The Unintended Tax Advantages of Gay Marriage

I. Introduction"[Tax is] a field beset with invisible boomerangs."1The Internal Revenue Code (the "Code") contains some 250 special rules applicable to the income taxation of spouses, parents, children, or closely-held businesses and other persons related by marriage, birth, adoption, or ownership.2 The average taxpayer is most likely to encounter the rules that authorize married couples to file joint returns3 and allow individuals to deduct personal exemptions for dependents;4 these two rules, however, are but the small tip of a very large iceberg. The collective importance of related-party provisions to the federal income tax system is hard to overstate.Given the importance of these rules, it is unfortunate that tax theory lacks a broadly productive way of thinking about them. Tax scholars have instead developed multiple modes of analysis, each intended to deal with a different part of the problem. One approach, used primarily to explore issues of rate structure, attempts to identify the proper "taxable unit."5 Is it the individual, the couple, or the family? Framed at this level of abstraction, however, the question resists clear resolution. It also fails to provide coherent answers to a myriad of urgent practical questions outside the rate structure context: "If I pay for W's hospitalization, will my costs be deductible?" "If I sell property at a loss to X, will my loss be disallowed?" "If Y buys my debt from my creditor at a discount, will I have debt discharge income?" "Must I take Z's income into account in determining whether I am eligible for the earned income credit?"Under current law, the class of individuals for whom the answer is "Yes" to each of the foregoing questions is different. Section 213(a) of the Internal Revenue Code allows the taxpayer a deduction for the expenses of medical care for her spouse or dependents.6 Section 267(a)(1) disallows taxpayer's losses on sales to her siblings, half-siblings, spouse, ancestors, or lineal descendants. Section 108(e)(4) requires taxpayer to recognize debt discharge income if her debt is purchased by her spouse, children, grandchildren, parents, or the spouse of any of her children or grandchildren.8 Section 32, finally, only requires that taxpayer take her spouse's income into account in computing adjusted gross income for earned income credit purposes.9 There is no uniformly defined taxable unit, nor does such a uniform definition seem likely.Sometimes theorists ask a narrower but related question: "Does the U.S. income tax system impose a penalty on marriage?"10 The phrase "marriage penalty" normally refers only to apparent rate anomalies that result from marriage. As a result, this line of inquiry typically does not address the many other negative income tax consequences of marriage, nor does it address the tax consequences of other close interpersonal or business relationships.11A third way of thinking about related-party problems, which I will call the "benefits and burdens of ownership" approach, focuses on the economic substance of property relationships:[Taxpayers, through sales and exchanges between related parties and entities, [can] easily manipulate the federal income tax regime by creating gain or loss without substantially changing their economic position with respect to the underlying properties. Taxpayers, through transactions with related parties or controlled entities, [can] technically realign their property ownership while effectively maintaining the benefits and burdens of the same property. For example, a husband [can] realize a loss upon the sale of property to his wife, but the benefits and burdens of ownership . . . remain within the family unit. Such transactions [can] be motivated solely to reduce overall taxation, without any real economic change in the taxpayer 's property holdings.12The House committee report on the bill that introduced the predecessor to Section 26713 stated: "These transactions [between 'various legal entities owned by the same person or persons'] seem to occur at moments remarkably opportune to the real party in interest in reducing his tax liability, but, at the same time allowing him to keep substantial control of the assets being traded or exchanged. …