How to Avoid Extra Taxes When Clients Avoid Marriage

Joint tenancies are "very convenient" for unmarried couples because when one partner dies, property ownership transfers to the survivor. However, if each partner doesn't contribute equally to assets held in the joint tenancy, it could trigger a gift tax. Furthermore, when one partner to a joint tenancy dies, the survivor will be treated as having owned 100% of that property unless they can prove otherwise "with clear and convincing evidence."

"This isn't a problem unless there's a taxable estate," Goffe said, "but if there is a taxable estate, […] it is important to either contribute jointly and have good documentation, or to have good documentation and have the account refunded so you don't inadvertently create multiple layers of tax."

Employee Benefits, ERISA Rules

Some employers may extend benefits to unmarried employees' partners in domestic partnerships or civil unions. Unlike married couples, though, the benefits can be counted in taxable income, Goffe said. Furthermore, employees can't use pretax dollars to pay for a domestic partner's coverage, or use HSA and FSA funds to pay for a domestic partner's medical expenses unless that person is a dependent.

"ERISA generally does not recognize an unmarried partner as entitled to benefits the way [it] would a spouse," Goffe said.

As of 2008, non-spouses are allowed to roll assets inherited from a qualified retirement plan into an inherited IRA on a tax-free basis, Goffe said, including some 403(b) and 457 plans.

A qualified domestic relations order is a court order to split retirement plan assets between partners, but it doesn't apply to unmarried partners.

"There are some very limited exceptions to that for an alternate payee, but other than that, it's not clear whether a plan can be amended to recognize any sort of order outside of marriage," Goffe said.

Continuation health coverage under COBRA does not extend to an unmarried partner, though it does cover dependent children, Goffe said. Some state COBRA plans may offer broader coverage.

Social Security recognizes unmarried couples as individuals, rather than couples, Goffe said. A person may inherit benefits from their partner if the state they live in recognizes them as a couple.

Regarding unmarried veterans, "some inroads have been made to find certain benefits not subject to marriage requirements," Goffe said, including "the transfer of post 9/11 GI Bill education benefits to dependents, participation in various group life insurance programs for veterans, and survivor and dependent education assistance."

"Granted these are very narrow benefits, but better than nothing," she said.

She added that in some cases, the secretary of the Veterans Administration may allow people in "committed relationships" with servicemembers to be buried in a VA cemetery.

Servicemembers who received a dishonorable discharge for violating the Don't Ask Don't Tell policy may apply for an upgrade to their discharge papers, Goffe said.

"Many of our unmarried clients were discharged for violating Don't Ask Don't Tell and otherwise had a very good service record. This can be turned around," she said.

Ultimately, "nobody should rely on default statutes," Goffe warned, as "responsibility or the right to inherit may fall to their sibling, their children, their parents, but not their partner."

Goffe recommends that advisors take into account the possibility that their unmarried clients may decide to get married later when they're drafting wills and other agreements.

"It's a couple of extra sentences in a will, and it makes all the difference in avoiding tax on the transfer from one spouse to the other," she said.

She also warned that advisors take care to define terms like "partner" in documentation to make sure that they apply to the person they're meant to. For example, if "partner" is defined in a will as "the person living with me at the time of my death," but the client dies in an assisted living facility or nursing home, they may run into trouble.