This is the first tax season in which many gay and lesbian couples will file federal income tax returns reflecting community property rules. The change affects tax returns for 2010, and also provides an opportunity (but not an obligation) to amend prior year tax returns if the result is a refund. Here are some questions and answers regarding the new filing requirement.
What caused this change?
A new analysis by the IRS, expressed in a legal memorandum (PDF) that became available in June 2010. The agency’s previous position was that gay and lesbian couples had to report their separate income on their federal income tax returns, even if they were subject to community property laws in the state where they lived. The new analysis, based in part on a change in California law that took effect in 2007, determined that the amount of income reflected on a federal income tax return must be determined in accordance with the way state law treats that income.
The memorandum cited above mentioned only California registered domestic partners. More recent guidance, including the IRS instructions for Form 1040-EZ (PDF), indicate that you’re affected if you live in a community property state that recognizes your same-sex marriage or partnership: registered domestic partners in California, Nevada and Washington, and married same-sex couples in California.
Does this mean these couples file joint returns?
No! Federal law does not recognize you as being married, so you have to file your federal income tax return as a non-married individual, even if state law permits or requires you to file a state income tax return as a married person.
Okay, so we each file as single?
Not necessarily. It’s possible one of you would qualify as a surviving widow(er) or head of household (see below).
Then how does this make a difference?
Although you’ll still file as a single individual, you and your partner or spouse will each report half the community income on each of your federal income tax returns.
Example: You earn $90,000 and your partner earns $30,000, all of the earnings being community income. Under the old IRS position, your tax return would report $90,000 of income and your partner’s return would report $30,000. Under the new approach, you and your partner will each file separate returns showing $60,000 of income.
So we simply add up all our income and divide by two?
Nothing in the world of taxation is that simple. Under the laws of your state, some of your income may be considered separate income, not community income. If you or your partner have separate income, that amount gets reported on the return of the recipient. These rules aren’t exactly the same in all states. For details on how to distinguish between community income and separate income see IRS Publication 555 (PDF).
Note: As of this writing, IRS Publication 555 has not been updated to reflect the new IRS position applying community property rules to same-sex couples, but you can use this publication for guidance on issues such as when income is or is not community income.
What about withholding?
For earnings that are community income, each partner reports half the income and each claims half the credit for withholding. See Publication 555, cited above, for an explanation of how to report this on your income tax return.
Slower refund: Your return may require an attachment that makes electronic filing impossible, delaying your refund if you have one coming.
Can one of us file as head of household?
The position taken by the IRS on income splitting for California domestic partners does not in itself prevent one partner from filing as head of household and the other from filing single. You would have to meet all the requirements for head of household, however, including providing more than half the cost of maintaining a home. Expenses paid with community income are deemed paid equally by both partners, so if community income is used to pay the cost of maintaining a home, the IRS may take the view that each partner paid exactly half the cost, and therefore neither one paid more than half the cost, which is required for this favorable filing status. You may be able to avoid this result by having a partner who otherwise qualifies as a head of household pay some portion of the cost of maintaining the home from separate (non-community) funds, assuming any such funds are available.
When do these rules take effect?
The IRS memorandum cited above seemed to say the new approach would be optional for the 2010 tax year, but subsequent guidance (such as form instructions) indicate that the it’s mandatory. The memorandum is clear, however, in saying that amendment of prior year returns to apply the new approach is optional: you can do this if it would save money (producing a refund) but you don’t have to do this if it would make no difference, or if it would produce a tax increase.
Really? What if one partner amends and the other doesn’t?
Apparently the IRS didn’t think about that before publishing the memorandum. It simply says taxpayers are permitted but not required to amend prior year returns. If you read that literally, partners could take inconsistent positions.
Example: In 2009, one partner earned $100,000 and the other earned $20,000. In accordance with IRS rules then in effect, each filed a return reporting his own income. According to the IRS memorandum, the one who reported $100,000 can file an amended return showing only $60,000, half of the community income. It isn’t clear that the other partner would then be required to amend as well, showing a $40,000 increase in income.
Note: Even assuming both partners amend, so that one has a decrease in income and the other has an increase, the overall effect may be a reduction in the total tax.
Alert: Tax practitioners should take care to raise the possibility of amending prior year returns with affected clients, early enough to take action before April 15, when the statute of limitations will expire for amending most income tax returns for tax year 2007.
Can we expect more guidance from the IRS to clarify these issues?
Don’t hold your breath. Initially they seemed eager to provide more information, but after they realized how many difficult issues needed to be resolved, they changed their response to “no comment.”