For years people have been trying to predict what the Supreme Court will do about same-sex marriage. That speculation has intensified now that the Supreme Court has decided to hear marriage cases originating in the 6th Circuit that upheld the state-level bans against same-sex marriage and recognition. How will the Supreme Court decide this crucial issue? In fact, it has already tipped its hand on the outcome. To understand why, you have to understand tax law.
Back in June of 2013, the Supreme Court held that for federal purposes it was impermissible to limit the term marriage to a man and a woman. In response, several circuit courts issued decisions recognizing same-sex marriage in the states under their jurisdictions. (The 6th Circuit was the only exception.) Some states sought review of these decisions, but the Supreme Court denied stays, which would have allowed the states to refuse to recognize the marriages until the Supreme Court made a final decision. Because the Supreme Court failed to issue stays, the states must perform and recognize same-sex marriages. In turn, this means the federal government will recognize couples living in those states as married for federal tax purposes. Being married also means that employers can provide certain benefits governed under tax laws to the employees who are now considered married. If the Supreme Court holds that the 6th Circuit is correct and states can both ban same-sex marriage and refuse to recognize out-of-state marriages, there will be large-scale tax problems for tens of thousands if not hundreds of thousands of taxpayers.
Justice Antonin Scalia articulated this exact tax problem as the next area of controversy in his dissent on same-sex marriage in Windsor. Yet when this controversy came before the Supreme Court this past October and November, the dissenting justices in Windsor did not dissent from the refusal to grant stays of Circuit Court decisions. Since the Supreme Court refused to address this issue several times, why has it now set itself up to punish taxpayers and employers who have been complying with the federal tax laws?
The current story begins on Nov. 6, 2014, when the 6th Circuit broke from the ranks of the 4th, 7th, 9th, and 10th circuits and decided that state-level bans on both same-sex marriage and official recognition of out-of-state marriages passed constitutional muster. On Nov. 14, 2014, parties challenging the marriage bans petitioned for review in the Supreme Court, and on Jan. 16, 2015, the Supreme Court decided to decide the issue.
There has been confusion over how to apply the 6th Circuit’s decision. For example, 300 or so same-sex marriages were performed in Michigan during the appeal of the District Court cases to the 6th Circuit. Michigan Attorney General Bill Schuette interpreted the Sixth Circuit’s decision to mean that these marriages were “void and cannot be recognized for any purposes.” This statement may be right, but it may be wrong. For the state of Michigan’s purposes, this may be a correct characterization of the way that the state treats these couples for purposes of inheritance, state taxes, and the like.
However, the IRS decided in Revenue Ruling 2013-17 that a couple would be married for federal tax purposes if the state of domicile recognized their marriage. We do not know what the status of these Michigan couples is for federal tax purposes. Are they married? The state did recognize the marriages at the time they were performed, but the state claims it does not recognize the marriages now. The prior IRS guidance does not address this situation.
Does this disparate tax treatment of couples in Michigan create a compelling reason why the Supreme Court should decide the case in favor of same-sex marriage? Schuette would argue no. He would say that to the extent that there are problems, they are finite and limited to a small number of couples. He is probably right. Remedial actions by the IRS for 300 taxpayers would not upset the entire apple cart.
A more interesting thought experiment about the importance of the tax ramifications of a Supreme Court decision is to consider what would happen if the Supreme Court decided that the 6th Circuit was correct. Couples that relied on their regional Circuit Court decisions for marriage recognition would no longer be married, and their marriages would not be recognized for federal income tax purposes. Under the current IRS ruling, they would not be treated as married in their state of domicile. Currently, without taking into account the pending 5th Circuit decision, this would mean residents of some 16 states would be affected.
What should these couples do? Nothing? Amend their prior returns? And what should their employers do? Did they improperly withhold or grant federal benefits? Unlike the problem posed by the small number of Michigan couples, the IRS would now be faced with questions relevant to hundreds of thousands of taxpayers. That is why the Supreme Court granted review of the 6th Circuit cases.
The practical effect of a Supreme Court decision agreeing with the 6th Circuit would be a seismic disruption and dislocation of the tax system. The justices are smart people; they deal with tax law nearly every year and even mentioned this tax problem in an earlier same-sex marriage case, so they presumably know this. It follows that the Supreme Court may have already decided it will not affirm the 6th Circuit.