Paul L. Caron

Wednesday, June 2, 2010

IRS: California Registered Domestic Partners Can Split Income and Tax Withholding 50/50 Without Adverse Gift Tax Consequences

IRS Logo The IRS on May 28 issued three important rulings dealing with tax issues faced by same-sex couples who are registered domestic partners under California law.

Priv. Ltr. Rul. 201021048 (May 5, 2010):

  1. Taxpayer must report on his individual federal income tax return one-half of the combined income that Taxpayer and Domestic Partner earn from the performance of personal services and one-half of the combined income derived from their community property assets.
  2. Taxpayer is entitled to half of the credits for income tax withholding from the wages of Taxpayer and Domestic Partner.
  3. The requirement under California law to treat Taxpayer’s earnings as community property, and thus half of Taxpayer’s earnings as vested in his partner, does not result in a transfer of property by Taxpayer to his partner for federal gift tax purposes under § 2501.

Chief Counsel Advice 201021050 (May 5, 2010):

On February 24, 2006, the Office of Associate Chief Counsel (Income Tax & Accounting) issued Chief Counsel Advice (CCA) 200608038 concluding that an individual who is a registered domestic partner in California must report all of his or her income earned from the performance of personal services. In light of a change to California law, effective in 2007, you asked us whether California registered domestic partners should each report half of the community income on their federal returns. You also asked whether individuals who filed returns in accordance with CCA 200608038 must amend those returns. ...

By 2007, California had extended full community property treatment to registered domestic partners. Applying the principle that federal law respects state law property characterizations, the federal tax treatment of community property should apply to California registered domestic partners. Consequently, for tax years beginning after December 31, 2006, a California registered domestic partner must report one-half of the community income, whether received in the form of compensation for personal services or income from property, on his or her federal income tax return.

You also asked how to treat a registered domestic partner who reported all of his or her earned income in accordance with CCA 200608038. For tax years beginning before June 1, 2010, registered domestic partners may, but are not required to, amend their returns to report income in accordance with this CCA.

Chief Counsel Advice 201021049 (May 5, 2010):

[T]he IRS can consider the assets of the taxpayer's registered domestic partner in the State of California when determining whether to accept the taxpayer's Offer in Compromise under § 7122. State law determines whether there is a property interest, ... and California state law provides that both domestic partners have an equal interest and liability in the community property.

(Hat Tip: Pat Cain, Ann Murphy.)

Update: Theodore P. Seto (Loyola-L.A.):

The headline understates the significance of the IRS's new position:

The IRS will apply Poe v. Seaborn to California registered domestic partners for all federal tax purposes from 2007 on. The positions distinguish CCA 200608038 on the ground that California had not, at the time, applied its mandatory community property rules for state income tax purposes. Since it has now done so, Poe v Seaborn rules.

The consequence, as I have pointed out elsewhere, is that "married" gay couples in California are now taxed at substantially lower effective rates than similarly situated heterosexual couples or than similarly situated same-sex couples in other states. See The Unintended Tax Advantages of Gay Marriage, 65 Wash. & Lee L. Rev. 1529 (2008).

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a tax-preparer and former IRS auditor friend of mine had this to say:

Remember that this is a PRIVATE letter ruling and applies only to the taxpayer that applied for it--no one else. It is an indication that change may come but it hasn't come yet. I wouldn't advise any same sex couple to file a joint return as it would be begging for trouble.

Posted by: anonymous | Jun 24, 2010 3:28:57 PM

The IRS ruling is wrong.
I couldn’t disagree more with the premise of your article. The IRS ruling hurts domestic partners not helps them.
It forces Domestic Partners to file their tax returns in a way that may not be beneficial to them.
Currently the IRS refuses to allow Domestic Partners to file as married. In all other relationship/business ownership cases the IRS uses State property and ownership laws for Federal income tax purposes. In California’s case that means the only legal entity the IRS recognizes for Domestic Partners is as partners in a partnership. Under California law partnerships do not have to be written, and income and expenses can be allocated by partners by agreement. Under this premise the IRS ruling is non-sense and should/will be overturned.
Some of the more than 100 harms that ALWAYS requiring splitting all the joint income in half will contribute to:
1) Low income parents will lose grants and scholarships based on their income for their children in college.
2) Income from dividends and interest cannot be allocated to the lower income partner resulting in higher taxes.
3) Expenses for the payment of the mortgage and property taxes cannot be allocated to the higher income partner who actually made the payments. In other words the IRS now is trying to say that Domestic Partners must file as single - yet refuses to allow them to take their mortgage interest deduction which they made 100%.
4) Self employed persons with spouses that get health coverage for them will have their health benefits taxed 100% on one partner’s Federal return and o% deductable on the other partners return. In other words the IRS wins both ways and the taxpayers lose both ways.
The IRS ruling is twisted and illogical. It only benefits Domestic Partnerships where one partner is rich and the other a stay at home partner. For over 90% of Domestic Partners it will hurt them. Note the 90% figure is my estimate based on over 30 years of income tax preparation.
My only hope is that the IRS having really messed up its rulings will have to recognize the marriages as marriages and put all this nonsense to rest.
Sorry but posting must be anonymous to protect me and my clients from IRS retaliation.

Posted by: anonymous | Jun 18, 2010 4:12:00 PM

I live in Texas which is a community property state. If my partner and I registered as domestic partners in California, which does not require residency in California, would this new ruling also apply to us?

Posted by: Richard Werner | Jun 10, 2010 2:00:17 PM

With regard to this PLR...
1) Is this applicable to all RDPs or just the one that filed that PLR?

2 ) If it is applicable to all, would you suggest having RDP's file a post-nup, separate property agreement by 7/1/10?

3)Would the federal taxes rates be for MFS, and other items be MFS like itemized deductions, Cap Loss limitations etc?If so, would filing the post-nup nullify this, and allow filing the 1040 as single?

4)What other ramifications do you see? What should be done?

Posted by: HLCPA | Jun 9, 2010 11:48:16 AM

Ron, to avoid the risks associated with sexually transmitted diseases, I would suggest that you go f*@# yourself.

Posted by: Carlton Van Nostrand | Jun 8, 2010 1:37:51 PM

Ron: that is probably the stupidest argument your bigotry could ever make for your position.

Posted by: Sam | Jun 7, 2010 12:09:27 PM

Woody, that wouldn't do any good. In order to get this preferential tax treatment, you need to have a domestic partner.

Can heterosexuals obtain domestic partner status? If both people are decently-compensated professionals, it has a pretty good tax advantage compared to being married or single.

Posted by: anon | Jun 5, 2010 3:38:04 AM

The Ninth Circuit Court of Appeals says that California domestic partners are not "married." See Smelt v. County of Orange, 447 F.3d 673. DOMA applies to married couples. The big question is whether these rulings would apply to married same sex couples.

Posted by: Stu | Jun 3, 2010 8:22:08 PM

To avoid these conflicting tax issues, there's a way around them - simply marry someone of the opposite sex.

Posted by: Woody | Jun 3, 2010 2:50:26 PM

At the risk of appearing overly sensitive, the CA Supreme Court has ruled definitively that I'm married, not "married". I'm not sure if the quote marks were for emphasis or distinction, but the courts have held there is none of the latter.

Posted by: Ron | Jun 3, 2010 7:23:04 AM

Actually, this ruling complies with DOMA and state property law in the only way it can. When my partner earns $100, I am by California law entitled to $50 of it. It's my property, my income. DOMA says we can't be taxed jointly (since that would of course be the end of Western civilization) but doesn't overrule the allocation of income that takes place by operation of California law.

Posted by: Richard Fuller | Jun 3, 2010 1:44:40 AM

The rulings are interesting insofar as they may shed light on what the folks at 1111 Constitution are thinking. (Readers: be careful what you ask for, as you may get it.) But none of these IRS rulings constitutes authoritative precedent. 26 U.S.C. 6110(k)(3). It is lamentable that tax professionals (including taxprofs) cite such rulings without mentioning that key qualification.

Posted by: Jake | Jun 2, 2010 2:54:30 PM

Yes, it does undermine DOMA, but does this Administration really care about enforcing current law, whether it is marijuana possession, immigration, or DOMA?

Posted by: Jeff Barry | Jun 2, 2010 10:00:19 AM

All of these documents studiously focus on the narrow questions posed regarding domestic partners in California in light of the enactment, effective 2007, that applies all of the state's community property law concepts to them, including for state tax purposes. The documents all recite the well-worn mantra that "Federal tax law generally respects state property law characterizations and definitions," and then proceeds to advise that these registered domestic partners from California should be treated the same as married couples for purposes of reporting and allocating community property income and credits....

OK. There is NO mention anywhere of the federal Defense of Marriage Act, presumably because these are registered domestic partners, not spouses, and thus the IRS is not forbidden by DOMA from recognizing their relationship for this purpose. However, do these documents leave open the question of how the 18,000 legally married same-sex couples in California should treat their income for federal tax purposes? For purposes of California law, they are subject to the same community property regime as all married California couples, right? But under DOMA, the federal government is not allowed to recognize their relationship as spouses. Would the IRS treat them as virtual domestic partners for this purpose?

Posted by: Art Leonard | Jun 2, 2010 9:04:22 AM

Doesn't this effectively undermine the Defense of Marriage Act as applied to taxation (not that that's necessarily a bad thing)?

Posted by: mike livingston | Jun 2, 2010 6:49:06 AM