Same-Gender Married Couples in Utah May Now File Joint Income Tax Returns

This is an update to my original blog post on this subject.
A U.S. federal district judge ruled on December 20, 2013, that Utah's constitutional ban on same-sex marriage violates the U.S. constitution.  About 1,400 gay couples rushed to get married in Utah before the U.S. Supreme Court issued a stay on the district judge's ruling on January 6, 2014, pending an appeal.  The Utah governor announced that the state would not recognize the gay marriages performed during this brief time period, pending an appeal.  The Obama administration announced that the federal government would recognize these marriages.  To address the confusion of whether 2013 Utah income tax returns could be filed using a joint status, the Utah State Tax Commission issued an announcement on January 15, 2014 that reverses its earlier guidance referenced below.

Same-sex couples who are eligible to file a joint federal income tax return and who elect to file jointly, may also file a joint 2013 Utah individual income tax return.  Note that this announcement applies more broadly than to just those marrying in Utah in late December 2013.  It also appears to apply to couples legally married in other states.  Eligible married couples may file a joint return if they are married as of December 31, 2013.  The notice is expressly limited to the 2013 tax year.  It also mentions the possibility that taxpayers may be required to amend their 2013 tax return depending upon future court rulings.

Previously it was announced:
On October 9, 2013, the Utah State Tax Commission released a notice stating that same-sex couples in Utah must file a Utah income tax return with a filing status of single or head of household.  This guidance comes in light of an IRS ruling (Rev. Rul. 2013-17) that same-sex couples may file a joint Federal income tax return, no matter where they live, if their marriage is legally recognized in the state in which the marriage ceremony was performed.  Utah does not recognize same-sex marriages.  Those who are impacted by this notice must provide the same Federal income tax information on the Utah tax return that the taxpayer would have provided prior to the IRS ruling.  This means that another Federal income tax return must be prepared only for Utah tax purposes, using either a single (not married filing separately) or a head of household status.

Utah Health Insurance Marketplace Exchange

In Utah, the health insurance marketplace exchange is bifurcated in two.  The Federal government runs the individual exchange and the State government runs the small business exchange.  The Individual and Family Exchange is accessed at www.HealthCare.gov.  Select “Get Insurance” and then “Individuals & Families.”  Next choose Utah from the drop-down box.  The website won’t become active until October 1, 2013, but you can gather some general information at this point.  The individual mandate to have health insurance coverage or else pay a penalty begins January 1, 2014.

Because of the complexity in figuring out how to purchase health insurance on the exchange, and in determining whether financial subsidies apply for purchasing insurance, the Affordable Care Act created the concept of “navigators” to help with the application process.  Such assistance is particularly needed by those who haven’t had health insurance in the past.  The term “navigators” appears to have recently been changed to “marketplace assisters.”  Find help from navigators at https://localhelp.healthcare.gov/.  

The Utah small business exchange is called Avenue H and is accessed at www.avenueh.com.  The website is currently active.  A small business is one with 2 to 50 employees.  Avenue H provides a unique way for an employer to provide health insurance to its employees.  Rather than the employer purchasing a group plan for the employees, Avenue H is a “defined contribution” type of plan.  The employer provides a set amount of money that the employee controls and uses to purchase their choice of health insurance.  Employees can compare plans and premiums from different providers and apply for coverage online.  See the website for more details. 

The next several weeks and months will bring many changes into the health insurance marketplace.  In addition to the websites listed above, the IRS has a web page devoted to the Affordable Care Act at www.irs.gov/uac/Affordable-Care-Act-Tax-Provisions-Home.

Employer Notice Required by October 1, 2013, Regarding Health Insurance Marketplaces (Exchanges)

One of the key provisions of the Affordable Care Act (Obamacare) is the establishment of health insurance marketplace exchanges.  As originally contemplated, the States would each establish their own exchange.  But, the U.S. Supreme Court ruled that the Federal government couldn’t punish States that chose not to establish exchanges by withholding Federal Medicaid cost sharing payments.  Following the ruling, many States chose not to set up state-run exchanges.  The Federal government will establish and run exchanges in those States.  The government has recently been using the term “health insurance marketplaces” in place of the original term, “exchanges.”  The marketplaces are supposed to be up and running October 1, 2013 with policies beginning coverage as early as January 1, 2014. 

The ACA requires employers to give notice to all of their employees about the existence of marketplaces in their states.  All employees must be given the written notice regardless of health insurance plan enrollment status (if applicable) or of part‐time or full-time employment status.  The notice must be given to new employees within 14 days of starting work.  The notice is required even though an employer might not be a “large” employer subject to the employer health insurance mandate now postponed to 2015.  The notice requirement applies to employers subject to the Fair Labor Standards Act. 

If employees are not offered affordable, “bronze-level” health insurance benefits, they may go to the marketplaces to purchase health insurance.  Employees with household income of up to 400% of the Federal poverty level may receive tax subsidies to offset the cost of premiums.  The government is requiring employers to educate their employees about the marketplaces. 

The government has provided two model notices at www.dol.gov/ebsa/healthreform/.  You must select the proper notice.  The proper notice depends upon whether or not you, as the employer, currently offer health insurance to your employees.  The model notice is provided in “Word document” format so that you can complete it for your business. 

There is no financial penalty if you fail to provide the required notice in a timely manner.  Quoting from the DOL website at http://www.dol.gov/ebsa/faqs/faq-noticeofcoverageoptions.html,   “Q: Can an employer be fined for failing to provide employees with notice about the Affordable Care Act's new Health Insurance Marketplace?  A: No. If your company is covered by the Fair Labor Standards Act, it should provide a written notice to its employees about the Health Insurance Marketplace by October 1, 2013, but there is no fine or penalty under the law for failing to provide the notice.”

Avoiding Tax Problems with Shareholder—Corporation Loans

Owners of closely-held corporations will often either borrow money from the corporation or lend money to it.  Many times these arrangements are informal and not carefully documented.  In such cases it can appear as though the corporation’s bank account is functioning as if it were another personal account of the shareholder or vice versa.  These loose arrangements are problematic from an income tax point of view because the corporation and the shareholder are treated as distinct persons for tax purposes.

Poorly documented amounts borrowed from a corporation may be deemed instead by the IRS as a distribution.  For a C corporation, a deemed distribution is a dividend taxable to the shareholder and not deductible to the corporation.  For an S corporation, a deemed distribution may give rise to a potential second class of stock problem that could invalidate the S election, or perhaps the IRS might treat the deemed distribution as compensation subject to payroll taxes normally avoided by true S corporation distributions.

On the other hand, poorly documented amounts loaned to the corporation may be deemed instead by the IRS as a contribution to shareholder capital.  A contribution of capital cannot be repaid to the shareholder like a loan can be.  Instead repayments are treated as distributions to the shareholder with the applicable treatment depending upon the classification of the corporation.

In order to avoid these kinds of problems with shareholder—corporation loans, be sure to observe the following factors that have been considered by the courts when ruling on disputes between taxpayers and the IRS.  The main factor in determining whether the transaction is a loan for tax purposes is whether the parties intend for the money to be repaid.  Such intention should be contemporaneously evidenced as follows.

1.       Is there a promissory note or other written obligation promising repayment?

2.       Is adequate interest being charged?

3.       Has a fixed schedule for repayment and maturity date been established?

4.       Has collateral been given to secure repayment?

5.       Have repayments actually been made?

6.       Is there a reasonable prospect that the borrower can repay the loan?

Another factor to consider is this:  if the shareholder does not respect the separate existence and legal form of the corporation, will the corporate “veil” of limited liability be pierced if there is a third-party lawsuit, putting the shareholder’s personal assets at risk?

New “Simplified” Option for Deducting Home Office Expenses

Certain home office deductions are permitted for businesses run out of an individual’s home.  However, to be eligible for home office deductions, two basic requirements must be met:

1.     Regular and Exclusive Use:  You must regularly use part of your home exclusively for conducting business.  This test can be difficult to meet if the business part of your home isn’t separated from the personal part of your home such as by a door or by a separate structure.

2.     Principal Place of Your Business:  If business is conducted outside of your home, you can still qualify if you can show that you also use your home substantially and regularly to conduct business.  For example, you might have in-person meetings with clients or customers in the home.

The business home office deduction cannot exceed gross business income less other business expenses.  Any excess home office deduction can be carried over to the next year.

If you are not the business owner, but are an employee, then in addition to the above two tests, you must also meet the following two tests:

3.     Your business use must be for the convenience of your employer.  If the use of the home office is merely appropriate and helpful, you cannot deduct expenses for the business use of your home.

4.     You may not rent any part of your home to your employer and use the rented portion as the employee.

Starting with 2013 tax returns a new simplified option is available.  Instead of keeping track of actual expenses and prorating by the percentage of the square feet of your home used for business, a flat rate prescribed by the IRS multiplied by the business square footage can be used.  The simplified option does not change the above rules for qualifying for the home office deduction.  Rather, the method is like a standard deduction:  a $5.00 rate times up to 300 square feet (roughly 17 by 17 feet), or $1,500 is permitted.  You can choose each year to use either the regular or the simplified method.  Once selected, the method cannot be changed for that tax year.

Benefits of the simplified option include:

1.     Mortgage interest and real estate taxes can be deducted in full as itemized deductions.  They are not considered part of the $5.00 rate.

2.     The $5.00 rate is not considered to include home depreciation (and none may be claimed under the simplified option), so there is no depreciation recapture if you later sell your home.

3.     The $5.00 rate does not reduce other business deductions that are unrelated to the home.

Disadvantages of the simplified option include:

1.     The business square footage is limited to 300 square feet.

2.     Any excess home office deduction above business net income may not be carried over to the next tax year.

3.     No home depreciation deduction can be claimed.  If actual expenses are used in a later year, depreciation is computed using the optional depreciation table as if there had been no interruption in depreciation years.

4.     A carryover of unused home office deduction from an earlier tax year may not be claimed.

Despite the limitations imposed on the simplified option, some taxpayers may benefit from it.  More information can be obtained by referring to RevenueProcedure 2013-13, IRS Publication 587, or Form 8829.

Employer Health Insurance Mandate and Reporting Delayed

In a post on the White House blog on July 2, 2013, the Obama administration unexpectedly delayed the mandate for “large” employers to provide minimum essential, affordable health insurance to full-time employees.  According to the law, the mandate begins after 2013 with a noncompliance penalty assessed on a monthly basis.  How the executive branch can unilaterally change the effective date of enacted law is a question many commentators are asking.  Nevertheless, affected employers may appreciate the one-year enforcement delay to 2015.  The Deseret News (7/3/2013) reported that in Utah, 93% of large employers already provide health insurance to their employees, so the delay will have minimal impact in Utah.  The Administration cited the complexity of the law for the delay, but some commentators smell political motivations in light of the coming 2014 election when the mandate was originally to begin.  The delay of the employer mandate does not delay the individual mandate, the establishment of health insurance exchanges, or other provisions of the Affordable Care Act.

Also delayed to 2015 is the employer’s annual insurance information return.  This return was to identify each full-time employee and the number of months each employee was covered by an employer-sponsored health insurance plan and whether the employee’s share of premiums was “affordable.”  Not only would the information assist the IRS in penalizing employers that fail to meet the mandate’s requirements, the information is critical to the insurance exchanges.  The exchanges need the information to determine who qualifies for premium support tax credits.  On July 5, 2013, the Administration released new rules that also postpone to 2015 the requirement for exchanges to verify an applicant’s income and health insurance status before granting tax credits.  So for 2014, applicants are on the “honor system” in providing truthful information to the exchanges for purposes of calculating the amount of the tax credits.  Given these postponements and previous adjustments, we are beginning to see evidence of the oncoming “train wreck” described by Obamacare supporter and retiring Montana Democrat, Max Baucus, several months ago.

U.S. Supreme Court Rules Section 3 of DOMA Unconstitutional

The U.S. Supreme Court released the Edith Schlain Windsor case decision on June 26, 2013.  In a 5 to 4 decision, it held Section 3 of the Defense of Marriage Act (DOMA) unconstitutional under the Fifth Amendment to the U.S. Constitution providing for equal protection of persons.  DOMA was enacted in 1996 and Section 3 provided that Federal tax benefits for married persons were conditioned upon a legal marriage between one man and one woman.  The consequences of the decision will have far reaching implications for same-sex married couples.  The IRS announced on June 27, 2013 that it would act swiftly to provide guidance.

The Windsor case concerned the use of the unlimited marital estate tax deduction for the survivor of a same-sex married couple.  Ms. Windsor, as the widow, was denied the estate marital deduction.  She paid $363,053 of estate tax and sued for a refund and declaration that Section 3 of DOMA was unconstitutional.  A federal district court and the Court of Appeals (Second District) found in favor of the taxpayer.  Justice Kennedy wrote that while marriage law is within the province of the States, DOMA created unequal treatment of married couples within a state recognizing same-sex marriages.  For example, prior to this decision, a same-sex couple living in a state recognizing same-sex marriage was entitled to a joint state income tax return but had to file as two single persons for Federal tax purposes; whereas an opposite-sex married couple could file a joint Federal tax return.  Now it appears that a Federal joint income tax return is permitted, so both kinds of marriages would be entitled to have the same filing statuses apply.  Questions arise as to how to handle past tax returns, some of which may be closed by the three-year statute of limitations.  Some same-sex taxpayers may have filed protective refund claims to hold open the statute of limitations pending the outcome of this case.

Now legally married same-sex couples who are recognized as married for Federal tax purposes will enjoy the same tax benefits and suffer the same “marriage tax penalties” as opposite-sex married couples.  Each couple’s situation will differ and tax planning should be tailored to individual circumstances and personal goals.

There will also be implications to employee benefits.  These include:

1.     Spousal coverage under employer-provided health insurance.

2.     COBRA continuation of health insurance.

3.     Spousal right to pension plan joint and survivor annuities.

4.     Spousal consent to name a non-spouse beneficiary of a defined contribution retirement plan.

5.     Retirement plan and IRA minimum required distribution and rollover provisions.

6.     Qualified domestic relations orders (QDRO) for dividing retirement benefits in a divorce.

7.     Qualifying for exchange premium support credits under Obamacare.

How will this decision impact legally married same-sex couples who move to a state that does not recognize the marriage?  Will they be able to file joint Federal tax returns even though required to file single person state income tax returns?  Section 2 of DOMA was not before the Supreme Court.  Section 2 provides that states do not have to recognize same-sex marriages performed in other states.  Democrats have introduced the Respect of Marriage Act in the U.S. House of Representatives.  The Act is designed to repeal Section 2 and to require states that do not permit same-sex marriages to recognize same-sex marriages legally performed in other states.