California permit couples to file joint returns, which is easy – list all the income and expenses of both individuals on one return.
The federal government requires that each spouse file either as a single person or head of household, which means that domestic partners divide and report their income under community property rules; however, there are no lines on the federal tax return to indicate this division.
The problem arises when one spouse makes $100,000 and the other $15,000. Each is supposed to report $57,500 as income, but IRS computers expect to see W-2 income of $100,000 and $15,000 respectively.
The same issue occurs with Form 1099 information returns (usually independent contractor income) involving community property income.
Consequently, each individual needs to report the full amount of his or her W-2 and information returns on the appropriate lines, then make an adjustment to 50% of the total income for the couple.
Absent rules on how to report community property income and expenses on an individual return, it is probably wise to have a tax professional deal with the issue.
If you want to file yourself, consider making a positive or negative adjusting entry on Form 1040 line 21 (other income) with a statement “community property adjustment” in the explanation portion. Line 61 (federal income tax withheld) should contain the taxes withheld based on an equal division of credits.
There should be a schedule or disclosure form (Form 8275) attached to the back of the Form 1040 that contains the name and social security of the spouse and how the income and tax withholdings were divided between the two tax returns.
Each spouse should make the appropriate adjustment on line 21 (Note: one adjustment will usually be positive and the other negative) with the same explanations and calculations, but with the other spouse’s name and social security number.
Navigating through the community property rules and then matching up the income and credits on two separate tax returns is a royal pain. Remember, marital agreements may be used to overcome the community property presumption, but check with an experienced family law attorney first, since there could be negative ramifications upon separation or divorce.
The retroactive effective date may result in tax refunds for prior years, but you will need to file amended returns for those years to claim any refunds.