On Jan. 17, 2017, nearly 3 ½ years after the U.S. Supreme Court’s decision in United States v. Windsor1 was released (which declared Section 3 of the Federal Defense of Marriage Act (DOMA), limiting the recognition of marriage to one man and one woman, to be unconstitutional), the Treasury Department and the Internal Revenue Service released Notice 2017-15 to provide further post-Windsor guidance to same-sex married couples.
On June 27, 2013, in an article for wealthmanagement.com summarizing the effects of the Windsor opinion, I advocated that the unconstitutionality of the decision would cause DOMA to be void ab initio (interpreted as if it never existed). The effect of this would be that technically, retroactivity should apply and that certain rights or benefits that were denied in the past to same-sex married couples as a result of DOMA should now be available. The only question was the mechanics of how to apply the retroactivity.
Since Windsor was decided, the Treasury and the IRS have issued several documents providing tax guidance with respect to the opinion—most notably Revenue Ruling 2013-17, IR-2013-72 and Treasury Regulations Section 301.7701-18, implicitly acknowledging this legal concept of retroactivity. The caveat to retroactivity is that any guidance for its implementation must be carefully drafted and considered; otherwise, there could be significant and detrimental collateral effects. For this reason, guidance hasn’t—nor should it have—been swift. The Notice validates this concept. In the Notice, the Treasury and the IRS continue the implicit acknowledgment of the retroactive application of DOMA’s unconstitutionality by tackling two separate transfer tax issues: the pre-Windsor use applicable exclusion amount for prior gifts and the generational-assignment of pre-Windsor transfers to a same-sex spouse or to the spouse’s family members for purposes of the generation-skipping transfer (GST) tax.
Restoration of Applicable Exclusion Amount
The first part of the Notice grants partial relief to a same-sex married spouse who used applicable exclusion amount on a gift to his spouse. The relief provides that even if the year in which the gift occurred is closed for gift tax purposes, through the use of a separate (as yet undetermined) calculation worksheet, the previously used applicable exclusion amount will be restored to the gifting spouse. What isn’t restored or refunded, however, are any gift taxes that may have been paid. According to the Notice, such paid or payable taxes will continue to be allowed as a credit in the calculation of any future gift or estate taxes.
Example: Suppose that in 2007, A and B, a same-sex married couple, wish to purchase a residence. A, the wealthier spouse, uses her personal funds and places the title in the joint names of the spouses with right of survivorship. If A and B were an opposite-sex married couple, the gift would qualify for the gift tax marital deduction under IRC Section 2523, and A wouldn’t have used any of her then $1 million gift tax applicable exclusion amount (recall that under the law as then in effect, the estate and gift tax unified credits were actually different amounts, with the gift tax exemption amount remaining fixed at $1 million, while the estate tax exemption, then $2 million, would increase and top off in 2009 at $3.5 million). However, because DOMA caused their marriage to not be recognized for purposes of federal law, A was deemed to have made a taxable gift to B of one-half of the value of the residence. If the purchase price were $4 million, A would have made a gift to B of $2 million and, after applying her $1 million gift tax applicable exclusion amount, would have paid federal gift taxes of $435,000.
As a result of the Windsor decision, DOMA is void ab initio. In 2007, the transfer of the 50 percent interest in the residence from A to B was a gift to a spouse and should have qualified for the marital deduction. Further, if the marital deduction had been applied, there would have been no taxable transfer and no use of A’s gift tax applicable exclusion amount. A should have her $1 million applicable exclusion amount restored; however, because 2007 is a closed tax year, A isn’t entitled to receive a refund of the $435,000 of gift taxes paid.
Under the Notice, when IRS ultimately issues the worksheet calculation, A will have her applicable exclusion amount restored. How the calculation will work, however, is a mystery. Presumably, one way of achieving this result is to remove—according to the “adjusted taxable gifts” under IRC Section 2001(b)—any transfer to a same-sex married spouse that would have otherwise qualified for the marital deduction. While doing so would restore the previously used exemption, the Treasury and the IRS were clear in the Notice that any gift taxes paid would still be used as a credit against future transfers. If that’s the case, then the prior transfers couldn’t be excluded from the calculation of adjusted taxable gifts because the only manner in which there could be a credit for gift taxes paid or payable is if the prior transfers were included in adjusted taxable gifts. This question will be resolved when the IRS releases its worksheet for the calculation.
The Notice also states that if the gift in question would have qualified for the gift tax marital deduction as “qualified terminable interest property” had the election been made, it’s possible to retroactively make the election. However, the election isn’t automatic and must be undertaken through an application for late relief under Treas. Regs. Section 301.9100-3.
GST – Reclaiming Exemption Based on Adjusted Generation Assignments
Under IRC Section 2651(b), a recipient’s generational assignment for purposes of the GST tax is based on the familial relationship to the transferor or the transferor's spouse. Regardless of the difference in ages, spouses are always assigned to the same generation, and descendants are assigned the applicable generation below the transferor or the transferor’s spouse.
If there’s no spouse and if the recipient has no familial relationship to the transferor, then under Section 2651(d), the generational assignment is determined by the difference in ages as to the transferor. An age difference of 12 ½ to 37 ½ is assigned to one generation below the transferor, and every 25 years thereafter is one additional generation below the transferor.
Prior to Windsor, a transfer to a same-sex spouse or a descendant of a same-sex spouse wouldn’t fit within the familial assignments under Section 2651(b) and, for GST tax purposes, would instead be assigned based on the difference in ages as set forth in Section 2651(d). Therefore, if, back in 2007, A and B were a same-sex married couple whereby A was 25 years older than B, because federal law didn’t recognize B as A’s spouse, and B wasn’t related by blood to A, B’s generational assignment as to A under Section 2651 was based on the age difference between A and B. Because B was 25 years younger than A, B was assigned to the generation immediately below A. If B had children from a prior relationship, and any of those children were more than 37 ½ years younger than A, those children would have been assigned to the second generation below A. If A had gifted amounts to B’s children in excess of the gift tax annual exclusion amount under Section 2503(b), any such transfers would have been transfers to a “skip person” under IRC Section 2613(a)(1) and resulted in a GST tax transfer as a direct skip under IRC Section 2612(c). Assuming that A had, at the time of the transfer, available GST tax exemption under Section 2631, such exemption would have been used on the transfer.
Under the Notice, the Treasury and the IRS have concluded that, as to a transfer from a party in a same-sex marriage, the allocation of GST tax exemption to a prior outright transfer to the transferor’s spouse or the spouse’s child is void. Applying this to the above example, even though B is 25 years younger than A, B is A’s spouse so B is assigned to A’s generation. Thus, any prior gifts by A to B or to any of B’s children—even in closed tax years—are now deemed to not have been GST tax transfers. Based on a calculation worksheet to be released in the future, A will have his GST tax exemption restored. As with the gift tax, if any GST taxes were paid and the particular tax year is closed, no refund is allowable.
Other Important Points from the Notice
With respect to the procedures for implementing the relief granted by the Notice, the Notice provides the same procedures with respect to the covered marital and GST tax transfers.
First, the adjustment for the applicable exclusion amount and GST tax exemption will occur on the first federal gift tax return (709) to be filed by the taxpayer after the issuance of the Notice. If the taxpayer dies prior to filing a 709, the adjustment should be made on the taxpayer’s federal estate tax return. If the year in question is an open year, then an amended Form 709 for that year should be filed.
Second, with whichever return is filed, a statement at the top of page 1 should be added, which reads, “FILED PURSUANT TO NOTICE 2017-15.”
Third, the taxpayer must attach a statement supporting the claim for the marital deduction/adjustment to the GST tax exemption and detailing the recalculation of the taxpayer's remaining applicable exclusion amount/GST tax exemption.
For same-sex married couples who were denied federal tax benefits prior to the issuance of the Windsor decision, the Notice is a major step towards the reconciliation of constitutional law concepts and the practical effects when applied to federal tax statutes. The only open item with respect to the restoration of previously used gift tax applicable exclusion amount is to understand the methodology under which the IRS will implement the relief described in the Notice. The relief for GST tax exemption, however, doesn’t appear to be as complex, and its implementation should be much simpler procedure.
- United States v. Windsor, 570 U.S. ___ (2013).