Civil unions in Illinois are not without tax issues. The federal tax law does not allow joint returns to be filed by partners of a civil union.
By Bruce L. Richman, Valuator, and Richard A. Wilson, Family Lawyer
On June 1, 2011, the “Illinois Religious Freedom Protection and Civil Union Act” came into effect. Under this law, two persons – both at least 18 years of age and without regard to gender – will be permitted to obtain a civil union with the same rights and benefits afforded to opposite-sex couples under the state’s marriage laws.
The Act does not amend the existing Illinois Marriage and Dissolution of Marriage Act (“IMDMA”), but is a separate provision of the law that both provides for Civil Unions under Illinois law, and incorporates relevant and particular provisions of the IMDMA, where necessary. Basically, it provides for and guarantees all of the rights, benefits and burdens of marriage available under Illinois law by formally equating partners to a civil union with “spouses” under all of Illinois law.
The Act also mandates that any person who enters into a civil union in Illinois consents to the jurisdiction of the courts of Illinois for the purpose of any action relating to the civil union, even if one or both parties cease to reside in the state ofIllinois. Thus, the Act mandates the continued jurisdiction of the state of Illinois courts to dissolve a civil union without regard to the residence of either party or whether either, or both, continues to live in Illinois.
But there is a far more reaching financial issue with the current Act for those seeking a civil union in Illinois. There is a clear conflict between the state recognition and the existing federal law under the Federal “Defense of Marriage Act” or “DOMA,” which both defines “marriage” and “spouse” for purposes of federal law and declares that the states are free not to recognize a same-sex marriage from another jurisdiction.
DOMA provides that 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. This federal definition of “marriage” and “spouse” alone creates significant and substantial conflict with the recent Illinois Act, and ensures unavoidable and unequal impact on parties to a same-sex marriage, or civil union, that is recognized by the state but not by the federal government. There are more than 1138 federal programs, rules, tax laws, and benefits that depend upon or use the term “spouse” or “marriage,” and where the civil union relationship is not recognized for purposes of federal law, or where substantive rights and benefits accorded by the state, which are dependent upon the relationship conflict with or are not available under federal law.
Some of the major issues that this article focuses on are with the impact of the Federal Tax Laws including not only things such as tax filing status, but also the important financial benefit to divorcing parties, such as the lack of tax consequences in the division of the marital estate upon the dissolution of a marriage.
Civil Unions in Illinois Are Not Without Tax Issues: The Filing Status
The Act did not change the Illinois income tax laws. TheIllinoisincome tax act permits joint income tax returns to be filed only when a joint income tax return is filed for federal tax purposes. The problem here is that based on the Defense of Marriage Act (“DOMA”), the federal tax law does not allow joint returns to be filed by partners of a civil union. Thus, since the Federal government does not allow a joint return for federal tax purposes, the state of Illinois does not allow a joint return either. Thus, for federal tax purposes, one would have to file as single or head of household. However, the Illinois Department of Revenue issued a statement on November 28, 2011, declaring that Illinois residents in a civil union would, after all, be entitled to file joint state tax returns. This decision reversed an earlier statement, on June 2, declaring that this would not be allowed.
Therefore, Illinois now formally permits parties to a civil union to file state tax returns as married and thus file jointly, despite federal non-recognition. The parties have to prepare a pre forma federal return, which they do not file, to determine their federal taxable income in order to proceed to prepare their Illinois state income tax return.
Homebuyer’s Tax Credit
Partners in a civil union who bought a home and expected to enjoy the homebuyer’s tax credit will need to split the $8,000 tax credit. However, since they would not be combining their income, they may benefit from phase-out provisions.
Buying a House with a Civil Union Partner
Suppose that Sue and Jill have a civil union and purchase a house together. Let’s further assume that Sue is a successful lawyer and Jill is not working. The down payment of the house was $400,000 and they purchased the home in both of the names with joint ownership. It is very conceivable that theirs would construe this as a gift of $200,000 from Sue to Jill, thus creating potential gift tax issues. Obviously, if it was a marriage of Josh and Talia, no issue would be present as there is unlimited gifting between spouses. Let’s go further with respect to the mortgage.
The mortgage company will normally send one Form 1098 to report the amount of interest expense paid and real estate taxes. Since only one social security number will be on the Form 1098 there could be a matching problem for the IRS when they go to match the interest deduction taken with IRS Form 1098 that was filed since the parties will not be able to file a joint income tax return.
Additionally, what about the payment of the mortgage itself? In order to take the deduction for the mortgage interest, one has to be the party who paid for the mortgage. In this case, advance planning must be done. In our example, if they are both on the mortgage and the payment is made out of a joint account, there may be a need for a tracing regarding how the joint account is funded. If solely funded by Sue, again, there could be an issue of a gift or denial of the interest deduction by Jill. If Jill is not jointly on the mortgage, the simple payment of the mortgage by Sue would probably be a gift to Jill by the amount of the increase in equity in the property as the mortgage is paid down.
Exclusion of Gain on Personal Residence
The Internal Revenue Code allows for a taxpayer to exclude $250,000 of their gain on the sale of their personal residence if they used the residence as their personal residence for two out of the last five years. Married couples can get a $500,000 exclusion. Only one spouse needs to meet the test. The problem may arise when one gets divorced. Having foreseen this issue, the IRS put in a safe harbor provision for “unforeseen circumstances,” which includes divorce. The problem with civil unions, since DOMA does not recognize the marriage, is that they would probably not allow this safe harbor provision.
Civil Unions in Illinois Are Not Without Tax Issues: The Joint Accounts
Usually for married couples filing a joint return, it doesn’t matter when the bank sends out one Form 1099, or the mortgage company sends one Form 1098 for the interest expense to be reported, as they normally complete the form with one person’s social security number.
Since same-sex partners cannot file joint returns, one will need to include a statement on ones tax return to indicate this information. Even so, it may get pulled by the IRS since the amounts shown on the tax return will not match the amounts reported to the IRS under one’s social security number.
Property Settlements in Divorce
This can become a major problem. Currently there is unlimited gifting between spouses with no tax implications. However, gifts between members of same-sex marriages or civil unions will be limited. Any gifts given to their partners above the $13,000 limit will be subject to filing a gift tax return and possibly gift taxes. Anything over the annual exclusion will be used against lifetime exemption.
Section 1041 of the IRC allows for no tax implications upon the transfer of property pursuant to a divorce. Again, since DOMA does not recognize the marriage, this can become a problem in allocating property upon the divorce of partners in a civil union as IRC 1041 would not be available.
Spousal Support – Alimony
Here, the federal tax code provides that when payments meet certain rules, the payor of alimony would be includable in the income of the receiving former spouse, and deductible by the paying former spouse. However, since DOMA does not recognize the marriage to begin with and defines the meaning of spouse as someone of the opposite sex, it is questionable whether payments would qualify as alimony under IRC section 71. This section clearly states that only payments from a spouse can be classified as alimony. Thus, it is unclear whether the paying spouse would be allowed a deduction for any payments required under a divorce of partners to a civil union.
The other problem is that the payments to the other party would probably be considered income, as the payments clearly would not qualify as a gift as detached and disinterested generosity. Since it would not be exempt under Section 71 or as a gift, the payments to the former partner would probably be taxable income.
Clearly this creates a problem of double taxation as one partner would recognize income for the payments received, and the paying partner would not get a deduction.
Civil Unions in Illinois Are Not Without Tax Issues and the Division of Retirement Benefits
Since DOMA does not recognize the marriage to begin with, one would assume that it would bar neutral treatment of division of retirement benefits, as one would not have the ability to obtain a Qualified Domestic Relations Order (QDRO) in transferring retirement benefits from qualified plans.
Bruce L. Richman CPA, ABV, CVA, CFF, CFE, CDFA, CPEP, Partner, COHNREZNICK Advisory Group – Valuation Advisory Services.
Richard A. Wilson, Attorney is a partner with Grund and Leavitt. He is also a member of and holds or has held leadership positions in the National LGBT Law Association.