Identifying Income, Deductions, and Credits(p4)

If you file separate returns, you and your spouse (or RDP/California same-sex spouse) must be able to identify your community and separate income, deductions, credits, and other return amounts according to the laws of your state.

The following is a discussion of the general effect of community property laws on the federal income tax treatment of certain items of income.

A spouse's (or RDP's/California same-sex spouse's) wages, earnings, and net profits from a sole proprietorship are community income and must be evenly split.

Dividends, interest, and rents from community property are community income and must be evenly split. Dividends, interest, and rents from separate property are characterized in accordance with the discussion under Income from separate property, later.

Alimony or separate maintenance payments made prior to divorce are taxable to the payee spouse only to the extent they exceed 50% (his or her share) of the reportable community income. This is so because the payee spouse is already required to report half of the community income. See also Alimony paid, later.

Gains and losses are classified as separate or community depending on how the property is held. For example, a loss on separate property, such as stock held separately, is a separate loss. On the other hand, a loss on community property, such as a casualty loss to your home held as community property, is a community loss. See Publication 544, Sales and Other Dispositions of Assets, for information on gains and losses. See Publication 547, Casualties, Disasters, and Thefts, for information on losses due to a casualty or theft.

There are several kinds of individual retirement arrangements (IRAs). They are traditional IRAs (including SEP-IRAs), SIMPLE IRAs, and Roth IRAs. IRAs and ESAs by law are deemed to be separate property. Therefore, taxable IRA and ESA distributions are separate property, even if the funds in the account would otherwise be community property. These distributions are wholly taxable to the spouse (or RDP/California same-sex spouse) whose name is on the account. That spouse (or RDP/California same-sex spouse) is also liable for any penalties and additional taxes on the distributions.

Generally, distributions from pensions will be characterized as community or separate income depending on the respective periods of participation in the pension while married (or during the registered domestic partnership/same-sex marriage in California) and domiciled in a community property state or in a noncommunity property state during the total period of participation in the pension. See the example under Civil service retirement, later. These rules may vary between states. Check your state law.

If you were born before January 2, 1936, and receive a lump-sum distribution from a qualified retirement plan, you may be able to choose an optional method of figuring the tax on the distribution. For the 10-year tax option, you must disregard community property laws. For more information, see Publication 575, Pension and Annuity Income, and Form 4972, Tax on Lump-Sum Distributions.

For income tax purposes, community property laws apply to annuities payable under the Civil Service Retirement Act (CSRS) or Federal Employee Retirement System (FERS).

Whether a civil service annuity is separate or community income depends on your marital status (or your status as a RDP/California same-sex spouse) and domicile of the employee when the services were performed for which the annuity is paid. Even if you now live in a noncommunity property state and you receive a civil service annuity, it may be community income if it is based on services you performed while married (or during the registered domestic partnership/same-sex marriage in California) and domiciled in a community property state.

If a civil service annuity is a mixture of community income and separate income, it must be divided between the two kinds of income. The division is based on the employee's domicile and marital status (or RDP/California same-sex marital status) in community and noncommunity property states during his or her periods of service.

Henry Wright retired this year after 30 years of civil service. He and his wife were domiciled in a community property state during the past 15 years.

Since half the service was performed while the Wrights were married and domiciled in a community property state, half the civil service retirement pay is considered to be community income. If Mr. Wright receives $1,000 a month in retirement pay, $500 is considered community income—half ($250) is his income and half ($250) is his wife's.

State community property laws apply to military retirement pay. Generally, the pay is either separate or community income based on the marital status and domicile of the couple while the member of the Armed Forces was in active military service. For example, military retirement pay for services performed during marriage and domicile in a community property state is community income.

Active military pay earned while married and domiciled in a community property state is also community income. This income is considered to be received half by the member of the Armed Forces and half by the spouse.

If an interest is held in a partnership, and income from the partnership is attributable to the efforts of either spouse (or RDP/California same-sex spouse), the partnership income is community property. If it is merely a passive investment in a separate property partnership, the partnership income will be characterized in accordance with the discussion under Income from separate property, later.

For spouses, community income exempt from federal tax generally keeps its exempt status for both spouses. For example, under certain circumstances, income earned outside the United States is tax exempt. If you earned income and met the conditions that made it exempt, the income is also exempt for your spouse even though he or she may not have met the conditions. RDPs and same-sex married couples in California should consult the particular exclusion provision to see if the exempt status applies to both.

In some states, income from separate property is separate income. These states include Washington, Nevada, California, Arizona, and New Mexico. Other states characterize income from separate property as community income. These states include Idaho, Louisiana, Wisconsin, and Texas.

When you file separate returns, you must claim your own exemption amount for that year. (See your tax return instructions.)

You cannot divide the amount allowed as an exemption for a dependent between you and your spouse (or RDP/California same-sex spouse). When community funds provide support for more than one person, each of whom otherwise qualifies as a dependent, you and your spouse (or RDP/California same-sex spouse) may divide the number of dependency exemptions as explained in the following example.

Ron and Diane White have three dependent children and live in Nevada. If Ron and Diane file separately, only Ron can claim his own exemption, and only Diane can claim her own exemption. Ron and Diane can agree that one of them will claim the exemption for one, two, or all of their children and the other will claim any remaining exemptions. They cannot each claim half of the total exemption amount for their three children.

If you file separate returns, your deductions generally depend on whether the expenses involve community or separate income.

If you file separate returns, expenses incurred to earn or produce:

• Community business or investment income are generally divided equally between you and your spouse (or RDP/California same-sex spouse). Each of you is entitled to deduct one-half of the expenses on your separate returns.
• Separate business or investment income are deductible by the spouse (RDP/California same-sex spouse) who earns the income.

Other limits may also apply to business and investment expenses. For more information, see Publication 535, Business Expenses, and Publication 550, Investment Income and Expenses.

Payments that may otherwise qualify as alimony are not deductible by the payer if they are the recipient spouse's part of community income. They are deductible as alimony only to the extent they are more than that spouse's part of community income.

You live in a community property state. You are separated but the special rules explained later under Spouses living apart all year do not apply. Under a written agreement, you pay your spouse $12,000 of your $20,000 total yearly community income. Your spouse receives no other community income. Under your state law, earnings of a spouse living separately and apart from the other spouse continue as community property.

On your separate returns, each of you must report $10,000 of the total community income. In addition, your spouse must report $2,000 as alimony received. You can deduct $2,000 as alimony paid.

Deductions for IRA contributions cannot be split between spouses (or RDPs/California same-sex spouses). The deduction for each spouse (or RDP/California same-sex spouse) is figured separately and without regard to community property laws.

Expenses that are paid out of separate funds, such as medical expenses, are deductible by the spouse (or RDP/California same-sex spouse) who pays them. If these expenses are paid from community funds, divide the deduction equally between you and your spouse (or RDP/California same-sex spouse).

The following is a discussion of the general effect of community property laws on the treatment of certain credits, taxes, and payments on your separate return.

You may be entitled to a child tax credit for each of your qualifying children. You must provide the name and identification number (usually the social security number) of each qualifying child on your return. See your tax package instructions for the maximum amount of the credit you can claim for each qualifying child.

The credit is limited if your modified adjusted gross income (modified AGI) is above a certain amount. The amount at which the limitation (phaseout) begins depends on your filing status. Generally, your credit is limited to your tax liability unless you have three or more qualifying children. See your tax return instructions for more information.

This section discusses the effect of community property laws on the imposition of self-employment tax on the earnings and profits of a sole proprietorship and partnerships. For the effect of community property laws on the income tax treatment of income from a sole proprietorship and partnerships, see Wages, earnings, and profits and Partnership income, earlier. The following rules only apply to persons married for federal tax purposes. RDPs and same-sex spouses in California report community income for self-employment tax purposes the same way they do for income tax purposes.

With regard to net income from a trade or business (other than a partnership) that is community income, self-employment tax is imposed on the spouse carrying on the trade or business.

All of the distributive share of a married partner's income or loss from a partnership trade or business is attributable to the partner for computing any self-employment tax, even if a portion of the partner's distributive share of income or loss is community income or loss that is otherwise attributable to the partner's spouse for income tax purposes. If both spouses are partners, any self-employment tax is allocated based on their distributive shares.

Report the credit for federal income tax withheld on community wages in the same manner as your wages. If you and your spouse file separate returns on which each of you reports half the community wages, each of you is entitled to credit for half the income tax withheld on those wages. Likewise, each RDP/California same-sex spouse is entitled to credit for half the income tax withheld on those wages.

In determining whether you must pay estimated tax, apply the estimated tax rules to your estimated income. These rules are explained in Publication 505.

If you think you may owe estimated tax and want to pay the tax separately (RDPs and same-sex spouses in California must pay the tax separately), determine whether you must pay it by taking into account:

1. Half the community income and deductions,
2. All of your separate income and deductions, and
3. Your own exemption and any exemptions for dependents that you may claim.

Whether you and your spouse pay estimated tax jointly or separately will not affect your choice of filing joint or separate income tax returns.

If you and your spouse paid estimated tax jointly but file separate income tax returns, either of you can claim all of the estimated tax paid, or you may divide it between you in any way that you agree upon.

If you cannot agree on how to divide it, the estimated tax you can claim equals the total estimated tax paid times the tax shown on your separate return, divided by the total of the tax shown on your return and your spouse's return.

If you paid your estimated taxes separately, you get credit for only the estimated taxes you paid.

You may be entitled to an earned income credit (EIC). You cannot claim this credit if your filing status is married filing separately.

If you are married, but qualify to file as head of household under rules for married taxpayers living apart (see Publication 501, Exemptions, Standard Deduction, and Filing Information), and live in a state that has community property laws, your earned income for the EIC does not include any amount earned by your spouse that is treated as belonging to you under community property laws. That amount is not earned income for the EIC, even though you must include it in your gross income on your income tax return. Your earned income includes the entire amount you earned, even if part of it is treated as belonging to your spouse under your state's community property laws. The same rule applies to RDPs and same-sex spouses in California.

For more information about the EIC, see Publication 596, Earned Income Credit (EIC).

The amount of an overpayment on a joint return is allocated under the community property laws of the state in which you are domiciled.

• If, under the laws of your state, community property is subject to premarital or other separate debts of either spouse, the full joint overpayment may be used to offset the obligation.
• If, under the laws of your state, community property is not subject to premarital or other separate debts of either spouse, only the portion of the joint overpayment allocated to the spouse liable for the obligation can be used to offset that liability. The portion allocated to the other spouse can be refunded.