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The annual income tax season is no fun for any of us but it can be a lot worse for same-sex couples in California, Nevada, and Washington. Those three states follow community property law and recognize either same-sex marriages or domestic partnerships. The combination makes tax filing an even bigger hassle than the rest of us face.
Because the Defense of Marriage Act (DOMA) denies federal recognition of those relationships, the IRS applies special rules to same-sex couples in the three states, rules that don’t apply to couples—same- or opposite-sex—in other states. Those rules complicate tax filing and can result in higher (or lower) income and payroll tax bills. (I blogged yesterday on more general issues concerning DOMA and taxes.)
Community property law generally requires that married couples split income evenly between spouses. That rule also applies to domestic partners in the three community property states that recognize them.
Splitting income makes little difference for opposite-sex married couples but creates tax issues for same-sex partners because of DOMA. Here are just a few of the problems that the IRS has explained in various publications.
- Same-sex couples with children may or may not be allowed to file as heads of household. The issue revolves around the requirement that a head of household provide more than half the support for a dependent child. Because spending out of community property income comes equally from both partners, neither provides more than half the support, so neither can claim the dependent. Only if some support comes from non-community property may one partner file as head of household.
- Domestic partners in community property states must split the income from a business operated by one partner, even if the other partner has no involvement. In contrast, in the case of opposite-sex couples, earnings from a business are attributed only to a spouse who is actively involved in the business. Further, each domestic partner must pay self-employment tax on her half of business earnings, a situation from which a special provision protects opposite-sex couples. As a result, same-sex couples could pay as much as double the payroll tax that finances Social Security that an opposite-sex couple would pay.
- The IRS applies community property laws inconsistently with regard to tax credits. For example, the earned income credit, the dependent care credit, and the refundable portion of the child tax credit all ignore community property laws in determining a domestic partner’s earnings but split all income in measuring adjusted gross income.
Same-sex couples may also benefit from being denied joint filing status. A person who adopts her same-sex partner’s child may claim the adoption credit, a benefit not available to opposite-sex spouses. And as I explained yesterday, being denied joint filing status protects same-sex partners with similar incomes from incurring marriage penalties.
Taxpayer Advocate Nina Olson has pointed out additional problems for same-sex couples caused not by tax rules but rather by IRS procedures. For example, domestic partners in community property states must split both earnings and the income tax withheld on those earnings. But the IRS has rejected returns filed electronically because its software failed to allocate withheld taxes correctly between partners.
The IRS appears to have first offered guidance for same-sex couples in 2010, three years after California granted community property rights to domestic partners and shorter periods after similar action in Nevada and Washington. At that point, the IRS gave domestic partners the option of filing amended returns reflecting community property laws but did not require them to file new returns. Affected couples could recompute their taxes and file new returns, but in a final kicker, a partner owing more tax would have to pay interest on the underpayment (offset, at least in part, by interest paid on the refund presumably going to the other partner). At least the IRS waived penalties for underpayment.
Finally, the interaction between the federal income tax and California’s tax complicates tax filing for same-sex couples. The state’s tax return requires a couple to enter adjusted gross income from their joint federal return, even though they cannot file that return with the federal government. That means such a couple must prepare three federal returns—one joint for their state taxes and two individual to file with the feds—plus a state return.
Same-sex couples in Nevada and Washington are luckier—neither state imposes an income tax.
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