Community Property Rules Applies to California Registered Domestic Partners

If Domestic Partners file amended returns to take advantage of favorable treatment under this decision, one partner will owe more and the other will owe less. Does the IRS collect penalties and interest on the amount one partner owes after the recharacterization of community income? Given that this decision was not available until now, it would seem unfair to collect penalties from those of us who refile.

An excellent question. In this situation I would argue that the taxpayer has reasonable cause and therefore late-payment and interest penalties should be waived.

Thanks.

Any word yet on whether will apply to same sex married couples in California, or just registered domestic partners?
Thanks!

Elaine, the analysis laid out in CCA 201021050 applies assumes a situation in which two taxpayers are registered domestic partners in the state of California. Presumably the same logic applies to married couples, as married couples by default fall under California’s community property laws. So, I think the same IRS ruling applies equally to married couples. However that specific point was not mentioned in the ruling.

The rule goes back to tax year 2007 and says we may, but are not required to, file amended returns.

1. Do we get to choose which years (2007, 2008 and 2009)?

2. Does this type of ‘amended return’ have the 3 year time limit? (Do we have to amend the return for tax year 2007 which was filed April 15, 2008, by April 15, 2011?

So why is it that the IRS recognizes these relationships for tax purposes, but the Federal Government won’t? This seems blatantly wrong, to me, in that when it comes to collecting revenue, it matters, but when it comes to equal rights and recognition, it doesn’t. Something’s fishy in Washington.

There is a fly in the ointment regarding your response to Elaine. Unfortunately, the Defense of Marriage Act (DOMA) prevents recognition of same-sex marriages at the federal level. Residents of states that explicitly recognize same-sex marriages are actually at a disadvantage because of DOMA. A lawsuit from Massachusetts addresses the fundamental inequality of this tax situation, and is making its way through the court system–it will likely land on the docket of the U.S. Supreme Court. Until then, same-sex couples in states that allow “marriage” will not receive the tax advantages of the recent IRS ruling.

Good point, David. As I take it, this ruling is addressing the narrow issue of whether registered domestic partners are required to report community income and deductions for federal tax purposes under California’s community property laws. This ruling is saying, yes, California’s community property rules apply at the federal too. It’s an open question of whether other domestic partners or same-sex married couples in other community property states also must report their income using that method as well.

How does one actually go about filling out the tax forms for this? I assume we can’t just fill out the Married Filing Jointly forms (due to DOMA)- do we split everything in half and enter those amounts into filing as Single forms. Isn’t that likely to trigger an audit as none of the numbers will match the numbers expected by the IRS?

Are deductions also split in half? No one seems to mention deductions. A married couple would split the deductions if filing jointly but can domestic partners?

Jen, Publication 555 on the IRS Web site provides the general rules for applying the community property rules. The California Franchise Tax Board will be issuing an update to their publication 737 to explain how to go about reporting community property.

The general gist of these rules is that most income is “community income” (wages, interest, capital gains, etc.) and most deductions are community deductions. You total up community income and split in half. Each partner reports half on his or her federal return (using the single filing status, unless you qualify for the head of household status). Same with community deductions: total up and each partner reports half.

There are notable exceptions. Social Security, IRA distributions, IRA deductions and other types of income and expenses must be reported only for the individual person. These cannot be community property.

Another notable exception: if the partners have executed a valid agreement (say a pre-nup or post-nup) specifying that certain income, assets or deductions are “separate property” then that would override the community property rules.

As for the IRS’s expectations, well they are the ones who issued this ruling. You could write “filed pursuant to CCA 201021050″ at the top of the Form 1040. I plan to be filing these tax returns on paper with plenty of worksheets to show how I arrived at the numbers on the return.

In terms of filling in the federal tax forms, are federal and state taxes withheld also considered to be community property? In other words, should my husband and I indicate on our 1040 that we each paid 50% of our total taxes withheld, rather than the actual amount on our individual W2s?

Thanks for all the great advice so far. It’s been really helpful.

Thank you, that was extremely helpful!

Are pensions treated as community income or do they have to be reported separately like Social Security?

Debbie, I refer you to Publication 555 from the IRS, specifically the section on income. Distributions from IRA-type accounts are separate income. Some or all pension and 401(k) distributions might be community income.

This has been a very helpful article. Do you think it would be a good or bad idea to include the name and SSN of the RDP on accompanying worksheets, statements or explanations?

I’ve been intimately involved in this issue and the community property splitting rules are actually required for your 2010 tax return. The paragraph that you refer to mentioning the
June effective date is about amended returns. Steve Toomey the IRS Author of the CCA has confirmed it is required for 2010 tax returns. His phone # is at end of the actual CCA. Also it should apply to registered domestic partners and same sex married couples in California, Nevada and Washington state. They all have full community property rights. Also to straight couples who are rdps in CA (one person has to be age 62).

Thanks for your input, Karen, it is highly valued.

When filing a community partnership return, do you combine social security taxes withheld and divide that amount in half? Also, if one partner was eligible for ROTH IRA contributions for 2007, 2008 & 2009 and now is ineligible because of combining income, do you need to remove the contributions from the ROTH IRA?

Social security taxes that were withheld from either partner’s paycheck are generally not part of the federal income tax return. If one person is over-withheld because he or she worked at two or more jobs, then that person would be entitled to a refund of the overpaid Social Security tax. However I cannot find any reference to this specific situation on the IRS.gov web site. My best guess is that only the individual who was over-withheld would claim the tax credit, since the same would be true of married couples who filed separately. Please refer to the newly revised Publication 737 from California’s Franchise Tax Board for California-specific rules and Publication 555 from the IRS for federal-specific rules.

I’m curious how this community property rule will apply in the year we entered the California Registered Domestic Partnership. My understanding is that we will file a joint return for California income taxes, so all our wages for the entire year will be considered community property even though we have only been registered domestic partners for part of the year.

But what about the separate federal returns? Do we only average the income since our partnership was registered with the state or do we average the income for the entire year?

IRS Publication 555 says: “If you and your spouse file separate returns on which each of you reports half the community wages, each of you is entitled to credit for half the income tax withheld on those wages.” http://www.irs.gov/publications/p555/ar02.html#d0e776

I am retired with a pension, and thus not able to contribute to a Roth. My RDP is still working and able to contribute to a Roth because of earned income. Since I will now be required to report half of his earned income on my tax return, does that now allow me to contribute to a Roth IRA?

I’m confused by a paragraph in Publication 555 that addresses CA RDPs: “California domestic partners. If you are a registered domestic partner in California, the rules discussed in this publication for reporting community income do not apply to you. You must report all wages, salaries, and other compensation received for your personal services on your own return. Therefore, you cannot report half the combined income that you and your domestic partner earned as a married person filing separately does in California.”

So now I’m really confused. Do we have to file as community propery or not?

Publication 555 has not been updated since May 2007. That publication does not yet incorporate the Chief Counsel’s Advice mentioned above.

Yes,thank you, I noticed that after I posted. One last question…what form do we use? The regular 1040? And do we mark “Married but filing separately?” We aren’t technically married. And will they know we are claiming community property? Or is there a special form for this?

Thank you!

Catherine, the IRS has stated they will be updating Pub. 555 around Feb. 18 (today). Presumably, this will just remove the CA RDP restriction.

The regular 1040 will work just fine, but you do still need to mark “Single.” The best advice I’ve read is to mail your return and include a worksheet that details how you split the income. Also, staple W-2s from both partners on each return, and on the top of the return write that it was prepared according to the new ruling.

That’s one valid option, but TurboTax has just announced that they will be updating their product to deal with these changes. The ETA on this is March 10. You might want to wait for this, because this should give you the ability to e-file (and speed up your refund by several weeks), and it will likely reduce your chances of audit as well.

Good luck!

My parnter is the only one working in our household.I had no income to report for 2010. My daughter and I recieve our medical benefits through her employer. Under this new law would the medical benefits now be taxed due to me having to claim half her income? Am I no longer a dependent since I have to claim half of her wages? Could I now claim head of house hold since I am the biological mother and would now be reporting half of her wages? This seems like it would lower us into a significantly lower tax bracket. I would qualify for Earned Income Credit with my daughter. Would I be allowed to claim this also since I would be reporting half of her wages?

Jamie, the EIC would be based only on your own earned income. Your spouse’s wages that are allocated to you as community income won’t qualify you for EIC. EIC is one of four tax breaks where I’ve found that community property laws are disregarded. You may indeed qualify as HOH. You would not be a dependent of your spouse. The medical insurance benefits will continue to be taxable (at least federally) to your spouse, but the medical expense deduction for the premiums paid could be allocated as a community deduction.

I have created several documents that provide an overview of the community property questions raised in your comments. I would greatly appreciate your feedback, especially if a point or issue isn’t clearly explained. Community property rules for federal tax returns this is the main article with links to articles with further details.

The new Publication 555 is available. (Dated December 2010.)

http://www.irs.gov/pub/irs-pdf/p555.pdf

Nevada, Washington, and California domestic partners.
This publication is also for registered domestic partners (RDPs) who are domiciled in Nevada, Washington, or California and for individuals in California who, for state law purposes, are married to an individual of the same sex.

Thank you, this is the most helpful information I have found. I still have a lot of reading and calculating and number crunching to do, but hopefully will be able to figure it out. Our situation is that we both are self-employed so the whole Schedule C thing has my head spinning. As well as how to properly figure each of our SEP-IRA contribution. This would be SO MUCH easier if the IRS would let us file jointly. If it is true that TurboTax will have a version that works for CA RDPs in March, I may just have to dump the work we did in TaxAct and start over then.

Kathy, take a look at the new articles I posted above under the heading “updated articles.” I think these cover most of the questions you raise. Basically, each of you will have your own separate self-employment tax and SEP-IRA calculations based solely on your separate Schedule C income. I don’t think any software (including professional software) is designed to handle community property very well. I do all the allocating and splitting in a spreadsheet before preparing the returns in the software.

OK, I understand what you are saying regarding Schedule M (Making Work Pay Credit) and that it ignores community property allocations. However when I look at the form and instructions a little bit closer, it looks to me like for the Eligibility (Question 1A) on Schedule M that requires the worksheet to be filled out, ignores the community property allocation. It looks like Question #5 on this form is specifically asking about 1040 Line # 38, which would be 1/2 of the income theoretically. There is no where in the instructions where it says that this question #5 ignores the community property laws. Looks like it only applies to the worksheet, what do you think?

As follow-up to my previous question regarding Schedule M, Line #5, I called the IRS and got clarification. She told me to use whatever the amount is on Line 38 Form 1040. In my example this amount is 1/2 of the community property income, which makes me eligible for the full $400 Making Work Pay Credit. If I only included my separate income on this line (which turbo tax calculates – before their software update) I would only be eligible for $ 91 Credit. That’s a full difference of $ 309 extra Refund. Of course I took down her name and ID# in case I get audited, so wanted to share the good news!!

Very interesting, EdV. I see that now too. Not sure if that advice is correct or not, but it does sound hopeful.

William, you wrote that “Same with community deductions: total up and each partner reports half. There are notable exceptions. Social Security, IRA distributions, IRA deductions and other types of income and expenses must be reported only for the individual person. These cannot be community property.” I receive disability insurance income had federal tax w/h and received a related W-2. My partner was unemployed part of the year and received unemployment benefits with federal tax w/h with a related W-2. Would the income from both of these be split between us and the tax w/h or are either one another exception.

Jon, that’s a truly excellent question. I’ll look into it. Now the Social Security and IRA provisions for separate property, these I pulled out of the federal tax code. I’ll look to see if there’s any federal or state rules regarding unemployment benefits and disability insurance.

Here is an example of how the discrimination continues. My partner and I have been in the process ofgoing through a desolution of our registered domestic partnership throughout 2010. The last time we resided in the same residence was November 2009. Our desolution was not final until January 2011. If we had been a married heterosexual couple, we would not be required to combine and average our income and withholding if we had not lived together the previous year. Since we were a same sex couple, we are required to combine and average our incomes and withholding even if we have not lived together for the previous year.
What is the big deal? If you were my ex partner, nothing. You came out smelling like a rose. My ex , you see, did not have enough withheld from her salary. I on the otherhand, claimed zero deductions so, when I received my refund I would have a buffer to help me pay the mortgage on our house she walked away from. I am still in the house struggling to make my half and her half of the mortgage. My ex walked away after we had taken out equity to pay off her bills not once but twice. The amount of equity we took out to pay her bills $70,000. So, bottom line is I receive $5,000 less refund. This law needs to be changed.

I’ve managed to get most our returns figured out, but what do I do with the social security and medicare withholding amounts on our W2s? Since these figures don’t make its way to 1040s, I’m not sure it makes much difference to the IRS, but does this mean that my partner, who makes more than I do, will see his recorded SS contribution amounts, and therefore eventual benefits, drop, while mine go up? Or is Social Security dutifully recording the actual amounts that went into our accounts, and whatever I do with the figures on the W-2’s lines 4 and 6 is irrelevant?

I’ve contacted both the IRS and Social Security on this and have gotten conflicting answers and “I don’t know. That’s a good question”s. And all this is exacerbated by the fact that some of my income comes from self-employment, and therefore my Social Security contributions will be going down.

Help!

Simon, that is a good question. Basically, Social Security and Medicare taxes are paid individually (they’re not part of the community property). Your SS and Medicare taxes (including self-employment taxes) are paid by you and are based entirely on your salary and self-employed income. Your partner’s SS and Medicare taxes are paid separately and based entirely on your partner’s salary. Similarly for Social Security benefits: those will be calculated only on each person’s compensation without regard to community property laws. And when either of you begin receiving SS benefits, that will be classified as separate income even if you reside in a community property state at the time.

And as a side note, it seems to me your SS benefits would actually go up if you have additional income from self-employed enterprises, since you’ll have higher income and more tax paid in.

Question regarding student loan interest deduction. According to the publication, if your status is Married, Filing Separately you CANNOT take this deduction (Page 9). However, since I have to file Single – can I still take this deduction? is it community property – do I divide it in half?

Thanks William. I should add I have been researching too for the last two weeks and cannot find anything. I even called the number at the end of the IRS Memorandum #201021050 and the lawyers are out of the office until 3/30. Any help would be greatly appreciated !

My RDP and I live in Washington State. I have self-employment income and expenses. Questions:
1. I split the Schedule C net profit and report half on each return for income tax purposes, right?
2. Does the full self-employed 401K deduction (From 1040 Line 28) go on my return only…or is it split?
3. Does the full self-employment tax (Form 1040, Line 56) go on my return only…or is it split?
Thanks!

Regarding where to report income – I just spoke to an IRS representative about how to report community property income. She informed me that I should report my half of our community property income on Line 7. I have been reading some blogs and Turbo Tax’s instructions that say to report my income on Line 7 and then make an adjustment to that income on Line 21. I specifically asked if this was correct – after about 30 minutes of research she confirmed that according to the 1040 instructions in conjunction with PUB 555 – i should NOT make an adjustment on Line 21 – but should accurately report my half on Line 7 only. I would assume that this would apply to taxes and deductions as well…

Income (and any community adjustments to income) should, I believe, occur on the line of the tax return to which they relate. My reasoning is that different types of income have different tax treatments (for example, qualifying dividends are taxed at a different rate). However, if your only income is wages, then the correct place to put that is on Line 7.

Can you allocate the wihholdings on an amended return?

William: In comment No. 38, you write:
“I’ll look to see if there’s any federal or state rules regarding unemployment benefits and disability insurance.”
This was in regard to whether they are considered community income for a married or DP couple.
Did you find an answer?
Thanks.