Guest Blogger

Gay Tax Planning: Lowering Your Income Tax By Creating Artificial Losses

Filed By Guest Blogger | August 25, 2009 9:30 AM | comments

Filed in: Politics
Tags: IRS loopholes

Editors' Note: Guest blogger Gideon Alper publishes the Gay Couples Law Blog. gideonalperheadshot.jpgThe blog discusses new developments in same-sex family law and estate planning. He lives in Atlanta, Georgia, and you can email him at [email protected] or follow him on twitter.

In general, when someone loses money, they can use that amount to offset their income. That means they only have to pay taxes on the amount that their income exceeds their losses.

Now, imagine if you could create losses out of thin air. You then use the artificial losses to offset any income you receive.

Sound too good to be true? For most people, it is. But for same sex couples, it's another case where it can pay to be gay.

How it works:

People use one of two accounting methods: cash and accrual. Peter Pappas, a CPA and tax attorney that publishes the Tax Lawyer's Blog, has a nice summary of the differences between the two methods. The basic difference lies in when to recognize income and losses.

  • Cash method: you have income when someone pays you and have losses when you pay someone else.
  • Accrual method: you have income when someone owes you money and have losses when you owe someone else money.

Under the accrual method, you can have income even if you haven't actually received any money yet. Similarly, you can incur a loss even if you haven't actually paid anyone.

Individuals and businesses choose which accounting method they use. Most people use the cash method, and most businesses use the accrual method. Businesses using the accrual method often do transactions with individuals using the cash method.

So let's take a hypothetical married couple, Amy and Bob. Amy owns a business. Her business makes an obligation to make a deductible payment of $10,000 to Bob. No money actually changes hands--Amy's business now owes Bob $10,000.

Because Amy's business uses the accrual method of accounting, her business immediately recognizes a loss of $10,000. That's because her business recognizes losses when money is owed, not given.

But Bob, using the cash method, hasn't actually gotten any money. So Bob doesn't recognize any income. Since Amy and Bob pool all their money together anyway, Bob isn't ever going to make Amy's business actually pay him.

All of the sudden, Amy's business has a $10,000 loss to offset any income it has received. The loss isn't real--it's just on paper.

Unfortunately for Amy and Bob, the IRS won't let married heterosexual couples create losses out of thin air. Instead, because Amy and Bob are spouses, Amy's business can't recognize a loss until Bob recognizes the income.

But what if you're gay:

According to the IRS, gay couples, even if legally married, are unrelated. That means the IRS treats gay couples making this kind of transaction just like it treats a random business owing money to a random person.

With enough planning, gay couples could take advantage of this technique and create phantom losses whenever they want.

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Robert Ganshorn Robert Ganshorn | August 25, 2009 10:10 AM

Hooray Gideon!

I have often espoused the advantages of "S" corporations in Gay relationships. When we purchased a house in 1990 I surprised my better half by telling him that he, employed by our company, would make the full house payments. (the look on his face was priceless) I took no particular salary from our business as we built his taxable income going into the period when his Social Security could have only been enhanced by showing greater income. He was 6l at the time and I was 37. All our money was joint anyway, but this move increased his SSI nicely. He is now 80 years, one month and eight days old.

He hated paying extra taxes for those four years, but he saw the benefits many times over.

Good for you for taking advantage of the tax law, Robert. From my impressions with talking with people, many couples are just unaware of all the little things they can do to save exploit the IRS's non-recognition of gay relationships. I think with enough planning the benefits can be very substantial.

But what happens the following year? If my corporation claims a $10,000 obligation to my partner, wouldn't I have to then pay it the following year? When my partner recieved it, wouldn't they then have a $10,000 profit? That doesn't sound like creating losses out of nothing, that sounds like transfering income from one calendar year to another. Or if the IRS doesn't recognize our marriage and forces us to file seperately, transfering income from one partner in one year to the other partner the next year.

I suppose my corporation could never pay the obligation, but how many years would it be before that would be in violation of some kind of tax law?

In general, the business would obligate itself to pay the partner at some unspecified time. It would be a real obligation, but one that would never be paid assuming the partner doesn't sue the business for the amount.

The IRS assumes that, if the business and person it owes money were actually unrelated, then the person owed money would demand the business pay according to its obligation.

Of course, I have to add a disclaimer: this isn't my legal opinion, and you should talk to a tax attorney before relying on anything you read on the internet.

Feel free to email me with more questions about this or anything else. Hope I can help.