Posted tagged ‘GRIT’

Modern Families – Estate Planning for Same-Sex Couples

May 17, 2012

 by David Kovsky

Although President Obama has recently come out in support of recognizing same-sex marriages, the law of the land from a federal tax perspective remains the Defense of Marriage Act (“DOMA”).  Under DOMA, the federal government will only recognize marriage as a union between one man and one woman.

To the chagrin of many same-sex couples, the definition of marriage under DOMA precludes the use of fundamental estate planning mechanisms such as the unlimited transfer of wealth between spouses during life, the deferral of estate taxes until both spouses die and, for 2012, the portability of the estate tax exemption.  In many ways, the tax code is structured to benefit married couples.  Nevertheless, married same-sex couples have some unique planning opportunities available to them specifically because the federal government does not recognize their marriage as valid.

Here are two planning ideas that are only available to unrelated parties but may be very effective wealth transfer strategies for same-sex couples:

1. Grantor Retained Income Trust.  This strategy involves transferring assets that the grantor expects will grow and appreciate over time to a new trust while retaining an income interest for a predetermined period of years.  The value of the gift to the beneficiaries is reduced by the value of the income interest retained by the grantor.  The goal here is to freeze the value of the assets at the time of the transfer while permitting the growth and appreciation to occur outside of the grantor’s estate.  Congress recognized the potential for abusing this type of transaction through the investment in non-income producing assets.  Accordingly, Chapter 14 of the Internal Revenue Code was enacted to provide that among applicable family members, the value of a retained interest for transfers in trust is zero, unless that interest is a “qualified” interest.  One such qualified interest is an annuity (hence the common usage of grantor retained annuity trusts).  Since DOMA does not recognize a marriage between same-sex couples, the limitation to qualified interests that is imposed on these types of trusts among family members is not applicable.  Instead, a lawfully married same-sex couple can utilize this very effective (and often overlooked) estate planning device.

2. Qualified Personal Residence Trust.  This type of trust is designed to transfer the ownership of a residence to the trust beneficiaries following the completion of a term of years during which the grantor is entitled to remain in the residence.  The value of the gift to the trust beneficiaries is reduced by the value of the grantor’s right to remain in the residence.  The concept here is to transfer the residence (including all of the appreciation over the term of years) to the trust beneficiaries at a discounted price.  However, when the beneficiaries receive the residence, they are subject to carry-over basis and may incur a substantial capital gains tax on the subsequent sale of the residence.  Had the grantor died owning the residence, the beneficiaries would receive a step up in basis to the fair market value as of the date of the grantor’s death.  Consequently, the subsequent sale would trigger little or no gain.  One way to ameliorate this planning hurdle would be to purchase the residence back from the trust and have it pass through the grantor’s estate.  However, Treasury Regulations governing the use of qualified personal residence trusts specifically prohibit the grantor from buying the residence back when the trust beneficiaries are members of the grantor’s family.  The same prohibition, however, is not applicable to same-sex couples because in the eyes of the government they are unrelated.  To take advantage of this planning opportunity, the grantor should purchase the residence back from the trust (at no gain or loss, due to the grantor trust rules) prior to the conclusion of the trust term.  The same “value” passes to the trust beneficiaries in the form of cash while the residence will ultimately pass through the grantor’s estate and receive a step-up in basis at his or her death.

With the recognition of same-sex marriage quickly becoming a buzz worthy campaign issue, it is possible that we may see the repeal of DOMA sometime in the next few years.  However, until that happens, it is important to advise same-sex clients to double-down on the government’s definition of marriage as the union of one man and one woman and to take advantage of the unique planning opportunities available to them as “unrelated” parties.