For wealth managers whose clients includes same sex couples, the legislation that legalized same sex marriage created some opportunities, and headaches, in terms of tax issues.

For wealth managers whose clients includes same sex couples, the legislation that legalized same sex marriage created some opportunities, and headaches, in terms of tax issues. By changing the tax treatment in the state of New York, same sex couples have the opportunity to save money on their tax bills now and in the future; at the same time, the differences in tax treatment between state and federal law makes for challenging financial planning and tax issues.

Specifically, same sex couples can choose to file married, filing jointly on their New York State tax returns to take advantage of a lower tax bracket and tax rate than filing single for state tax purposes. However, because federal law doesn’t recognize same sex marriage, they can’t file using a married status, but must chose the single status if there are no children, or head of household if there are children and they qualify, according to Carlyn McCaffrey, a partner with McDermott, Will & Emery, a law firm in New York, NY.

There are numerous other issues involved, including gift taxes, estate taxes, taxes on health insurance and other benefits. And because federal taxes are generally much higher than state taxes, it makes sense to plan with federal taxes paramount, says Jim Toto, a partner with WeiserMazars, an accounting firm in Edison, NJ. “On the estate side, you need to do your planning with respect to the federal tax because we don’t know where the estate tax is going in 2013. It’s likely that there will be some restoration of the estate tax at levels that are higher than today with a lower exemption and a higher tax rate.

“Obviously, the same sex marriage law is a boon for same-sex couples and they will save some money via filing jointly on their state returns and state estate taxes,” he adds. “But planning is going to have to be done around the federal tax rules, because the tax is larger.”

Filing status

Filing status is one of the obvious issues that wealth managers will need to be aware of in regard to same sex couples. As McCaffrey noted, same sex couples can file jointly in New York, but not on their federal returns.

“If the couple has children and each can climb the necessary hurdles, it could make sense for each to file as head of household for federal purposes,” notes Toto. “Then you could have two taxpayers filing head of household, each with their exemption and a child’s exemption. Then they file a join return for New York State, where all four of them are encapsulated into that return.”

For couples who don’t have children or only have one child, at least one would have to file single and the other could potentially file under the head of household status, which gives an extra exemption for that child and has a lower tax bracket, Toto continues.

Gift and estate tax implications

Under New York law, as spouses, same sex couples can pass on their estate to their surviving spouse without that spouse paying estate taxes. However, under federal law, the two aren’t related so in the absence of a trust or some other type of estate planning tool, taxes will be due on estates of $5 million or more, according to Susan Slater-Jansen, a trusts and estate planning attorney with Kurzman Eisenberg Corbin & Lever in White Plains, NY.

Even if steps are taken by a savvy wealth manager to avoid estate taxes via trusts and other vehicles, there are certain kinds of trusts that are preferable so that the estate won’t be taxed when it is passed on by the second partner to the couple’s children or other beneficiaries, says McCaffrey. “A grantor annuity trust is one such vehicle that allows free transfer to surviving beneficiaries,” she adds.

“Wealth managers really need to associate with attorneys, accountants and others who are expert in these areas to get the best advice that will benefit their same sex clients who live in New York and choose to get married because these are very complicated issues,” she continues.

Under federal law, a taxpayer can give up to $13,000 a year to a non-spouse; amounts over that threshold will be counted towards the overall gift tax limit, which can be an issue for same sex couples, says Slater-Jansen. “However, by using the tax law and paying certain bills directly to educational institutions or hospitals, you can avoid gift tax in special circumstances,” she adds. That’s because payments made directly to an educational body for educational expenses and those made directly to a hospital for healthcare expenses don’t count under gift tax rules.

Benefit issues

Last but not least are issues involving benefits. Under federal law, spouses don’t have to pay taxes on health benefits or other benefits included in a cafeteria plan, so same sex spouses wouldn’t have to pay taxes in New York, but there could be imputed income resulting in taxes on a federal level, Toto says.

There are significant retirement plan issues in terms of surviving spouses because under the federal ERISA law and the Defense of Marriage Act same sex couples aren’t legally married and therefore can’t benefit from certain spousal retirement benefits, he continues. Slater-Jansen agrees, noting: “Under federal law, spouses are required to get a survivor annuity from most qualified retirement plans. But this doesn’t include same sex marriage.”

Also, a survivor of a same sex marriage wouldn’t be able to inherit an IRA on the same basis as an opposite sex married couple and would have to handle the IRA inheritance differently, taking distributions, he adds. Toto, Maier and Slater-Jansen believe that there will be a lot of litigation over the issues in the coming years, which will determine if these issues can be handled differently than they are currently. But for now, wealth managers with same sex couples in New York will have to stay on their toes regarding these complicated issues.