Smith, Burnett & Hagerman, LLC

The Cohabitation Penalty

The U. S. Supreme Court in 2015 made same-sex marriages on par equal with heterosexual marriages in all states (Obergefell etal v Hodges, Director, Ohio Department of Health, etal, decided June 26, 2015).

Some states allowed such marriages prior to Obergefell. Kansas did not and has not changed its state law. Nor did we recognize same sex marriages as legal if performed in a state that legalized the practice. Kansans adhered to the more traditional one-man one-woman marriage. Obergefell will change that for Kansas, however. Our personal "views" may not change just because the Supreme Court has spoken, but the law will change.

However, what about changing the "cohabitation penalty" for the heterosexual man and woman who have lived together for two decades?

The cohabitation penalty involves the estate tax. Larger estates pay a 40% estate tax above certain "exemption" limits (currently $11.5 million). Most of us will never have to pay Uncle Sam an estate tax.

However, an unmarried heterosexual couple do not get benefit of the marital exemption for estate tax purposes. It also means they don't have benefit of "portability" (allowing your $11.5 million exemption to become a $23 million exemption for the second "spouse.")

Revenue Rulings 2013-17 indicate that if persons (whether same sex or heterosexual) are spouses for income tax purposes depends on the law of the state where they reside as to whether they allow such "marriages," or whether they recognize valid marriages in other states between same sex couples. That was before Obergefell. A heterosexual couple who obtains a common law marriage designation somewhere in the country would be "spouses" in Kansas under Obergefell and presumably entitled to the marital exemption.

But what about two people who live together long-term who never got a legal marriage and do not consider themselves common law spouses? This could include long-term live-together same sex couples, too.

The marital exemption is striking. Regardless of the size of the estate, a surviving spouse gets the entire estate of the first-to-die spouse without any tax. The estate could be worth billions, but it is untaxed to the first spouse to die. Notice the presence of the word 'spouse.' That's the marital exemption -- meaning it is available to spouses and is now available to heterosexual and same sex "spouses." Unmarried persons can give land and property to an unmarried partner by Will or by Trust document, but there is no marital exemption to an unmarried partner when it comes to taxes paid. The property can come to the unmarried heterosexual partner, but the exemption is the decedent's—and it is limited to $11.5 million. That nonmarital relationship can end up being a multimillion-dollar mistake.

The logical question is why do we care, when there are few estates in Kansas exceeding $11.5 million? The "Tax Cuts and Jobs Act of 2017" which raised the estate tax threshold to $11.5 million has a nasty little sunset clause. The bill says that by 2025, if Congress doesn't make the law permanent, the $11.5 million reverts back to $5.4 million. That will bite into many decent sized Kansas family farms and businesses.

Who knows how kindly the Congress will feel towards each other in 2025, the last year they can act before the January 1, 2026 sunset date strikes?

And there would have to be significant estate planning done using revocable trusts and jointly owned property in order to avoid some estate taxes if the estate is more than $5.4 million and the couples are unmarried.
One way around the limit, to obtain the marital deduction and portability would be if the unmarried heterosexual partner could prove a common law marriage. The children of the deceased's first marriage may, or may not, have a good relationship with the current spouse. If the relationship isn't so good, the kids may fight the common law marriage claim. The IRS prefers large estates and small exemptions in order to kick in the 40% estate tax.
There are many reasons long-term live-together couples do not marry nor hold themselves out as married for "common law" purposes. But with gay and lesbian couples now able to take advantage of marital property laws and resulting tax benefits, the cohabitation penalty may be something to think about—and avoid if possible—through estate planning. As it is now, Americans with wealth are penalized for cohabitation if they don't marry. Given that the Old Order is ending, is the penalty any longer wise policy?