A memo issued by the IRS earlier this month clears up some lingering questions about community property laws and same-sex partners. Since this blog is for individuals and not other tax preparers, I’ll spare the details here. The upshot is this: Same-sex registered domestic partners who live in community property states (i.e. California) must now use community property rules when preparing their federal tax returns…even though they continue to be prohibited from using Married filing status. And they have the option to amend previously filed returns to use community property rules if it’s more advantageous.
(One additional note: the memo addresses a case involving Registered Domestic Partners specifically, and not same-sex spouses who married during one of the periods when same-sex marriage was allowed. Since the community property rules are the same for RDPs and same-sex married partners, presumably the reasoning applies equally in both cases.)
The legal justification pretty much works out like this: Established case law has upheld the principal that state law trumps federal law in areas of property ownership. Community property laws in states that recognize same-sex marriage dictate that income must be treated as equally earned by both spouses (unless it is derived from “separate property”, but that’s another discussion). Since property laws of states trump federal law, the IRS has determined that same-sex married couples must use community property laws. However, the Defense of Marriage Act declared that under Federal law only marriages between opposite sex partners are recognized, and (so far) there is no legal basis for state marriage laws trumping federal marriage laws. Therefore, the federal rule prohibiting same sex marriages applies for purposes of determining filing status even though it doesn’t matter for purposes of determining property (and therefore income) ownership.
On that note, I’ll share a brief political commentary. Funny how the conservative, “states’ rights” people don’t seem to have any problem with the Federal government telling states who can and can not marry even though the authority to define marriage at the Federal level is found nowhere in the Constitution. Just how ridiculously complicated are things going to have to get before certain people decide it’s best for the government to just stay the hell out of individuals’ relationship decisions?? But I digress…
So what does this latest IRS ruling mean for same-sex couples in community property states? Well, good news and bad news.
First, the bad news–doing your taxes just got a little more complicated than it already was. All of your income and many deductions and credits will now have to be adjusted so that they are equally split between both spouses. Two negative issues (besides the basic matter of increased complexity) may arise from this. First, same-sex partners can expect a lot of IRS letters attempting to “adjust” their returns as they report income, deductions, and withholding that do not match what is on forms reported to the government such as W-2’s and 1099’s. This will be an annoyance as same-sex couples will have to deal with additional unnecessary correspondence with the IRS to explain their tax calculations. Second, and more troubling, is the possibility some deductions and credits may only be allowed at a 50% level. As an example, let’s say one spouse is a student who qualifies for the Lifetime Learning credit on $8,000 of school expenses, which would be a $1600 credit. Under the latest rules, the IRS may determine that only $4,000 was paid by the spouse in school, and $4,000 paid by the spouse not in school. The spouse in school can claim a credit on only $4,000 in expenses, while the spouse not in school is ineligible to claim a credit at all due to not being a student and the spouse not being a “spouse” on the Federal return. This would be grossly unjust if the IRS rules this way, but there’s certainly room within the rules as they’re now being applied for the IRS to take this stance.
Now, the good news. In most cases, the community property rules will probably result in tax savings, especially for spouses with significantly different levels of income. The simple reason is that if two spouses are in different tax brackets, the community property rules effectively move some of the income from the higher tax bracket spouse to the lower tax bracket spouse. Furthermore, because same-sex spouses have the option, but not the obligation, to amend prior year returns, they can amend their returns in order to get additional money back, or choose not to amend if there’s no savings to be found. Not often does the IRS allow you to follow the law only when it’s in your favor, but this is one of those cases.
In summary, tax preparation just got a little more complicated for same-sex spouses, but I expect in most cases same-sex couples will see some tax savings as a result. Same-sex spouses should only do their own return if they are very well-versed in community property rules. But given the complexities involved, I definitely recommend same-sex partners seek out a tax advisor who is very knowledgeable about the unique taxation issues faced by same-sex spouses.