Community Property

March 13, 2024

787 / How does community property law affect the federal income tax treatment of dividends received from corporate stock?

<div class="Section1">If state law characterizes the income as community income (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="785">785</a>), the dividends are treated as having been received one-half by each spouse. This rule has been held to apply to dividend income received by a spouse as marital property under the Wisconsin Marital Property Act.<a href="#_ftn1" name="_ftnref1">1</a> If the dividends are characterized as separate property and the spouses file separate returns, each spouse reports his or her own separate income.<a href="#_ftn2" name="_ftnref2">2</a><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  Rev. Rul. 87-13, 1987-1 CB 20. <a href="#_ftnref2" name="_ftn2">2</a>.  IRS Pub. 555. </div></div>

March 13, 2024

788 / If spouses move from a community property state to a common law state, will their community property rights in the property they take with them be recognized and protected by the law of their new domicile?

<div class="Section1">Yes.<a href="#_ftn1" name="_ftnref1">1</a> Thus, if the spouses report their incomes separately, the income from the community property or from property into which the community property is traceable is reported by the spouses as belonging one-half to each.<a href="#_ftn2" name="_ftnref2">2</a> If income is community income, the deductions applicable to it must be taken one-half from each spouse’s portion if they file separately.<a href="#_ftn3" name="_ftnref3">3</a> But if community property is commingled with one spouse’s separate property so that the original community property cannot be traced, the income from the property must be reported as that spouse’s separate income, if the spouses file separately.<a href="#_ftn4" name="_ftnref4">4</a></div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. Johnson v. Commissioner, 7 BTA 820 (1927). <a href="#_ftnref2" name="_ftn2">2</a>. Phillips v. Commissioner, 9 BTA 153 (1927). <a href="#_ftnref3" name="_ftn3">3</a>. Stewart v. Commissioner, 95 F.2d 821 (5th Cir. 1938). <a href="#_ftnref4" name="_ftn4">4</a>. Johnson v. Commissioner, 1 TC 1041 (1943), appeal dismissed, 139 F.2d 491 (8th Cir. 1943). </div>

March 13, 2024

785 / How can community property law affect the federal income tax treatment of investment income?

<div class="Section1">Community property law applies in determining whether property and the income it produces is community property or separate property if (1) in the case of income from personal property, the spouses (or either spouse) is domiciled in a community property state; or (2) in the case of income from real property, the property is located in a community property state, regardless of the spouses’ domicile(s).<a href="#_ftn1" name="_ftnref1">1</a><div class="Section1"> In the states of Arizona, California, Nevada, New Mexico, and Washington, income from separate property is separate property of the spouse who owns the property. In the states of Idaho, Louisiana, and Texas, income from separate property is community property. (In Wisconsin, under the Marital Property Act, income from individual (separate) property is marital (community) property. For federal income tax purposes, the IRS has recognized that spouses’ rights under the Wisconsin Marital Property Act are community property rights.)<a href="#_ftn2" name="_ftnref2">2</a> In May 1998, Alaska adopted a wholly consensual community property statute, which allows married couples to select which assets are community property and which assets are to be held in some other form of ownership. Both resident and non-resident married couples may classify property as community property by transferring it to a community property trust which has been established under the provisions of the statute. In all community property states, the income from community property is, of course, community property. And in all states, spouses can have community property converted to separate property by partitioning or by making gifts or sales of their community interests in property. For federal income tax purposes, the distinctions between separate property and community property are important when the spouses file separate returns. The rules in all community property states for determining whether property is separate or community are quite similar. In general, separate property is (1) property owned by a spouse before marriage and brought into the marriage as such, (2) property acquired by a spouse by gift, will or inheritance during marriage, and (3) property exchanged for separate property or bought with separate funds during marriage. Once property is identified as separate property, it remains separate property as long as it can be traced. All other property is community property (i.e., property owned one-half by each spouse). Earnings of the spouses while domiciled in a community property state are community property. Property acquired during marriage with community funds is presumed to be community property even if title to the property is taken in the name of one spouse only. The presumption can be rebutted only by clear and convincing evidence that the spouses intended the property to be the separate property of the spouse who has title. The Tax Court held that a married couple’s marriage contract had the effect of stopping the application of Louisiana’s community property laws for federal income tax purposes, noting that, shortly before marrying, the couple “filed for registry” (in the parish where both of them resided) a marriage contract stating that “the intended husband and wife shall be separate in property.”<a href="#_ftn3" name="_ftnref3">3</a> In general, if property is bought partly with community funds and partly with separate funds, the property is partly community and partly separate in proportion to the source of the funds. If the property is bought with separate and community funds that have been so commingled that it is not known what part is separate and what part is community, the whole will probably be considered community, and consequently the property purchased will likewise be community. But see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="788">788</a> for a different effect of commingling when spouses move to a noncommunity property state. The IRS may disallow the benefits of any community property law to any taxpayer who acts as if he or she were solely entitled to certain income and failed to notify his or her spouse before the due date (including extensions) for filing the return for the taxable year in which the income was derived of the nature and amount of such income.<a href="#_ftn4" name="_ftnref4">4</a> In Service Center Advice, the Service stated that taxpayers domiciled in community property states have an undivided one-half interest in the entire community so that their filing status must be married filing jointly or, if married filing separately, their returns must each reflect one-half of the total community income and expenses. The Service must establish facts and evidence to demonstrate that IRC Section 66(b) applies (i.e., it may disregard community property laws where the spouse is not notified of community income).<a href="#_ftn5" name="_ftnref5">5</a> A California appeals court held that a spouse’s early retirement benefit must be characterized as community property where (1) the benefit is payable pursuant to a contract entered into during the marriage, and (2) the years of qualifying employment occurred before the parties’ separation.<a href="#_ftn6" name="_ftnref6">6</a> The Tax Court held that in a community property jurisdiction, the spouse of a distributee who did not receive a distribution from an IRA should not be treated as a distributee (under IRC Section 408(d)) despite whatever his or her community property interest in the IRA may have been under state law. Thus, under these circumstances, distributions are taxable to the distributee and the penalty tax (under IRC Section 72(t)) applies to the distributee spouse, only.<a href="#_ftn7" name="_ftnref7">7</a> The Tax Court also held that a taxpayer’s gross income from his continued employment—which he received in lieu of retirement benefits—did not include the amount of payments to which his former spouse was entitled under California community property law on the basis of the pension earned by the taxpayer. However, the appeals court reversed the Tax Court’s decision, holding that the fact that the taxpayer owed money to a creditor—in this case his former spouse—did not justify excluding any amount of his wages from income.<a href="#_ftn8" name="_ftnref8">8</a> For guidance on the classification for federal tax purposes of a qualified entity that is owned by two spouses as community property under the laws of a state, foreign country, or possession of the United States, see Revenue Ruling 2002-69.<a href="#_ftn9" name="_ftnref9">9</a> For more information, see IRS Publication 555, Federal Tax Information on Community Property. </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  Poe v. Seaborn, 282 U.S. 101 (1930); Boris I. Bittker, Federal Taxation of Income, Estates and Gifts (Boston: Warren, Gorham & Lamont, Inc., 2nd Ed., 1991) vol. 3, ¶ 76.2. <a href="#_ftnref2" name="_ftn2">2</a>.  Rev. Rul. 87-13, 1987-1 CB 20. <a href="#_ftnref3" name="_ftn3">3</a>.  Downing v. Commissioner, TC Memo 2003-347. <a href="#_ftnref4" name="_ftn4">4</a>.  IRC § 66(b). <a href="#_ftnref5" name="_ftn5">5</a>.  SCA 200030022. <a href="#_ftnref6" name="_ftn6">6</a>.  Drapeau v. Drapeau, 93 Cal. App. 4th 1086 (2001). <a href="#_ftnref7" name="_ftn7">7</a>.  See Morris v. Commissioner, TC Memo 2002-17, Bunney v. Commissioner, 114 TC 259 (2000). <a href="#_ftnref8" name="_ftn8">8</a>.  Commissioner v. Dunkin, 500 F.3d 1065 (9th Cir. 2007), reversing, 124 TC 180 (2005). <a href="#_ftnref9" name="_ftn9">9</a>.  2002-2 CB 760. </div></div>

March 13, 2024

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

<div class="Section1">Special rules apply when reporting certain community income of two individuals who are married to one another at any time during the calendar year, if all the following conditions exist:<div class="Section1"> (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.<a href="#_ftn1" name="_ftnref1">1</a> 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 <a href="javascript:void(0)" class="accordion-cross-reference" id="785">785</a>) 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.<a href="#_ftn2" name="_ftnref2">2</a> 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).<a href="#_ftn3" name="_ftnref3">3</a> The Service has released guidance for taxpayers seeking equitable innocent spouse relief under IRC Section 66(c).<a href="#_ftn4" name="_ftnref4">4</a> 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).<a href="#_ftn5" name="_ftnref5">5</a> 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).<a href="#_ftn6" name="_ftnref6">6</a> 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. </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC §§ 66(a), 879(a), 1402(a)(5). <a href="#_ftnref2" name="_ftn2">2</a>.  IRC § 66(a). <a href="#_ftnref3" name="_ftn3">3</a>.  IRC § 66(c). <a href="#_ftnref4" name="_ftn4">4</a>.  See Rev. Proc. 2003-61, 2003-2 CB 296, as superseded by Rev. Proc. 2013-34, 2013-43 IRB 397. <a href="#_ftnref5" name="_ftn5">5</a>.  Beck v. Commissioner, TC Memo 2001-198; revised acq., AOD CC-2002-05 (12-9-2002). <a href="#_ftnref6" name="_ftn6">6</a>.  Bernal v. Commissioner, 120 TC 102 (2003). </div></div>