Community property laws view marriage as a partnership in which both spouses equally share the income and assets they acquire after the wedding. Nine states—Wisconsin, Washington, Texas, New Mexico, Nevada, Louisiana, Idaho, California and Arizona—have community property statutes that affect a married couple's federal income tax return.
When Dr. Phil says marriage isn't a 50/50 proposition, he's not referring to spouses owning property in a community property state. Community property laws view marriage as a partnership in which both spouses equally share the income and assets they acquire after the wedding.
Nine states—Wisconsin, Washington, Texas, New Mexico, Nevada, Louisiana, Idaho, California and Arizona—have community property statutes that affect a married couple's federal income tax return. According to Racine, Wisconsin CPA Carla R. Dentartigh, community property couples have more to think about.
"'What's mine is mine and what's your is yours' doesn't always apply," she says. “From the date you were married, you've got to consider that half of what he makes is yours and half of what you make is his."
Tip 1: Know your state's law
Assets and income that you and your spouse can consider to be separate for tax purposes depend on the laws of your state. When you file jointly, you report all income from all assets. When you file separately, you must follow your state's definition of separate and community property.
"You can't just say, 'That's not my money,'" notes Dentartigh. Some states consider income earned from separate property, such as dividends on stock owned prior to marriage, to be separate income reported only by the owning spouse on his return. Wisconsin, Louisiana, Idaho and Texas consider it income earned equally by both spouses.
How you report Social Security income to the IRS also depends on state law. Knowing how your state distinguishes between shared and separate income and assets makes tax preparation and estate planning easier.
Tip 2: Document payments and transactions
Community property couples must pay attention to the documents they use to support their tax returns. Dentartigh cites an example of a spouse claiming a deduction for half of the mortgage interest on a jointly owned home who runs into trouble when the Internal Revenue Service can’t match it with the 1098 mortgage interest statement supplied by the mortgage company. "Whose Social Security number is attached to the asset matters," she says.
Keeping track of separate assets also serves as a financial security blanket should your marriage fail. "Spouses with more at risk can use a prenuptial agreement to protect their separate assets," adds Dentartigh, who finds that problems usually arise at divorce time.
Good record keeping can support deductions that reduce federal taxes. Depending on your state, the types of separate property you want to document may include:
- Assets you owned before you married and income they generate
- Inheritances and personal gifts you received before or during the marriage
- Separate money used to buy or improve jointly owned property
- Medical and personal expenses paid with separate funds
- Individual IRA contributions and withdrawals
- Separate business income
- Community assets you have legally changed to separate assets
Tip 3: Figure your tax both ways
The IRS suggests married couples in community property states look at their tax situation under both joint and separate filing options to determine which version saves them the most (TurboTax will do this for you).
Filing a joint return may be less complex and qualify you for tax credits. Dentartigh says filing separately depends on your situation and how your itemized deductions stack up against the standard deduction.
When you live in a community property state and file separate returns, you each must report 50 percent of your spouse's income and half of income generated by community assets, plus all of your separate income. The IRS has an allocation worksheet to simplify your calculations in Publication 555 Community Property. You also have to decide who will claim dependent children.
Tip 4: Protect your spouse with estate planning
Estate planning can reduce any capital gains tax that a surviving spouse in a community property state will face when selling jointly held property inherited from the spouse who passed away. Community property states give couples an option to conserve more of their estate by converting separate assets to community assets through a written agreement.
These agreements can designate property ownership as "community property with right of survivorship" or "joint tenants with right of survivorship." With the survivorship agreement—recognized in Arizona, California, Nevada, Texas and Wisconsin—these assets pass on to your spouse after you die without going through probate. The IRS recognizes these agreements when applying the capital gains provisions of the tax code.
Tip 5: Know same-sex marriage tax rules
In California, Nevada or Washington, community property law extends to same-sex registered domestic partners—RDPs. But they do not have the option of filing a joint federal return unless they are married. The IRS does not recognize their relationship unless they are married under state law. They must file separate federal income tax returns as “head of household” or “single” and include their separate and community income. Californian RDPs must also prepare a mock "married filing jointly" 1040 return in order to complete the California state tax return. Paying close attention to gifts and expenses helps community property RDPs manage their tax liability.