786 / How is community income reported if spouses live apart?

(1)  The spouses live apart for the entire year;

(2)  The spouses do not file a joint return for a tax year beginning or ending within the calendar year;

(3)  Either or both spouses have earned income for the calendar year that is community income; and

(4)  The spouses have not transferred, directly or indirectly, any of their earned income between themselves before the end of the year.

If all these conditions exist, the spouses must report their community income as explained below.¹

Earned income. Earned income that is not trade or business or partnership income is treated as the income of the spouse who performed the personal services.

Trade or business income. Trade or business income and deductions attributable to such trade or business are treated as the gross income and deductions of the spouse carrying on such trade or business or, if such trade or business is jointly operated, treated as the gross income and deductions of each spouse on the basis of their respective distributive share of the gross income and deductions.

Partnership income or loss. A partner’s distributive share of partnership income or loss from a trade or business carried on by a partnership is the income or loss of the partner, and no part of it is his spouse’s.

Income from separate property. Community income derived from a spouse’s separate property (see Q 785) is treated as that spouse’s income.

All other community income. All other community income, such as dividends, interest, rents, royalties, or gains, is treated as provided in the applicable community property law.²

If an individual subject to the foregoing special rules (1) does not include in gross income an item of community income properly includable under the above rules in the other spouse’s gross income, and (2) establishes that he or she did not know of, and had no reason to know of, such item of community income, and the IRS determines that under the facts and circumstances it would be inequitable to include such item of community income in that individual’s income, then the income item will be includable in the other spouse’s gross income (rather than in the individual’s gross income).³ The Service has released guidance for taxpayers seeking equitable innocent spouse relief under IRC Section 66(c).⁴

The Tax Court held that it has authority to review the Service’s determination that a spouse is not entitled to equitable relief under IRC Section 66(c).⁵ The Tax Court also held that unlike IRC Section 6015(e) (which provides for equitable relief from liability for the understatement of tax), IRC Section 66 does not provide for jurisdiction permitting a taxpayer to file a “stand alone” petition in response to a denial of a request for relief made pursuant to IRC Section 66(c).⁶

For the treatment of community income in general, see Treasury Regulation Section 1.66-1. For the treatment of community income where spouses live apart, see Treasury Regulation Section 1.66-2. With respect to the denial of benefits of community property law where the spouse is not notified, see Treasury Regulation Section 1.66-3. For the rules governing the request for relief from the operation of community property law, see Treasury Regulation Section 1.66-4.