Financial Advisor

January 2008

With Gay Marriage Comes Gay Divorce


When it comes to finances, Stephen Mandeville and his partner are the kind of couple who cross their ‘t’s and dot their ‘i’s. They became domestic partners in New York—which also put Mandeville on his partner’s insurance at McGraw-Hill. They set up trusts in the names of relatives to cut their estate tax bill. They’ve made sure that all of their joint property is owned 50/50 so ownership is not in question should one of them die.

And now that they live in New Jersey, they plan on having a civil union ceremony, as soon as they find the time. They’ve planned for love, they’ve planned for sickness and they’ve planned for death. The one thing they will never plan for: divorce.

“Plan for divorce while we’re still in love? Never,” Mandeville says. “Why should we? We’re gay. We’re never getting divorced.”

He’s only half joking. But his sentiment is shared by many in the gay community. Yet financial planners warn that gay couples, more than their heterosexual counterparts, need to plan for divorce, or they may find themselves facing some hefty financial consequences.

“I don’t think straight couples need to do financial planning to anticipate divorce the way gay couples do,” says Frederick Hertz, an Oakland-based attorney who advises gay couples on marriage and divorce.

The main problem is that the federal government, as well as most states, does not recognize gay marriage. That means when a gay couple divorces, any cash, property or assets transferred between partners is considered a “gift” in the eyes of the Internal Revenue Service. And that means it can be taxed—though it’s unclear whether the giver or the receiver would have to pay it. Even alimony is considered a gift. For heterosexual couples, alimony is normally deductible for the person paying it and counted as income for the person on the receiving end. But neither person is taxed.

And the idea that gay marriages are somehow stronger than their heterosexual counterparts is probably not a good bet, financial planners say. “Recent data shows that 50% of all marriages end up in divorce at some point, so you have to assume at least a percentage of that will apply to gay couples,” says Susan Moore, a CFP licensee and president of Moore Financial Advisors LTD, in Watertown, Mass. “Here’s the issue: When they split, we may see asset transfers ordered by a court that would have been tax-free for a heterosexual couple but are not for gay couples.”

One can gift up to $12,000 a year. Anything over that would be taxed. There’s also a lifetime gift limit of $1 million. That means if one partner gives another a lump sum of $1 million in the divorce, they’ll have exhausted their lifetime gift exemption.

“The IRS has been asked to give private letter rulings on this, and they’ve refused,” Moore says. “So the question for planners becomes, ‘What can we do to avoid this?’ ”

The more a couple can do up front—while they’re still in love—the better, says Debra Neiman, a certified financial planner in Arlington, Mass., and author of Money Without Matrimony. Neiman says she knows documents take the romance out of the relationship, but it can save two people a lot of grief on the back end.

“We do retirement planning, tax planning and estate planning for gay couples, and the divorce rate nationally is 50%, and yet people don’t plan for that—even though your chances of getting a divorce is high and it would probably happen a lot sooner than retirement,” Neiman says.

Neiman says she had a lesbian couple as clients, where one woman was a stay-at-home mother and the other was the income earner. When the two decided to separate, they hammered out a divorce agreement that involved alimony and child support. But before signing it, one of the women called Neiman to make sure it was the right thing to do. Neiman explained to her the financial implications of signing the agreement, and the fact that she would be taxed on her alimony and child support payments. The woman decided not to sign the agreement, and the couple have now opted to separate rather than divorce.

“They got married in 2004, and they did not even think about what might happen if they divorced,” Neiman says.

In fact Julie and Hillary Goodridge, lead plaintiffs in the state’s landmark gay marriage case, decided to call it quits in July 2006 after two years of marriage, though they, too, opted for separation rather than divorce. Perhaps Julie Goodridge, president of an investment advisory firm, NorthStar Asset Management, and Hillary Goodridge, program director for the Unitarian Universalist Funding Program, realized divorce was far too costly and complicated.

“There’s been so much focus on gay marriage, but no one’s focused on what happens with gay divorce. And with the divorce rate at 50%, it will happen,” Neiman says.

While savvy financial planners can concoct creative loan arrangements so that alimony or other asset transfers are not viewed as gifts—when there’s a child, assets can be transferred as extra child support. But the better option, planners say, is for the couple to plan for divorce at the outset.

They can set up a family limited partnership, for instance, in which shares are transferred from one partner to the other. Or if one partner has a lot more wealth than the other, the rich partner could begin funding a second home for the poorer partner early on. That way, if the couple separates and the courts call for an equitable distribution of assets, one partner has already begun accumulating some of the other partner’s wealth. The point is, by transferring the assets from one partner to another slowly over time, at a rate that falls below the $12,000 gift limit, the transfer occurs without setting off a taxable event.

Attorney Hertz says he can’t emphasize enough the importance of gay couples equalizing their assets early on. Imagine that two men, Bill and Steve, decide to register as domestic partners in California, or have a civil union in New Jersey, and 10 years later, they divorce. Steve would be entitled to a big chunk of Bill’s money, Hertz says. But if the couple had planned for it, Bill could have bought a duplex in Steve’s name and let that asset grow over time. That way, when the assets are divvied up during the divorce proceedings, there’s already some property in Steve’s name, a piece of property that may have cost $250,000 to buy 10 years ago but is now worth $1 million, Hertz says.

But Hertz thinks the tax issue is just one reason gay couples need to begin talking about divorce. The other reason is that they need to get more educated—about the financial obligations of a marriage—so that they can understand the financial obligations of a divorce.

The straight community seems to have a better grasp of that, Hertz says. Maybe they’ve been through a divorce, or their friend went through one. Straight couples understand that if you break up, you may have to pay alimony. And worse, if one person has debts, their partner may now be subject to them. Gay couples have no such understanding, Hertz says.

“So when a gay couple gets divorced, there’s a kind of shock that I witness a lot,” Hertz says. “They say, ‘What do you mean that’s half his?’ ”

Part of the reason is that gay couples are not always as financial intertwined as their heterosexual counterparts, Hertz says. He suggests that if one were to talk to a random 25 straight couples, a very high percentage of them will have pooled their money, have joint accounts, make joint financial decisions. They function as a couple, or a family, which is what the marital laws impose on them. But if one talked to similarly situated gay couples, one would find a much higher degree of financial autonomy, Hertz says.

That’s not to say gay couples are immune to forking over assets prior to gay marriage. People have been suing each other in civil courts for what they believe is rightfully theirs for as long as courts have existed. But for the most part, if the party suing had no documentation to back up their claim, they usually lost.

Marital law, however, requires no such documentation, and such laws would apply for couples married in Massachusetts or Canada, or registered in Vermont, New Hampshire, Connecticut, New Jersey, Washington, California and Oregon. There are presumptions about shared assets that are imposed on couples without regard to title, Hertz says.

In California, for instance, if the source of the money is income earned after the two parties were registered, it is considered to be owned 50/50, regardless of whose name the bank account is in. The rules vary slightly from state to state, but in general, there’s a presumption of sharing, a presumption of duty, and if you don’t like it, you have to opt out of it—with a pre-nuptial arrangement.

The old way, there was a presumption of separateness, of individuality, and if you wanted to share, you had to opt in to sharing. The new way is where marital laws apply and there’s a presumption that the assets are shared, and if you don’t like it, you have to opt out—with a pre-nuptial arrangement,” Hertz says. “There’s been a complete reversal of the default rules.”

The truth is, with the federal government not recognizing same sex unions, gay marriage—from a strictly financial perspective—is a pretty bad deal, according to planners. It may be why most of the planners interviewed says only about half of their gay clients have decided to marry. In marriage, gay couples are lumbered with many of the obligations of a marriage while receiving few of the benefits.

Only in New Jersey is it more financially beneficial for a gay couple to marry rather than remain single. And that’s because of the state’s inheritance tax, which can be punitive, according to Jennifer Hatch, president of Christopher Street Financial, an investment advisory firm that serves the gay and lesbian community. In New Jersey, if anyone leaves anything to a non-linear family member—say a cousin, a neighbor or a gay partner—there is an inheritance tax of as much as 17%, almost from dollar one, Hatch says.

“You can leave someone $50,000, and you’ll get hit with this,” Hatch says. “For gay couples, if they have a civil union, they become next of kin and they don’t have to pay this tax.”

And while federal tax laws are generally more advantageous for heterosexual married couples than for those of the same sex, there’s one benefit to being married and gay, and it stems from the fact that the IRS doesn’t recognize gay marriage: The partners continue to file taxes as individuals. That means all of the caps afforded to individuals are retained, says Dana Levit, a CFP licensee in Newton, Mass., and president of PridePlanners Association, a nonprofit group that educates financial professionals on the needs of nontraditional families.

For instance, where married couples must combine their income when figuring out how much mortgage interest they can deduct—the interest deduction erodes for income above $150,000—gay couples filing as individuals will take longer to bump up against that threshold.

That’s no small matter. Deducting mortgage interest is one of the largest deductions most people can take. For someone who earns $50,000 a year and falls into the 30% tax bracket, for instance, a $5,000 mortgage interest deduction could save them $1,500 in taxes.

“This is where it’s a good thing to be gay,” Levit says. “Things that get phased out for joint filers just don’t apply.”