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Saturday, January 15, 2011

NY Times: A Pyrrhic Same-Sex Tax Victory

New York Times, For Same-Sex Couples, a Tax Victory That Doesn’t Feel Like One:

A decision in May by the IRS that was hailed as a step toward equality for same-sex couples has instead become a headache for tens of thousands of gay and lesbian families in California. [IRS: California Registered Domestic Partners Can Split Income and Tax Withholding 50/50 Without Adverse Gift Tax Consequences]

Same-sex couples who are registered domestic partners — or who married during the brief legal window — are facing a new, more complicated tax status, one that has raised a litany of expensive concerns. Many of these families will now have to pay for professional help to file by April 15.

The issues involve an IRS decision that affects the three states with both community-property laws and same-sex marriage or registered domestic partnerships: California, Nevada and Washington.

Married heterosexual couples in those states have long had the option of filing their federal taxes separately and splitting their earned incomes (community property) on their tax returns. If one person makes more than the other, splitting can result in paying lower taxes by taking the higher earnings down a tax bracket or more.

After gay rights advocates fought for five years, the IRS decision let the same rules apply to legally partnered same-sex couples — an estimated 60,000 in California. ... But carrying out the change has proved challenging. ... Same-sex couples do not have the option of waiting for these issues to be resolved. The decision on income-splitting appears to be mandatory and immediate. “I do not believe taxpayers can choose whether to follow the income-splitting rule,” Patricia Cain, a law school professor at Santa Clara University and leading expert on same-sex tax law, recently wrote. ...

Confusing and costly tax returns are not the only fallout from the IRS change; the policy has set off a chain reaction of other concerns. In a report to Congress last week, the federal Taxpayer Advocate Service put the situation in its “most serious problems” category, saying the change could have many unintended consequences, like on student loan eligibility and tax credits for same-sex couples.

The more we look at these complications in the details of how to apply the rules, the more obvious it is that it would be much easier for everyone, especially the IRS, if same-sex spouses and RDPs were entitled to the same rules as similarly-situated opposite-sex spouses. Some have argued that these tax complications are likely to play a pivotal role in leading us closer to true equality for same-sex couples.

I made that point myself a couple of nights ago at a community seminar on the new tax law. I was joined by three expert tax-return preparers, Karen Stogdill, Deb Kinney, and Chris Kollaja,  who discussed a number of the complications.  If you're interested, you might take a look at the webcast:

This paper describes the federal tax treatment of California registered domestic partners (RDPs) historically and prospectively. In May 2010 the federal government issued guidance that materially revised the government's prior position of ignoring state law property characterizations and determined that 'the federal tax treatment of community property should apply to California registered domestic partners.' The paper discusses the tax implications of this guidance on registered domestic partners in California and other community property states as well as for the 18,000 same-sex married couples in California. The guidance moves RDPs closer to tax equality with opposite sex married couples in California. Nevertheless, the guidance leaves many questions unanswered.

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Comments

It's no surprise that the New York Times would print something so misleading. Of course "married heterosexual couples" can't just use income splitting whenever they please-- the Code and IRS rules impose punitive restrictions on "married filing separately" (MFS) taxpayers.

Treating same-sex domestic partners' income as community-property (and expenses, I presume) is essentially giving them income-splitting without the stiff penalties attached to MFS filings.

In nearly every case where same-sex domestic partners earn significantly different incomes, they will pay LESS in Federal income taxes than heterosexual married couples with identical incomes and expenses, because the same-sex partners will apply income-splitting but enjoy the other rules for single filers rather than the punitive rules for MFS filers.

Posted by: Two Things | Jan 15, 2011 2:56:01 PM

All "married heterosexual couples" who file as "married filing jointly" use income-splitting. ALL of them. That is what "married filing jointly" is-income splitting. Married filing separately is the opposite of income splitting.

Posted by: Correction | Jan 16, 2011 8:53:22 AM

"Correction," you are WRONG. Go look at IRS Pubs 501 and 555. MFJ is income summing, followed by application of MFJ brackets, standard-deduction or deduction rules, allowances, etc.

For married taxpayers in community property states (the ones of interest, including CA, WA, etc) MFS has income-splitting, but MFS taxpayers are NOT allowed the single deduction rules, allowances, etc. To quote Pub 501, "If you choose married filing separately as your filing status, the following special rules apply. Because of these special rules, you will usually pay more tax on a separate return than if you used another filing status that you qualify for."
See http://www.irs.gov/publications/p501/ar02.html#en_US_2010_publink1000220762

Homosexual registered domestic partners in the community property states have gained a huge tax benefit from the IRS' recent action.

Posted by: Two Things | Jan 16, 2011 10:18:39 AM