1.6 Community Property Rules
If you live in Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, or Wisconsin, the income and property you and your spouse acquire during the marriage is generally regarded as community property. Community property means that each of you owns half of the community income and community property, even if legal title is held by only one spouse. But note that there are some instances in which community property rules are disregarded for tax purposes; these instances are clearly highlighted in the pertinent sections of this book.
If the community property rules apply for tax purposes and you and your spouse file separate returns instead of filing jointly, then on your separate returns each of you must report half of your combined community income and deductions in addition to your separate income and deductions.
Separate property may still be owned.
Property owned before marriage generally remains separate property; it does not become community property when you marry. Property received during the marriage by one spouse as a gift or an inheritance from a third party is generally separate property. In some states, if the nature of ownership cannot be fixed, the property is presumed to be community property.
In some states, income from separate property may be treated as community property income. In other states, income from separate property remains the separate property of the individual owner.
Divorce or separation.
If you and your spouse divorce, your community property automatically becomes separate property. A separation agreement or a decree of legal separation or of separate maintenance may or may not end the marital community, depending on state law.
Community income rules may not apply to separated couples.
If a husband and wife in a community property state file separate returns, each spouse must generally report one-half of the community income. However, a spouse may be able to avoid reporting income earned by his or her spouse if they live apart during the entire calendar year and do not file a joint return.
To qualify, one or both spouses must have earned income for the year and none of that earned income may be transferred, directly or indirectly, between the spouses during the year. One spouse’s payment to the other spouse solely to support the couple’s dependent children is not a disqualifying transfer. If the separated couple qualifies under these tests, community income is allocated as follows:
- Earned income (excluding business or partnership income) is taxed to the spouse who performed the personal services.
- Business income (other than partnership income) is treated as the income of the spouse carrying on the business.
- Partnership income is taxed to the spouse entitled to a distributive share of partnership profits.
Innocent spouse rules apply to community property.
As discussed above, community property rules may not apply to earned income where spouses live apart for the entire year and file separate returns. In addition, a spouse who files a separate return may be relieved of tax liability on community income that is attributable to the other spouse if he or she does not know (or have reason to know) about the income and if it would be inequitable under the circumstances for him or her to be taxed on such income. Even if you fail to qualify for such relief because you knew (or had reason to know) about the income, the IRS may relieve you of liability if it would be inequitable to hold you liable.
The IRS may disregard community property rules and tax income to a spouse who treats such income as if it were solely his or hers and who fails to notify the other spouse of the income before the due date of the return (including extensions).
Relief from liability on joint return.
If you file jointly, you may elect to avoid liability under the innocent spouse rules (1.7) and the separate liability rules (1.8). In applying those rules, items that would otherwise be allocable solely to your spouse will not be partly allocated to you merely because of the community property laws.
Death of spouse.
The death of a spouse dissolves the community property relationship, but income earned and accrued from community property before death is community income.
Moving from a community property to a common law (separate property) state.
Most common law states (those which do not have community property laws) recognize that both spouses have an interest in property accumulated while residing in a community property state. If the property is not sold or reinvested, it may continue to be treated as community property. If you and your spouse sell community property after moving to a common law state and reinvest the proceeds, the reinvested proceeds are generally separate property, which you may hold as joint tenants or in another form of ownership recognized by common law states.
Moving from a common law to a community property state.
Separate property brought into a community property state generally retains its character as separately owned property. However, property acquired by a couple after moving to a community property state is generally owned as community property. In at least one state (California), personal property that qualifies as community property is treated as such, even though it was acquired when the couple lived in a common law state.
Supporting a dependent with separate rather than community income.
Filing a Form 2120 multiple support agreement is not necessary where either parent can prove that he or she has income that is considered separate income rather than community income; that parent may be able to satisfy the more-than-50% support test. In certain community property states, the law may provide that income of a husband and wife living apart is considered separate income rather than community income.
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