Partners in same-sex relationships often share the same financial goals as married spouses, but they face additional hurdles from federal and state laws in the United States that were written for traditional marriages. Addressing institutional biases requires specialized planning and, in many cases, will require partners to incur additional costs as well. Joseph T. Hahn, an attorney with Best Best & Krieger LLP in Indian Wells, CA, and a member of the UBS Attorney Network program,* who advises numerous gay and lesbian couples, uses a driving analogy: “Marriage is like the express road,” he said. “Domestic partnership is the toll road. Partners must recognize that they aren’t treated as one unit and must plan each step they take.”
Legal Issues
The federal defense of Marriage act (DOMA), which was signed into law in September 1996, has two major provisions. First, marriage is defined under federal law as “a legal union of one man and one woman as husband and wife.” The term spouse “refers only to a person of the opposite sex who is a husband or a wife.” second, each state (and other political territories such as possessions) has the power to recognize or deny the legality of same-sex marriages that are recognized in another state.
The requirement to file as two single taxpayers can create tax-reduction opportunities when partners are in different federal income tax brackets. Ideally, the lower-bracket partner should report investment income and capital gains while the higher-bracket partner should claim deductions. There are restrictions with this income- and deduction-shifting strategy, however. Taxpayers cannot separate an asset from its income; in other words, the taxpayer who owns the asset is responsible for the tax on its income. Likewise, domestic partners can’t decide arbitrarily which person will claim a particular deduction. Only the taxpayer who incurred the deductible expense can take it. As a result, the higher-bracket partner must transfer ownership of the asset to the lower-bracket partner in order to transfer an asset’s income, which means the gift-tax regulations come into play. Current law allows a donor (i.e., the gift giver) to give another person (who is not his or her spouse) a maximum of $13,000 per calendar year without incurring gift taxes. The amount above $13,000 is considered a taxable gift that reduces the donor’s lifetime estate tax exclusion.
As A Result Of DOMA:
• Same-sex couples cannot file their federal income taxes jointly
• Employer-paid health insurance premiums for an employee’s same-sex partner are treated as tax-able income
• Social Security survivor’s benefits are not available
• The federal estate and gift tax marital deduction is not available
While DOMA sets federal standards, some states permit same sex marriage, and several states give same-sex partners many of the same rights that are available to spouses under state laws. Partners must register with the appropriate state or local government agency to be recognized under these laws, but the registration process is inexpensive and straightforward.
Entering any of these arrangements brings responsibilities as well as benefits, however, and partners should consider the decision carefully. Specifically, what obligations do partners have if the relationship ends? It may seem harsh to plan for a partnership’s demise while it is strong, but many same-sex relationships – like traditional marriages – will end during the partners’ lives. “Many of the relationships I see dissolve at some point,” Hahn said. “It is incumbent upon partners to recognize this. Each partner should consider having separate legal counsel before they enter a domestic partnership or talk to someone about estate planning.”
Estate Planning
Domestic partners should start the estate planning process by deciding how they want their assets distributed at death (and during life, if lifetime giving is applicable). After establishing the distribution plan, partners must coordinate supporting documents and arrangements – wills, beneficiary designations, trusts, etc. – to achieve the desired distribution.
Wills
A will is the cornerstone of the estate planning process, so it is essential that both partners have current wills. If either partner dies intestate – without a will – the intestacy laws of the deceased’s resident state will determine the distribution of any assets that lack a joint owner or beneficiary. These laws generally do not recognize a same-sex partner; instead, the assets will be distributed to the deceased partner’s surviving relatives in a sequence that typically includes children, parents and siblings.
Revocable Living Trusts
A revocable living trust can be an important supplement to a will. The trust document, which is established during a person’s lifetime, names a trustee and successor trustee to manage the assets transferred to the trust. For example, a client might name himself as trustee and his partner as successor trustee. The trust’s terms can specify that the individual will manage the trust until he becomes incapacitated or turns over control voluntarily. At that time, his partner would become the trustee. Revocable living trusts have an additional benefit: the trust’s assets avoid probate, which may reduce delays and administrative costs while increasing the estate’s privacy.
Durable Powers Of Attorney
A durable power of attorney gives the person named – the “attorney” – the power to act in another’s place. This document facilitates management of someone’s finances if he or she is unable to act due to illness, incapacity or another reason. Domestic partners can name each other or another adult as attorney. Depending on the powers specified in the document, the person named could buy and sell investments, pay bills and so on. This arrangement is helpful to manage assets that are not owned jointly, including pension plans and individual retirement accounts. In a domestic partnership, if one partner does not create a durable power of attorney, the other partner will require a court’s permission to manage his or her affairs. Family members, who might oppose a partner’s interests, could file similar petitions and cause potentially expensive and damaging litigation.
Asset Ownership
The manner in which assets are owned influences the taxation and distribution of those assets at the death of the owner. Solely owned property is included in the decedent’s estate and distributed according to his or her will or state and local intestacy laws. Property owned jointly with right of survivorship passes directly to the surviving owner, but the estate tax treatment is more complex. The law assumes that 100% of the property is included in the estate of the first partner to die, unless the surviving owner can prove he or she contributed toward the purchase. For property held by partners as tenants in common, the surviving owner does not automatically receive the deceased partner’s share because the decedent’s will or the state intestacy laws control that share. However, only the decedent’s share of the asset is included in his or her estate. There is no presumption of 100% ownership.
Effective Beneficiary Designations
An individual’s distribution plans must work in tandem with his or her assets’ titles and beneficiary designations to achieve the de- sired results. To prevent conflicts, both partners should review and coordinate the distribution arrangements for all of their assets. Some financial assets that allow beneficiary designations require careful attention, however, because the amounts involved can be substantial and they have specific requirements. These assets include life insurance and retirement plans.
Life Insurance
Life insurers require an “insurable interest” between the insured and the beneficiary. Examples of insurable interests include traditional marriage, business partnership and joint home ownership, so the insurer might not recognize a partner’s interest in the other partner’s life. One possible solution to this problem is to establish a trust and have the trust purchase the policy on the partner who is to be insured. The trust can name itself as the life insurance beneficiary with the surviving partner as the trust’s beneficiary.
Self-Funded Retirement Plans
This category includes 401(k)s, 403(b)s for nonprofit organizations’ employees, iras and sepiras. The surviving partner can roll the account assets over into an “inherited IRA” and allow the assets to continue to grow tax-free. Rules regarding required minimum distributions apply, and income taxes will be incurred as distributions are made. This can be an important option to consider versus taking a lump-sum distribution and paying a large income tax liability immediately. Because same-sex couples lack an unlimited marital estate tax deduction that is available to spouses, they must plan for potential estate taxes on retirement plans. If the deceased partner’s estate is taxable, federal estate taxes on retirement plans can be substantial, and the tax is generally due within nine months of death. Using these retirement assets to pay estate taxes is problematic given that income taxes will be assessed on any withdrawals. Other assets should likely be considered first for satisfying any estate tax liability, such as life insurance held in a trust.
Partner-Owned Businesses
Life partners who are also business partners should ensure that the business would survive if one or both partners become ill or die unexpectedly. Long-term illness or disability has a double impact because it reduces both the business’ and the owners’ incomes. In addition, if a partner cannot return to work, he or she may wish to sell his or her share of the business to the healthy partner. A continuation plan funded with disability insurance that provides income for the disabled owner and cash for the healthy partner to finance a buyout can solve both of these problems.
A business owner’s death creates multiple problems. The deceased partner’s business interest will be included in his or her estate; if the estate is taxable, his or her administrator will require liquid assets to pay the estate taxes. The surviving partner also must facilitate an orderly transfer of the business ownership, which usually means acquiring the deceased partner’s interest.
A buy-sell agreement funded with life insurance allows the survivor to buy the deceased partner’s interest, and his or her estate can use the sales proceeds to pay any estate taxes. Buy-sell agreements should be discussed when the business is first created, if possible, and the terms should be clearly articulated in writing. The business’ legal structure – partnership, corporation or limited liability company (LLC) – influences the steps needed to ensure a smooth ownership transfer. Each structure has advantages and disadvantages that extend beyond estate planning, however, and both partners should seek legal and accounting advice before selecting or changing a structure.
Employer-Funded Retirement Plans
The spouse of an employee enrolled in an employer-funded retirement plan is the default beneficiary, but there is no similar default option for same-sex couples in most states. In those states, the employee-partner must file any required forms with the plan administrator to ensure that the surviving partner is the beneficiary. Domestic partners should check with their human resources departments to find out what they must do to designate each other as beneficiaries.
Reducing Estate Taxes
Lifetime gifts transfer an asset’s value and its future appreciation from the gift giver’s estate and reduce potential estate taxes. Annual gifts over $13,000 to any person reduce the gift giver’s lifetime credit (the lifetime gift tax exclusion is $1 million.); nonetheless, large gifts can be an effective income and estate tax planning tool. Completed gifts are irrevocable, however. Once an asset is gifted, it cannot be reclaimed.
Charitable Remainder Trusts
Charitable remainder trusts (CRTs) can reduce income and estate taxes while also generating income for an individual, his or her partner or both of them. a CRT’s operation is straightforward. The donor contributes assets to the trust, and the donation generates a tax deduction for the donor based on the asset’s value and the selected distribution option. The trust can sell the property without incurring capital gains taxes and reinvest the proceeds in income-producing assets. The trust then pays the beneficiary a distribution stream for a set period or life, and the distributions carry out the trust’s current and accumulated income and capital gains. When that set period ends, any remaining trust assets pass to a designated charity.
Life Insurance Trusts
Life insurance proceeds provide liquidity to pay estate taxes or can be invested to generate additional income for the insured’s survivors. if the insured owns his or her policy, however, the policy’s proceeds are included in his or her estate. To avoid this inclusion, the insured should first establish an irrevocable life insurance trust and transfer funds to the trust. The trust can then apply for and purchase the policy. Such an arrangement, structured properly, will keep the proceeds out of the insured’s estate.
Tax Planning
The requirement to file as two single taxpayers can create tax-reduction opportunities when partners are in different federal income tax brackets. Ideally, the lower-bracket partner should report investment income and capital gains while the higher-bracket partner should claim deductions. There are restrictions with this income- and deduction-shifting strategy, however. Taxpayers cannot separate an asset from its income; in other words, the taxpayer who owns the asset is responsible for the tax on its income. Likewise, domestic partners can’t decide arbitrarily which person will claim a particular deduction. Only the taxpayer who incurred the deductible expense can take it.
As a result, the higher-bracket partner must transfer ownership of the asset to the lower-bracket partner in order to transfer an as- set’s income, which means the gift-tax regulations come into play. Current law allows a donor (i.e., the gift giver) to give another person (who is not his or her spouse) a maximum of $13,000 per calendar year without incurring gift taxes. the amount above $13,000 is considered a taxable gift that reduces the donor’s lifetime estate tax exclusion.
Medical Concerns
Same-sex couples can face additional biases when dealing with healthcare providers. Completing healthcare directives and learning local policies can reduce the likelihood of problems.
Healthcare Directives
It is impossible to predict medical emergencies. When they occur, the stricken partner might be incapable of expressing his or her wishes regarding healthcare decisions, leaving the healthy partner without guidance. This dilemma can be avoided by creating healthcare declarations, also known as living wills, and powers of attorney for healthcare. Living wills allow partners to express their wishes regarding the use or avoidance of life-sustaining medical treatments. A healthcare power of attorney authorizes an agent to make healthcare decisions for another person if that other person can’t make decisions for himself or herself.
Visitation And Notification Rights
There have been widely reported incidents of hospital staff refusing to recognize same-sex partners as a patient’s immediate family. No one needs the added stress of being denied these rights when a partner is ill; preemptive action is the best strategy in those states that do not recognize same-sex unions in some fashion. Although the following actions do not guarantee access, they reduce the likelihood of problems:
• Partners should contact the doctors involved, particularly the primary care physicians, so they are aware of a partner relationship and the potential problem
• Partners should contact the hospital or treatment facility’s patient advocate to learn its policy on partners’ rights and ask what documentation it requires to prevent problems
The key to effectively handling these challenges and creating a successful long-term financial plan is flexibility. Partners’ financial needs and resources will change over time, as will the laws affecting their finances, and any plan must adapt to those changing circumstances. Same-sex couples cannot afford the luxury of assuming that the government will safeguard their interests, at least not at the federal level for the foreseeable future. It is a difficult situation, but one that can be managed with expert financial and legal advice.
This article has been written and provided by UBS Financial Services Inc. for use by its financial advisors.
