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IRS Guidance on Tax Reporting for Community Property RDPs
September 19, 2011 at 10:08 AM
Today the IRS released a Q & A document addressing a number of questions that have been asked by same-sex couples in the three recognition community property states, California, Washington, and Nevada.
Here is a sample:
Q-1: How do registered domestic partners determine their gross income for 2010?
A-1: Registered domestic partners must each report half the combined community income earned by the partners. In addition to half of the community income, a partner who has income that is not community income must report that separate income.
Q-2: Can registered domestic partners or same-sex spouses whose marriage is recognized under state law file federal tax returns using a married filing jointly or married filing separately status?
A-2: No. Registered domestic partners cannot file using a married filing separately or jointly filing status, because they are not spouses as defined by federal law. Likewise, same-sex partners who are married under state law may not file using a married filing separately or jointly filing status because federal law does not treat same-sex partners as spouses.
Q-3: Can a registered domestic partner qualify to file his or her tax return using head-of-household filing status?
A-3: Generally, to qualify as a head-of-household, a taxpayer must provide more than half the cost of maintaining his or her household during the taxable year, and that household must be the principal place of abode of the taxpayer’s dependent for more than half of the taxable year. If registered domestic partners pay all of the costs of maintaining the household from community funds, each partner is considered to have incurred half the cost and neither can qualify as head of household. However, if one of the partners pays more than half by contributing separate funds, that partner may qualify as head-of-household.
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Q-6: If a child is a qualifying child under section 152(c) of both parents who are registered domestic partners, which parent may claim the child as a dependent?
A-6: If a child is a qualifying child under section 152(c) of both parents who are registered domestic partners, either parent, but not both, may claim a dependency deduction for the qualifying child. If both parents claim a dependency deduction for the child on their income tax returns, the IRS will treat the child as the qualifying child of the parent with whom the child resides for the longer period of time. If the child resides with each parent for the same amount of time during the taxable year, the IRS will treat the child as the qualifying child of the parent with the higher adjusted gross income.
Q-7: Is a registered domestic partner the stepparent of his or her partner’s child?
A-7: If a registered domestic partner is the stepparent of his or her partner’s child under the laws of the state in which the partners reside, then the registered domestic partner is the stepparent of the child for federal income tax purposes.
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Q-17: If a registered domestic partner adopts the child of his or her partner as a second parent or co-parent, may the adopting parent claim the adoption credit for the qualifying adoption expenses he or she pays or incurs to adopt the child?
A-17: The adopting parent may claim an adoption credit to the extent provided under § 36C. Section 36C(d)(1)(C) does not allow taxpayers to claim an adoption credit for expenses incurred in adopting the child of the taxpayer’s spouse. However, the limitation in section 36C(d)(1)(C) does not apply to adoptions by registered domestic partners because registered domestic partners are not spouses as defined by federal law.
Q-18: Do provisions such as section 66 (treatment of community income) and section 469(i)(5) (passive loss rules for rental real estate activities) that apply to married taxpayers apply to registered domestic partners?
A-18. No. Like other provisions of the federal tax law that apply only to spouses or married taxpayers, section 66 and section 469(i)(5) do not apply to registered domestic partners.
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Comments: There are no big surprises here. The document does contain an answer with which I disagree. The question (question #11) concerns the reporting of self-employment income, normally reported on Schedule C. The IRS position in this document is that each partner should report half of the income and deductions on separate Schedule Cs and then also report that half of the net income on each partner’s separate Schedule SE. The result, in this case, is that the earner will report only half of his or her earnings for social security purposes. Opposite sex spouses report this community income only on the Schedule SE of the earning spouse (although it is split for income tax purposes). For my thoughts about this issue see my post here. If the IRS persists in its current position, and I have every reason to believe that it will, then the only way to resolve this issue is through litigation.
Note also that the document does not consistently refer to same-sex spouses as it should. In California, same-sex spouses are subject to the state’s community property laws. Yet, under DOMA, they are not treated as spouses. Thus every time an answer says that RDPs cannot rely on certain rules (or, in the case of the adoption credit, they benefit from being excluded from the term “spouse”), that same rule should apply to same-sex spouses.
To view the entire IRS document, click here.
Consider an RDP with a single earner, who has a taxable income of $300,000 and an AMT income of $340,000 (because of the higher base, which I think is a typical differential). Prior to the ruling, the earner would have been liable for AMT of approximately $91,700. With the ability to split income equally, and have one member claim head of household status, as the IRS acknowledges, the AMT would no longer apply, and the combined regular tax is approximately $68,800, almost 25% less. A married couple with the same numbers would be in AMT, and would owe approximately $86,800 of federal income tax. Something seems seriously wrong here.
In California, moreover, heterosexual couples can elect RDP status if one member is over age 62. This suggests that relatively well off older couples, like my wife of 47 years and myself, should seriously think about divorcing and electing RDP status. Again, a strange anomaly.
The big disadvantage of no longer being married used to be the loss of the marital deduction under the estate tax. But with a $5M estate tax exemption, and community property rules resulting in half of the combined assets being excluded from the first decedent's estate, this seems much less of a problem than earlier.
On issues such as this I think a married couple should be treated the same as two single people. The alternative would be to repeal DOMA and treat RDPs the same as spouses for federal tax purposes. But that only extends an unjustified marriage penalty to more people.
My take on this is that the Schedule C income should show up on a Schedule C of the business manager and then should be split between the two partners on line 21 as a community income adjustment. I think it is earned income of the business manager and it is community income of the other partner, but not that person's earned income. As a result, I don't think the allocation should allow the partner to set up a retirement plan.
On the dependency issue, so long as both parents don't claim the same child, no problem. And if they do claim the same child, then the IRS will use the tie-break rules in Section 152 and assign the child to the parent who had custody more of the year (equal if they couple is still functioning as a single unit) or to the parent with the higher AGI (again, equal if all incoime is community). So, here I see a real problem.
