On March 4, 2004 I posted the following question on the Queer Law discussion board
Joe H. answers:
You have already discussed the federal estate tax, but not the income tax.
One minor correction. The estate tax exemption amount for 2004 is $1.5 million. That amount inches up until it becomes an unlimited amount in 2010, but in 2011 and thereafter (unless the tax cuts are made permanent) it falls back to $1 million. This exemption can be left to anyone.
In addition to the $1.5 million exemption, you can leave an unlimited amount to your spouse free of the estate tax (if you are straight, that is; gay marriages, even when legal under your state law don't count for federal tax purposes, because of the Defense of Marriage Act). That unlimited amount is called the "marital deduction" in tax vernacular. The value of a retirement plan is subject to the estate tax, unless it is part of the $1.5 million exemption or is left to a spouse.
The estate tax is paid at the time of death or shortly thereafter.
Retirement plan contributions for which the decedent was allowed an income tax deduction (such as 401k's) and income earned on contributions (including income earned on nondeductible contributions to traditional IRAs, but not Roth IRAs) are also subject to the income tax when amounts are withdrawn from the retirement plan. As explained below, the law specifies when you must withdraw the amounts, and that's where it becomes unfair for gay couples.
Now this is where it gets complicated. A surviving spouse who is the beneficiary (i.e., the person designated as the beneficiary of the plan) of a deceased spouse's retirement plan has the option of "rolling" the inherited retirement plan into the surviving spouse's own IRA. A surviving spouse may be able to delay distributions for years, thus deferring the income tax for a long time.
Non-spouses who are beneficiaries of a retirement plan must receive the full amount remaining in the plan over the life expectancy of the surviving non-spouse or, if the decedent was already receiving distributions, then at least as quickly as the method used by the decedent.
If the retirement plan had no beneficiary (i.e., it passed under the decedent's will or by intestacy, because the decedent never got around to designating a beneficiary), then the full amount must be distributed within five years or, if the decedent had already begun his distributions, then over the decedent's remaining life expectancy. (What? A deceased person sill has a life expectancy!? Well, um, yes. That's why actuaries make so much money.)
It's even trickier if the retirement plan specified the method to be used to make distributions.
The bottom line is that surviving spouses get treated much better under the federal tax laws than surviving domestic partners, especially if the surviving spouse is still young at the death of his/her spouse.
I'm not an expert on the taxation of retirement plans. It is extremely complicated, and the above is only a cursory overview that omits many important details that could drastically alter the tax result. You also have to contend with the tax laws of your state.
There are several books on the subject of estate and financial planning for gay couples. I haven't read any of them, so I can't make recommendations. They cover wills, powers of attorney, partnership agreements, insurance, retirement plans, etc. Of all the issues, I think retirement plans are the most complicated, followed closely by insurance.
ÓCopyright 2004 by Joe H. Reprinted with permission for informational and non-profit purposes only. The writer adds that that “it is only a general overview and readers should consult their tax advisers for specific advice.”
Another reader wrote in that a legally married couple can set up a marital trust to pass on amounts over the maximum that this can be passed onto another subsequent heir starting over with the tax exemption.
Still another reader writes this in about the 401K problem: (slightly paraphrased)
The same-sex partner has to start taking distributions from the 401(k) (or, I believe, IRA) account by the end of the year following the year in which the participant died; otherwise he must close the account within five years after the end of the year in which the participant died. But the heterosexual married partner does not have to start taking distributions until the year in which the participant would have reached age 70½. In addition, the heterosexual married partner can roll over the inherited 401(k) to an IRA; the same-sex partner cannot.
Again, please see a tax adviser or attorney for specifics.