Protective 2008 refund claim for RDP's and SSM's

[appelman]

In view of the unsettled situation in the courts, I was wondering whether anyone in this forum was thinking of filing a protective refund claim for 2008 for RDP's and same-sex marriages. If so, I'd be interested to know how you might be planning to proceed.

[Gary2]

It's certainly something I'm tracking for myself as well as any potential clients. Each case is different, and you need to review all the issues with both parties.

In many cases, it won't be an improvement. The most common, significant tax issue (at least on the separate-property east coast) is imputed income due to health insurance and other benefits. This isn't as common as one might expect, because often it's cheaper for the two people to get individual coverage than to get family coverage through one partner (especially if there are no other dependents). Presumably people will have to amend their federal filing status to get the benefits, which raises the question of whether or not they even want to file a joint return, and if not, whether they're still better off amending to MFS without the imputed income versus leaving things alone.

Another interesting question is what happens if one partner chooses to amend from single to MFS while the other refuses, or if only one chooses to file the protective claim. I have no idea what the IRS (or possibly court) would do with this scenario. I think the choices are either to live with the anomaly for the few years in question, or prohibit the amendment by one spouse unless the other follows suit.

Finally, people who filed in states that didn't recognize SSM in those years will need to consider the impact on their state returns. While I don't foresee (in my totally personal, inexpert opinion) that any decision in the next few years will require all states to recognize SSM, many state tax laws are written with reference to federal filing status, and thus would automatically incorporate a change at the federal level. Theoretically, a federal amendment could compel a state amendment, which then raises a separate legal question with regard to the statute of limitations, if only a federal protective claim was filed.

The mechanics of filing a protective claim are discussed towards the beginning of Pub. 17. I suggest consulting the actual rules and regulations, just to be sure of the process. I believe that specific cases must be identified, in which case Gill is the obvious front runner, though there are a handful of others. Make sure citation is correct. And, as with any protective claim, make sure the taxpayers understand the implication with regard to the statute of limitations.

[appelman]

Thanks, Gary,

That's much to think about. My clients are in CA, so community property law makes MS/MJ pretty much a non-issue. And I wonder if you do need to cite a particular case, or even want to do so. A sleeper case could always come up after the statute of limitations would have run out.

[joanmcq]

I'm filing for clients who got married in 2008 (I'm in CA as well), but since RDP is not the same as 'married', I don't think a protective claim will work for a couple who did not get married in the window. It's one of my projects for November/December....but hasn't gotten started yet. I have some clients that would not benefit; usually when one of them is retired and is getting social security, but have quite a few that would benefit greatly.

[Gary2]

Correct, I don't see any benefits for RDPs. It's even questionable whether civil unions (e.g., NJ) would have any federal tax changes.

[appelman]

Well, my clients are actually married.

However, RDP's have, I believe, essentially all of the rights of marrieds in CA, including non-taxability of employer-provided medical benefits, which is where the real tax benefit is. The IRS does not make a distinction between SSM's and RDP's, e.g. in terms of the new rulings applying community property law. Since we don't know just how things will shake out, it's hard to predict, but it seems reasonable to me that RDP's and SSM's could be swept up together in whatever rulings come down.

A complication I foresee with one of my clients is that they are better off NOT applying community property laws to their 2008 returns. Only one of the spouses is a wage earner with medical benefits in play. What would happen if I only file the protective claim for that spouse? I really feel like I'm working blind here!

[Gary2]

However, RDP's have, I believe, essentially all of the rights of marrieds in CA, including non-taxability of employer-provided medical benefits, which is where the real tax benefit is. The IRS does not make a distinction between SSM's and RDP's, e.g. in terms of the new rulings applying community property law. Since we don't know just how things will shake out, it's hard to predict, but it seems reasonable to me that RDP's and SSM's could be swept up together in whatever rulings come down.

A complication I foresee with one of my clients is that they are better off NOT applying community property laws to their 2008 returns. Only one of the spouses is a wage earner with medical benefits in play. What would happen if I only file the protective claim for that spouse? I really feel like I'm working blind here!

I don't see how the RDP could create non-taxability of employer medical benefits at the federal level.

The community property decision is a result of applying state property ownership laws. The IRS doesn't apply DOMA because the federal law that determines who's taxed on income under state's community property laws doesn't explicitly reference marriage or spouses. But the federal law saying that medical benefits aren't taxable does. That doesn't mean that RDPs shouldn't file protective claims - but I wouldn't without a much stronger reason.

You're right that the question of what happens if only one spouse files a protective claim is a wide open legal question. It's conceivable that it's come up before with regard to an ordinary MFS filing and subsequent protective claim, but it seems unlikely to have been litigated. (Example: A couple files MFS, each claiming standard deduction. One of them is audited, the SOL is extended beyond the three years as a result, and then amends to itemize after the SOL has expired on the other spouse. With no fraud or significant understatement, can the IRS force the other spouse to itemize?)

There will be cases, probably many, where both spouses choose to refile as MFS, with one getting a refund and the other owing, but a net gain overall. The penalties on the return that owes should be waived (no promises, obviously - but factor the cost of getting them waived into your plans). The interest won't be waived, but should be offset by the interest paid on the other refund. (And yeah, the former isn't deductible but the latter is taxable.) I expect that most tax advisers will recommend that both spouses file in this case, precisely because of the legal black hole described in the previous paragraph.

Aside: Massachusetts will tax, as imputed income, employer-provided health insurance paid to an unmarried domestic partner. This has burned many a couple who reasoned "We don't need to get married; my company already pays health insurance."

[joanmcq]

I won't file any of my couples as MFS; the benefit would come from allowing MFJ, from deducting the medical from the federal wages to the higher tax brackets for my couples that have highly disparate incomes. For CA clients, since we've been preparing the proforma joint federal returns to complete the CA return, it's an easy exercise to determine if a protective claim is beneficial.

[appelman]

One or two protective claims?

Joan, are you thinking of one protective claim for each spouse or a joint protective claim? The latter strikes me as risky, since it is possible that the courts might, for example, allow non-taxability of family medical benefits but not address the question of whether the spouses must file as single.

[joanmcq]

If DOMA is struck down, I believe married is married, and protective claims would allow MFJ. I first read about protective claims being filed in MA, since they were the first state to recognize SS marriage and that is currently the state where the issue is being litigated.

[appelman]

And so?

Are you filing a joint claim or two separate ones? Since you don't have to use a 1040X, I would think you could do it either way. And I still think the separate claims would allow more flexibility.

[joanmcq]

How are you doing it if not on a 1040X?...Never mind, I did a search and saw Form 843.

[Gary2]

I don't know that either 1040X or 843 is specifically required, though I recall being advised to use 1040X with "Protective claim under such-and-such regulation" across the top. Regardless of which form, Pub. 17 says to file at the address that would normally be used for filing the 1040X.

My inclination would be to file two separate claims, to ensure that it's treated as a claim by each party on their own behalf, but for each one to include, as part of the claim, the right to file as either MFS or MFJ with such and such person. At this point, the mechanics exceed my experience, so I suggest researching elsewhere to be sure. I don't know if there's an advantage or disadvantage to identifying specific code sections and/or including a sweeping claim (e.g. asserting any and all rights that may result from a judgment finding such and such section of law to be unconstitutional).

[appelman]

Thank you both...

For lots to think about.

[joanmcq]

I'll be citing the MA case as the basis for the protective claim.