Monday, September 2, 2013

Colorado's "Civil Unionists" Get Some Welcome, If Partial, Clarification From the IRS

The U.S. government tax authorities this week gave a clarifying boost to Colorado's shared earning/shared parenting families in the choices they make in seeking to eliminate some of the tax discrimination they face.

The U.S. Department of Treasury and the Internal Revenue Service (the "IRS") released a ruling that "all legal same-sex marriages will be recognized [as marriages] for [federal] tax purposes." The ruling expressly does not apply to "registered domestic partnerships, civil unions or similar formal relationships recognized under state law."  While the ruling is directed at same-sex couples, it suggests that the IRS will regard heterosexual civil unions as not being marriages for federal tax purposes.

While the ruling does not completely clear up federal tax and benefits discrimination that applies to shared earning/shared parenting families, it does make it more visible that a hetero Colorado shared earning/shared parenting couple may find the benefits of using the new Colorado law to form a civil union and not a marriage outweigh the costs.  (If you are curious why shared earning/shared parenting families may prefer not being taxed as a marriage for federal tax purposes, I discuss that here and summarize some of the reasoning below in this post.)  For those couples already in a marriage, the process of converting to a civil union is difficult; you will want to consult with a specialist on those issues.

One caution: as I've mentioned elsewhere, this blog is intended to provide education on matters of broad public policy.  With regard to your own personal situation, I recommend looking at the particulars with your own advisor/counselor.

There are some benefits to being taxed as a marriage (ironically some of these apply more in the case of divorce) and all couples will want to weigh pros and cons of choosing a civil union over marriage taxation.  For couples setting up their families in the shared earning/shared parenting style the net effects over time tend to tilt toward at least beginning as a civil union and perhaps converting to a marriage only if circumstances later exist that marriage taxation is preferable.  (It appears that conversion from a civil union to a marriage can always be done later in the course of a relationship if a couple finds marriage taxation is preferable (the reverse, or conversion from a marriage to a civil union, as noted above, is a difficult process)).  Or some couples may want to stay in a civil union but use planning devices, such as joint property ownership or trusts, over the course of their marriage that will effectively get them the benefits of being federally taxed as a marriage without the costs.  Some experts who have counseled same sex couples have become quite adept with these methods.

Revenue Ruling 2013-17 and Colorado's Civil Unions Law

In earlier blog post here, I discussed the prior guidance the IRS had given on this issue.  This August 29, 2013 IRS ruling ("Revenue Ruling 2013-17") on same sex couples is much more information, because it has broad application, unlike the private letter ruling the IRS issued November 14, 2011, with regard to a heterosexual couple that had formed a civil union under Illinois' civil union law.  As noted by commentators, the 2011 ruling specifically cited the positioning of the Illinois civil union law.  The Illinois civil union law, unlike the Colorado civil union law, does not clearly differentiate a civil union from a marriage, and the 2011 IRS private letter ruling, which found that a heterosexual couple in a civil union was required to be taxed as a "marriage" at the federal level, was based on that lack of differentiation.

As I discussed here, the Colorado law differs from the Illinois law in several important respects, including that:

(1) The plain language of the Colorado's law expressly provides that "The provisions of this article shall not be construed to create a marriage between the parties to a civil union." (One caution: Colorado has a "common law" marriage statute, where a "marriage" is deemed to have occurred based on the parties' behavior, that participants to a civil union will need to avoid.)

(2) Colorado has a Constitutional amendment defining marriage that arguably works to render a civil union a different type of partnership that must be taxed individually.

Because Colorado's civil unions law does not (and cannot because of the Constitutional amendment) render a civil union equivalent to a marriage, it seems there is an argument that individual tax returns are possibly required, and at least an option.

From Colorado's heterosexual "civil unionists'" perspective, ideally we'd like to see two clarifications, however:

(a) We would like to see the IRS clearly state that this rule applies to heterosexual couples in the same manner as it states it applies to same-sex couples.

(b) We would like to see the Colorado legislature add clarifying language to the civil unions law to give express permission to parties to the civil union, especially hetero parties, to file individual tax returns.

Ideally, we would also like to see the Colorado legislature, or Colorado courts, clarify that the the Colorado "common law" marriage law does not apply to couples that have affirmatively chosen a civil union.

Even without these clarifications, however, it seems that some hetero Colorado shared earning/shared parenting couples may have little to lose, and much to gain, by using the new Colorado law and forming a civil union and not a marriage.

Why Does A Shared Earning/Shared Parenting Couple Want To Avoid Current Federal Marriage Taxation?

There are three problems with the way the U.S. government taxes marriage:

(a) There are currently "marriage tax penalties" for couples whose joint earnings fall below $30,000 per year or above $130,000 per year.  These penalties allow couples to save tax dollars, sometimes in significant amounts, by not marrying or by getting divorced. 

(b) There is a "stacking effect" problem where personal earnings of married couples are fictionally merged and each is deemed to have earned the income (or lack of income) of the other, including income or nonincome from that other partner's personal labor or other work.  Why does this matter if the marriage laws, and many couples themselves, consider family income to be earned for the whole family?  The problem is that this distorts the personal labor contributions of the partners in a manner that can have dramatic effects on the family over time, reducing its income, destabilizing it, and creating an environment that is not conducive to raising children.  Divorce is also more likely in families that suffer these distorting effects.  These distortions from the "stacking effect" occur because, upon marriage, the partner with lower earnings gets bumped up to the bracket of the partner with higher earnings, thus creating a "marriage tax penalty" for the lower earner.  The partner with the higher earnings gets bumped down to the lower earner's bracket (which can be zero if the other partner has no earnings), thus creating a "marriage bonus" for the higher earner.   This can have an accelerating effect over time, so that even if a couple starts out their marriage in neighboring brackets, the tax incentives to shift as much income as possible to one earner, such as by setting up a sole breadwinner/stay-at-home parent family, increasingly push them in that direction so that their brackets become as far apart as possible.

This is particularly an issue for peer couples because of the transfer payments they currently have to make to sole breadwinner families.  Even a peer couple that avoids this "stacking effect" by having relatively similar earnings and both being in the same bracket, still has to subsidize the "marriage bonuses" of couples who have the same basic family income but who use a sole breadwinner model.  A chart I posted here graphically illustrates this subsidy, which is effectively a transfer payment designed to encourage families not to do the shared earning/shared parenting model, despite its many benefits (and cost savings) to children, to the couples in these families and to society at large.  (In an upcoming post, I am planning to detail more of these benefits and cost savings.) Single/divorced people also have to make these subsidy payments.

The amount of this subsidy from peer couples (and single/divorced people) to couples that put all or most of their earnings on one partner can become quite substantial over time.  The Tax Policy Center describes these "marriage bonuses", reinforced by the tax reform done during George W. Bush presidency, as primary contributors to our federal deficit, because they were not entirely funded.   Mitt Romney's speech criticizing "the 47%" of people in the U.S. who pay no taxes could be seen as referring to him and his wife, because Ann Romney has never paid income taxes or payroll taxes.

(c) Social Security and Medicare, and the payroll taxes that fund them, are built around taxing people as individuals, but distributing benefits based on marital status.  An equal earning couple therefore pays in more and receives less back than a comparably earning sole breadwinner couple, as this chart illustrates.  These subsidies are also partially unfunded and are one reason the trust funds for these programs run deficits.  This problem is compounded by the effect that benefits in these programs are progressive (you receive more benefits relative to the taxes you pay if your income is lower), but only wages are taxed to support these programs.  Earnings from capital (such as dividends or capital gains) or property are not taxed.   This means that mid and high wage earners, particularly those who are single or are in two-earner marriages, do all the subsidizing of low-wage workers.  A company like Walmart, which employs low-wage workers on the sole breadwinner model, has used this system to great advantage, maximizing shareholder profit while shifting the costs of its employees' disability and retirement to mid and high wage workers outside the company.

The Current Picture For Shared Earning/Shared Parenting Families with Regard to "Civil Unions" in Colorado

The choice to form a civil union rather than a marriage thus seems likely to offer some if not many people in shared earning/shared parenting families substantial benefits, even if it does not remedy all the problems.   In the short term, a civil union appears that it will give such couples the ability to file as individuals on their federal returns, while allowing them the other benefits of legal "marriage" at the state level.  In the longer term, it may give them clearer means to seek remedy for the other discriminations as well.

The civil union law and the apparent individual filing option gives such couples:

(a) relief from any "marriage penalty" if their joint income is below $30,000 or above $130,000 (or if they anticipate they will be out of this zone for any significant portion of their married life);

(b) relief from the distortions of "stacking effect" problems and relief from a "marriage tax penalty" for the partner with lower earnings.  It does not give much relief from the required income or payroll tax subsidies to sole or heavily primary breadwinner families, although as noted below in (c), it may provide means for collective political action to end these required transfer payments.

(c) a means for "collective action" with regard to seeking an end to the sole breadwinner subsidies in the income tax code, Social Security and Medicare, including their contribution to the deficit in the United States.  The more couples who form "civil unions" in Colorado, the more visible the political protest becomes.  Colorado is exporting $0.22 of every federal tax dollar it pays, almost entirely to red states, and due in significant part to these sole breadwinner subsidies.  We lead the country in our ratio of female legislators (42%), have many mid and high-wage workers, and our economy will greatly benefit we can solve his problem of federal discrimination against the healthy, economically responsible shared earning/shared parenting families.