By: Kathleen Pender
In a significant move for same-sex couples, the Internal Revenue Service has decided to recognize California’s community property law and treat the income earned by California registered domestic partners as community property income for federal income tax purposes.
The decision, which was issued in a private-letter ruling on Friday, reverses a position the IRS took in 2006, when it said California’s registered domestic partners should each report on their own federal tax return only the income they personally earned, not one-half of their community income.
The new decision does not require or even allow California’s registered domestic partners to file their federal tax return as married filing jointly or married filing separately, as they must do with their state tax returns. They must each still file a single federal return, but each should now report one-half of their community income.
Suppose one partner earns $100,000 and the other earns $60,000. In the past, each reported only the income he or she earned. In the future, each would report $80,000, which is half their combined income. Each would also be entitled to half of the combined income tax withheld from their paychecks.
Itemized deductions get messy, but in general any deductible expense paid with community property funds should be split between the partners, says Chris Kollaja, a San Francisco CPA.
The new ruling could reduce federal taxes for some domestic partners, especially if one has a very large income and the other has little or none. A couple in this situation could even pay less than a married couple filing a joint return, Kollaja says.
But the ruling could hurt some couples, especially if one partner qualified for federal tax credits or benefits or college financial aid available only to low-income people. With a higher income, this person could potentially lose some benefits, says Pan Haskins, an Oakland CPA.
Private-letter rulings are issued in response to a question from an unidentified taxpayer and can be relied on only by that individual. Although they do not have the same force as a public revenue ruling, “tax preparers all the time look at them to understand the view of the IRS,” says Don Read, a Berkeley tax attorney who requested this private ruling on behalf of a client.
The IRS reiterated its position in a chief counsel advice, a memo that provides guidance to IRS field personnel. The memo says, “For tax years beginning before June 1, 2010, registered domestic partners may, but are not required to, amend their returns to report income in accordance with this” memo.
“This gives registered domestic partners a real advantage for past years,” Read says, because they can pick and choose which years to amend.
However, if a couple pays a tax preparer, the cost of amending a return could exceed the tax savings, Haskins warns.
According to attorneys, the new ruling applies only to domestic partners registered with the California secretary of state. Couples can register only if both partners are the same sex or at least one is 62 or older. It is not clear how the ruling will affect gay couples who married in California when it was legal to do so but did not register as domestic partners.
Same-sex-marriage advocates welcomed the IRS decision. “It is a positive development,” says Jenny Pizer, an attorney with Lambda Legal.
State property law
But it does not mean the IRS or the federal government recognizes same-sex marriages. It means the IRS is recognizing state property laws, as it usually does.
“All they are doing is reconfirming law that exists,” says Jean Johnston, a San Francisco tax attorney.
That law says that in California, any income earned or assets acquired during a marriage, except for gifts and inheritances, is generally considered community property and equally owned by each spouse.
A state law that took effect in 2005 gave registered domestic partners most of the same community property rights as married couples. But it said earned income could not be treated as community property for state income taxes.
California later amended that law, and starting in 2007, it treated such income as community property for state income tax purposes. Since then, registered domestic partners have had to file their state tax returns like married couples.
The private-letter ruling asked whether the taxpayer must report on his individual federal return one-half of the combined income that he and his partner earned from both their jobs and their community property assets. The answer, essentially, was yes. It also stated that “the vesting of half of taxpayer’s earnings in his partner” would not result in federal gift tax.
In another chief counsel advice, the IRS said it would consider the assets of a California taxpayer’s registered domestic partner when determining the “reasonable collection potential of a taxpayer’s Offer In Compromise.” That could make it harder for one partner who is trying to settle a federal tax debt to pay less than the full amount because the IRS, when determining his or her ability to pay, would look at the other partner’s resources.
Source: San Francisco Chronicle