Are You Subject to Community Property Rules
How Community Property Rules Affect Your Federal Tax Return
Spouses will need to compute their income and deductions using the community property rules
Nine states have community-property laws, which govern how married couples share their property and income. These states include Arizona, California Idaho, Louisiana Nevada, New Mexico Texas, Washington and Wisconsin.
Alaskan, Tennessee and South Dakota residents can opt in to community property law. They can manage their assets and debts this way, if they wish.
It is important to understand what this means for your tax situation, if you are a resident of one of these states or have chosen to follow the laws in one op-in state. It means that you must follow a unique set of tax provisions dictated by community property rules, to report your income and calculate your federal tax liability.
What is Community Income and Community Property?
When a married couple lives in a community property state, each spouse is legally entitled to an undivided one half interest in the total income or property of the marital community assets.
If you have separate property, such as assets that you own prior to marriage or income from those properties, you may be able to exclude this type of income.
In determining whether a source is community income or if a property belongs under community property rules or an individual, federal tax laws generally follow state laws.
Community property can only be acquired when the couple is legally married. The community income generated by each spouse’s earnings during marriage is also called community property. 50 percent of the earnings by your spouse is yours. You both share the responsibility for earning it in community property states 2022 taxes.
A spouse can still own separate property in a community property state if they meet certain conditions. Separate property may have been purchased separately prior to marriage, bought with separate funds, or exchanged for other property.
A legal agreement between spouses can be used to convert community property into separate property. This is called “transmutation”. Although transmutation laws can vary from one state to the next, they may not be applicable to all circumstances.
Gifts and inheritances that are not left to one spouse are often considered separate property. Separate property generates separate income. Separate income can be earned by renting out a property you own before you got married.
Income from most property that is not separate in Idaho, Louisiana, Texas and Wisconsin are still considered community property.
How to file Community Income Taxes
If you’re married and file a joint tax return, all your income and deductions will be reported on one return. If you’re married and file separate tax returns, each spouse would report half of their community income and half of their community deductions.
What is Strategic About Community Property?
Filing separately may be an option to lower your federal tax liability.
As an example consider a couple earning $50,000 a year. The spouse with the higher income earns $40,000 and the spouse with the lower income earns $10,000. The threshold for itemized medical expense deductions for most taxpayers is 10% of your adjusted Gross Income (AGI). A spouse who has an AGI of $25,000 could file a separate return to deduct $2,500 of medical expenses ($10% of $25,000 = $2,500).
If the same spouse files jointly on marital income of $50,000 or $25,000 each, however, this threshold would rise to $5,000
Separate property agreements may be necessary to separate your investments, real property, and other property from the marital home in states that allow this. To find out if this is possible, consult a tax professional. Do you need to use the Community Property Rules?
When do community property rules cease to apply?
Married couples living in a community property state with his/her spouse should adhere to the community property rules when allocating income or deductions. You may be able to ignore community property rules, or use a modified version of community property regulations in certain situations. Take, for example:
If one spouse fails to disclose the amount or nature of their income, it is possible for IRS community property rules to be ignored. However, proof would be required.
For spouses who live apart for an entire year, it is possible to modify the community property rules.
What Filing Status should I choose in a community property state?
In a community property state, spouses have the option to file jointly or separately. This is just like in other states. In certain situations, they can file as the head of household.
For federal tax purposes, registered domestic partners and civil union members can file as singles. If they are eligible, they can also file as the head of household. They can’t file jointly or separately as married at the federal level.
To be considered a head of household under federal law, you must fulfill three conditions:
The last day of the tax-year determines your filing status eligibility. According to IRS rules, if you are legally separated from your spouse, it counts as “unmarried”. If you are not legally separated or divorced yet, you may still qualify. However, you must not have lived together for at least six months during the year.
Your household maintenance costs must be more than half of the total cost.
A qualifying dependent must live with you for at least half of the year, unless the dependent is a qualifying parental dependent.
Frequently Asked Questions (FAQs).
Are there community property laws that apply to the same-sex couple?
If you are legally married, regardless of whether you are a different-sex couple or a same-sex one, the community property laws apply. For federal tax purposes, the IRS does not recognize registered domestic partnerships.
What do I need to report about my marriage?
Your taxes will be affected by whether you are married, such as how your income, deductions and credits work. Although you don’t have to file jointly with your taxes, you will need to indicate that you are married.
What is considered community property income?
If you live in a community property state listed above, and are legally married, any income earned by one of the spouses is considered to be earned 50% each. However, under community property rules, if any spouse has property acquired before marriage, and any income earned from that asset, is generally excluded from the calculation.