and qualified retirement accounts. Employer-provided health insurance coverage for unmarried partners (same-sex or otherwise) produces taxable income to the employee, but benefits for spouses are nontaxable.

Not all implications of married filing status are desirable. Some married same-sex couples will face the so-called “marriage penalty,” a higher combined tax liability than they would have if both filed as single.[15, 16]

Transfer Tax. Windsor and the IRS rulings have broad implications for federal transfer taxes (estate, gift and generation-skipping transfer). Same-sex couples now have the benefit of the federal estate and gift tax unlimited marital deductions, meaning any assets transferred during life or at death to (or in certain types of trusts for) a surviving spouse[17] will pass free of federal gift and estate tax. In addition, the first-deceased spouse’s unused federal estate tax exemption amount is “portable” to the surviving spouse. The new rules open up to same-sex married couples all the same planning options available to heterosexual married couples, including gift splitting, disclaimer trust planning and Clayton QTIP planning.[18]

Retirement Benefit Planning. Retirement plans are creatures of federal income tax, so the IRS “state of celebration” rule applies. Under Internal Revenue Code (IRC) §401(a)(11)(b), the general rule is that a married plan participant may not name anyone other than his or her spouse as beneficiary to receive benefits at death, unless the spouse executes a consent as directed under IRC §417. Thus any spouse in a valid same-sex marriage, regardless of whether the current state of domicile recognizes such marriage, will need spousal consent to name any beneficiary other than the spouse.

Tennessee Planning

As previously mentioned, Tennessee’s Constitution explicitly provides that a marriage between one man and one woman is the only recognized marital contract, and Section 2 of DOMA purports to permit states to define marriage for the state’s own purposes. Will these laws stand after Windsor? Perhaps not.

In July, a federal district court in Ohio applied Windsor in ruling that Ohio laws similar to Tennessee’s were constitutionally defective.[19] If this case is appealed to and affirmed by the Sixth Circuit, Tennessee federal courts could be bound to apply the same analysis to Tennessee’s statute and constitutional provision.[20] In October, a complaint directly challenging Tennessee’s nonrecognition of other states’ valid same-sex marriages was filed in the U.S. District Court for the Middle District of Tennessee.[21]

Among state law issues to be affected by the outcomes of these cases are the spousal intestate share, the spousal elective share, homestead, year’s support and statutory preference in serving as a fiduciary. Will same-sex spouses eventually be able to own property as tenants by the entirety, which can be advantageous for eliminating probate at the first death and providing creditor protection?[22]

Another uncertainty is the availability (or lack thereof) of divorce laws. Not every state that allows same-sex couples to be married in that state allows them to be divorced there unless they are domiciled in that state.[23] Thus, a same-sex couple residing in Tennessee may have no available jurisdiction for a divorce without either a change in Tennessee law or the couple’s domicile.

A related issue is the availability to same-sex couples of prenuptial and postnuptial agreements under Tenn Code Ann. section 36-3-501. Any prenuptial or postnuptial agreement for Tennessee residents should include language stating that it operates as a domestic partnership agreement to the extent that the couple’s marriage is not recognized in Tennessee or any other state.

The Tennessee gift tax was repealed effective Jan. 1, 2012,[24] so same-sex partners, married or not, may make lifetime gifts to each other without state gift tax. However, the Tennessee inheritance tax continues to apply until 2016[25] and the inheritance tax marital deduction is not currently available for same-sex married couples.[26]

Finally, many wills, trusts and other estate planning documents will present issues of interpretation and construction to determine who qualifies as a spouse or descendant, which in turn may depend upon the status of different laws in different states at different times, with a patchwork of federal overlay. Fiduciaries may find their duties and risks expanded by these uncertainties, potentially requiring them to seek court advice to limit their liability. Estate planners also may need to draft more thoughtfully in defining beneficiaries.

We live in a time when the pace of change is accelerating, creating opportunities and risks alike, with marriage law Exhibit A. Competent counsel will be essential to navigating the legal developments and planning implications.

Notes

  1. States that have legalized same-sex marriage are California, Connecticut, Delaware, District of Columbia, Iowa, Maine, Maryland, Massachusetts, Minnesota, New Hampshire, New Jersey, New York, Rhode Island, Vermont and Washington. Several counties in New Mexico and several Indian tribes have also legalized same-sex marriage.
  2. Countries that have wholly or largely legalized same-sex marriage include Argentina, Australia, Belgium, Brazil, Canada, Denmark, France, Iceland, Israel, Mexico, Netherlands, New Zealand, Norway, Portugal, South Africa, Spain, Sweden, United Kingdom, United States and Uruguay.
  3. Tenn. Const. Art. XI, §18 (2013). See also Tenn. Code Ann. §36-3-113.
  4. 1 USC §7, 28 USC §1738C.
  5. United States v. Windsor, 133 S. Ct. 2675 (2013).
  6. 110 Stat. 249, codified at 1 U.S.C. §7.
  7. Creating new 28 U.S.C. §1738C.
  8. http://www.opm.gov/retirement-services/publications-forms/benefits-admin....
  9. Secretary of Defense, “Memorandum for Secretaries of the Military Departments Under Secretary of Defense for Personnel and Readiness,” Extending Benefits to the Same-Sex Spouses of Military Members Aug. 13, 2013, available at http://www.defense.gov/home/features/2013/docs/Extending-Benefits-to-Sam....
  10. Rev. Rul. 2013-17, 2013-38 IRB 1; IR-2013-72. See William D. Jewet, et al., Complying with IRS Guidance on Same-Sex Marriage, Tax Analysts, Sept. 16, 2013.
  11. http://www.dol.gov/whd/regs/compliance/whdfs28f.htm.
  12. Charlie Savage, “V.A. to Provide Spousal Benefits to Gays, Administration Says,” N.Y. Times, Sept. 4, 2013, available at: http://www.nytimes.com/2013/09/05/us/va-to-provide-spousal-benefits-to-g....
  13. Internal Notice GN 00210 Basic, http:// secure.ssa.gov/apps10/public/reference.nsf/links/08092013111040AM.
  14. Generally, a tax year is open for three years following filing. Query, whether the IRS can limit amendment to years open under the statute of limitations, or whether a law declared unconstitutional is void ab initio? Some practitioners will advise clients to file refund claims for all years since marriage.
  15. Margot L. Crandall-Hollick et al., Congressional Research Service, The Potential Federal Tax Implications of United States v. Windsor (Striking Section 3 of the Defense of Marriage Act (DOMA)): Selected Issues, Sept. 9, 2013.
  16. I.R.C. §163(h)(3).
  17. Patricia A. Cain, Income and Transfer Tax Issues After IRS Announcement on Same-Sex Marriage, 7 Sept. 2, 2013 available at: http://meetings.abanet.org/webupload/commupload/RP190000/otherlinks_file....
  18. Id.
  19. Obergefell v. Kasich, No. 1:13-cv-51, 2013 WL 381462 (S.D. Ohio July 22, 2013). See Ohio Rev. Code. § 3101.01(C )(2)&(3) and Ohio Constitution Art. XV, §11.
  20. See Faizer, “A Tortured Path to Same-Sex Marriage in Tennessee — A Practitioner’s Guide,” Dicta (Knoxville Bar Association), Sept. 2013, for an argument that this must happen under the Windsor analysis.
  21. Tanco v. Haslam, Docket # 3:13-cv-01159 (M.D. Tenn. filed Oct. 21, 2013).
  22. In re Arango, 992 F. 2d 611, 613 (6th Cir. 1993) (“Under Tennessee law … a third party may not own a present possessory interest in the property without the approval of both spouses.”) (citing Third Nat’l Bank v. Knobler, 789 S.W.2d 254, 255 (Tenn. 1990)).
  23. As an example, New York requires at least one of the parties to a divorce complaint in that state to be a continuous resident for at least one year, N.Y. Dom. Rel. Law § 230 (McKinney 2013).
  24. 2012 Tenn. Pub. Acts c. 1085.
  25. 2012 Tenn. Pub. Acts c. 1057. The inheritance tax exemption is $1.25 million in 2013 and scheduled to be $2.5 million in 2014, $5 million in 2015, and repealed in 2016 and thereafter.
  26. Note also that the Tennessee inheritance tax exemption is not portable between spouses, regardless of gender.

Eddy Smith EDDY R. SMITH practices trust and estate law with Holbrook Peterson Smith PLLC in Knoxville. He is a fellow of the American College of Trust and Estate Counsel and past chair of the Tennessee Bar Association Estate Planning and Probate Section. He can be reached at edsmith@hpestatelaw.com. Some portions of this article were adapted, with permission, from materials prepared by Knoxville attorney Marshall H. Peterson. In addition, the author thanks Knoxville attorneys Dan W. Holbrook and Kathleen L. Waldrop for their significant and helpful comments.