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Preparing Separate Tax Returns using Community Property Rules

Tips for preparing separate federal tax returns under community property rules

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Married couples who live in a community property state and who are filing separate tax federal returns will need to take some extra steps when preparing their federal return. The extra steps are not difficult. In fact, the extra steps will help ensure that you've addressed all the relevant pieces of information and will provide a cross-check so that you know your separate tax returns are complete. Here's how I go about preparing separate tax returns using the community property rules.

Draft out Both Tax Returns, Just Like Normal

First, I begin by drafting out each spouses tax returns using each spouse's information regarding income and deductions. From this draft return I pull out information about each spouse's eligibility for Traditional or Roth IRA contributions and their eligibility for the earned income credit and the Making Work Pay credit. These four items disregard community property allocations, so I address those tax breaks before I make any further analysis.

Create a Spreadsheet for Allocating Income and Deductions

Secondly, I build a spreadsheet. My spreadsheet shows each spouse's income and deductions by type. For example, a spreadsheet might show wages, interest, IRA distributions, mortgage interest and property tax deductions, and so forth. I transfer the totals from the tax return to the spreadsheet. Then in the spreadsheet, I further categorize the income or deductions as community property or separate property. I do this for each spouse.

From there, I find out the total income and deductions attributed to the marital community, and split these amounts in half. Next, for each spouse I add up their separate income and deductions plus half of the community income and deductions for each category of income or deduction. The spreadsheet thus calculates the totals that should appear on each line of the tax return. I then revise the draft tax returns so that each line on the tax return matches up with the community property analysis. You can use the allocation worksheet found on page 10 of Publication 555. However I find that this worksheet does not provide me with enough space to show all my math.

I also attach a copy of the spreadsheet with the two separate tax returns. The IRS recommends that such a spreadsheet be attached to the tax return. The spreadsheet should clearly identify each spouse by name and Social Security number, and show how each spouse's income was allocated.

To make the necessary adjustments, I revise each line item on the tax return. For example, for wages, I will input half the community wages and half the community withholding instead of inputting the actual figures of each W-2. You could also report the total amount and show an allocation to the other spouse. For example, on your Schedule B for interest you could list the spouse's various interest incomes, then add further notations to show interest allocated to or from the other spouse.

You May Need to Manually Recalculate Some Tax Items

After inputting various revisions, the tax software might recalculate the IRA deduction, Roth IRA eligibility, earned income credit, or Making Work Pay credit. I ignore these revised calculations and substitute the calculations from the draft tax return for these items.

You May Need to Mail in Your Tax Return for Manual Processing

In all probability, you will need to mail in your separate tax returns to the IRS for manual processing. During manual processing, IRS agents will ensure that each spouse receives proper credit for tax withholding and estimated payments. Be sure your tax return has all the information the IRS might need, such as your community property allocation worksheet, copies of each spouse's W-2 forms and other documents showing withholding.

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