2014 Income Tax Changes

On June 26, 2013, the U.S. Supreme Court made a landmark decision by striking down Section 3 of the Defense of Marriage Act of 1996 (DOMA), paving the way for same-sex marriages to receive the same federal benefits and protections as opposite-sex marriages. This decision means that the legal definitions of "marriage" and "spouse" under federal law now include legal unions between same-sex partners as well as opposite-sex partners. On August 29, 2013, the Treasury Department and the IRS announced that all same-sex couples who are legally married in a state that recognizes same-sex marriages will be recognized as such for federal tax benefits, regardless of their state of residence. On September 18, 2013, the U.S. Department of Labor issued a similar statement regarding its application of laws to retirement plans.

As it stands, couples who reside in the 33* states that do not recognize same-sex marriage will be required to file 2014 federal tax returns as other married couples but may be required to file state returns as individuals. There are currently 17states, plus the District of Columbia, that recognize same-sex marriage: Connecticut, California, Delaware, Hawaii, Illinois (effective 6/1/2014), Iowa, Maine, Maryland, Massachusetts, Minnesota, New Hampshire, New Jersey, New York, Rhode Island, Vermont, New Mexico and Washington.

As a result of these developments, same-sex couples who are married in a jurisdiction that recognizes same-sex marriages must now file as married filing jointly or married filing separately, rather than single or head of household. Same-sex couples should consider the benefits and/ or changes that come with the changing in filing status, including income tax bracket levels, the standard deduction, personal exemptions and adjusted gross income (AGI) amounts, which affect qualification for certain benefits. For higher income earners, filing jointly often puts them in the "marriage penalty" pool, where inevitably they pay more taxes than if they filed separately. A variety of factors come into play, including income floors and thresholds that affect a variety of tax breaks. It is recommended that couples consider both scenarios of filing jointly or separately to determine the most advantageous situation.

In terms of estate and gift taxation, there are many benefits that same-sex married couples can take advantage of, including the marital deduction, gift-splitting and the portability of a deceased spouse’s unused exemption amount. The marital deduction allows spouses to make unlimited lifetime gifts to their U.S. citizen spouses, as well as unlimited transfers at death, without incurring the gift or estate tax. As discussed below, the portability of a spouse’s unused exemption amount ($5.34 million in 2014) is also available for same-sex married couples. The impact of the changes for same-sex couples is significant employee benefits plans, and the timing of plan amendments will take time. While the Department of Labor’s statement that it will treat same-sex couples the same as opposite-sex couples is encouraging, lots of details have to be worked out. Benefit plans expected to be impacted include cafeteria plans, flexible spending accounts, health savings accounts, COBRA offerings, and beneficiary rights and beneficiary designations.

3.8% Surtax on Unearned Income

The 3.8% surtax on "unearned income" applies to individuals, trusts and estates. "Unearned income" is defined as investment income such as income from interest, dividends, annuities, royalties, capital gains and other passive income. Two conditions must be met for the 3.8% surtax to apply. First, the taxpayer must have investment income, and second, the taxpayer’s modified adjusted gross income (MAGI) must exceed the limits below, which are not indexed for inflation:

• $250,000 for taxpayers filing jointly
• $125,000 for taxpayers filing married filing separately
• $200,000 for other taxpayers

For purposes of the 3.8% surtax, the MAGI limitation is simply the taxpayer’s adjusted gross income (AGI) plus any excluded net foreign income. In general terms, AGI is the number at the bottom of the first page of a taxpayer’s 1040 (line 37).

If those two conditions are met, then the 3.8% surtax applies to the amount of the investment income, or if smaller, the difference between the taxpayer’s MAGI and the limits listed above. For example, if a single taxpayer has $10,000 of dividend income and MAGI of $205,000, then the 3.8% surtax applies to $5,000. If the same taxpayer had MAGI of $211,000, the 3.8% surtax would apply to $10,000.

The 3.8% surtax does not apply to distributions from tax-favored retirement plans such as IRAs or qualified plans, although distributions from tax-favored retirement plans may increase a taxpayer’s MAGI over the limits discussed above and thereby potentially expose investment income to the 3.8% surtax. In general terms, the 3.8% surtax does not apply to active trades or businesses conducted by a sole proprietor, S corporation or partnership, or to the gains and losses on the sale of active trades or businesses. However, working capital is not treated as being part of an active trade or business for purposes of the 3.8% surtax.

Estate Tax

Under ATRA 2012, the estate, gift and generation-skipping tax exemption equivalent amount is unified for all three transfer taxes and is permanently extended and indexed for inflation. The exemption amount for 2014 is $5,340,000. The maximum estate and gift tax rate in 2014 will be 40%.

ATRA 2012 also extended the concept of "portability," meaning that a surviving spouse may receive a deceased spouse’s unused exemption amount if the appropriate elections are made with the IRS.

For 2014 the unified credit, which is the amount of tax credit used to determine the exemption equivalent amount, is $2,081,800 for an exemption equivalent amount of $5,340,000.

For 2014, the annual gift tax exclusion will be $14,000 per person. The annual exclusion gift for non-citizen spouses will be $145,000.

The estate and gift tax rate table is depicted below. The generation-skipping transfer tax (GSTT) rate is the highest marginal estate tax rate of 40%.

The information provided in these web pages is based on internal and external sources believed reliable; however, the accuracy and completeness of the information is not guaranteed and the figures may have changed since the time of printing. Examples are hypothetical illustrations and not intended to reflect the actual performance of any particular security. Please consult your tax advisor for questions relating to your individual situation.