California Domestic Partners – Tax Issues, Part 1 of 2

Introduction

Last year, IRS ruled that California registered domestic partners and married same-sex couples must comply with community property laws.

Because federal law does not permit domestic partners to file a joint return, the ruling has caused complexity and confusion as to how federal tax returns should be prepared.

IRS Ruling

IRS specifically ruled that effective January 1, 2007:

1. A taxpayer must report on his individual federal income tax return one-half of the combined income: (a) that taxpayer and domestic partner earn from the performance of personal services; and (b) derived from their community property assets.

2. A taxpayer Is entitled to half of the credits for income tax withholding from the wages of taxpayer and domestic partner.

3. For gift tax purposes, one-half of taxpayer’s earnings is vested in his or her partner; there is not a transfer of property by gift to his or her partner.

The ruling did not require amended returns after 2006, although taxpayers should consider amending returns if advantageous. Also, the ruling did not specify how to report the split in income and credits.

Community Property

The concept of community property is deceptively simple: a married couple is treated as an equal partnership — 50% of the earnings of one spouse belong to the other and vice-versa.

There is a presumption that earnings from personal services generated during the marriage are community property. Couples may overcome the community property presumption through marital agreements.

Title to Assets

In general, the character of real property and financial accounts depends on how title is held. If the assets are in the name of only one of the partners, there is a presumption of separate property. Separate property is reported in full by the taxpayer who owns the asset.

For example, if a residence or rental real estate is owned by one partner, that partner would report all the income and deductions associated with the property.

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