Federal Income Tax Return Preparation

The following discussion does not apply to spouses who meet the conditions under Spouses living apart all year, discussed earlier. Those spouses must report their community income as explained in that discussion.

Joint Return Versus Separate Returns

Ordinarily, filing a joint return will give you the greater tax advantage. But in some cases, your combined income tax on separate returns may be less than it would be on a joint return.

You can file separate returns if you and your spouse do not agree to file a joint return or if separate returns result in less tax. However, if you file separate returns:

1. You should itemize deductions if your spouse itemizes deductions, because you cannot claim the standard deduction,
2. You cannot take the credit for child and dependent care expenses in most instances,
3. You cannot take the earned income credit,
4. You cannot exclude any interest income from U.S. savings bonds that you used for higher education expenses,
5. You cannot take the credit for the elderly or the disabled unless you lived apart from your spouse all year,
6. You may have to include in income more of the social security benefits (including any equivalent railroad retirement benefits) you received during the year than you would on a joint return,
7. You cannot deduct interest paid on a qualified student loan,
8. You cannot take the education credits (the Hope and lifetime learning credits),
9. You may have a smaller child tax credit than you would on a joint return, and
10. You cannot take the exclusion or credit for adoption expenses in most instances.

Figure your tax both on a joint return and on separate returns under the community property laws of your state. Compare the tax figured under both methods and use the one that results in less tax.

If you file separate returns, you and your spouse must each report half of your combined community income and deductions in addition to your separate income and deductions. List only your share of the income and deductions on the appropriate lines of your separate tax returns (wages, interest, dividends, etc.).

Attach a worksheet to your separate returns showing how you figured the income, deductions, and federal income tax withheld that each of you reported. The allocation worksheet shown later can be used for this purpose. If you do not attach a worksheet, you and your spouse should each attach a photocopy of the other spouse's Form W-2 or 1099-R. Make a notation on the form showing the division of income and tax withheld.

An extension of time for filing your separate return does not extend the time for filing your spouse's separate return. If you and your spouse file a joint return, you cannot file separate returns after the due date for filing either separate return has passed.

Identifying Income and Deductions

To figure the best way to file your return -- jointly or separately -- first identify your community and separate income and deductions according to the laws of your state.

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.

Military retirement pay. 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.

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

Civil service retirement. 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 the marital status 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 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 in community and noncommunity property states during his or her periods of service.

Example. 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.

Lump-sum distributions. If you receive a lump-sum distribution from a qualified retirement plan, you may be able to choose optional methods of figuring the tax on the distribution. For the 5-year or 10-year tax option, you must disregard community property laws. (The 5-year option is repealed for tax years beginning after December 31, 1999.) For more information, see Publication 575, Pension and Annuity Income, and Form 4972, Tax on Lump-Sum Distributions.

Gains and losses. 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 (Business and Nonbusiness), for information on losses due to a casualty or theft.

Business and investment expenses. 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. Each of you is entitled to deduct one-half of the expenses on your separate returns, or
• Separate business or investment income are deductible by the 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.

Personal expenses. Expenses that are paid out of separate funds, such as medical expenses, are deductible by the spouse who pays them. If these expenses are paid from community funds, divide the deduction equally between you and your spouse.

Individual retirement arrangements (IRAs). There are several kinds of individual retirement arrangements (IRAs). They are traditional IRAs (including SEP-IRAs), SIMPLE IRAs, Roth IRAs, and education IRAs. Community property laws do not apply to IRAs. See Publication 590, Individual Retirement Arrangements (IRAs), for the rules that govern IRAs.

Personal exemptions and dependents. When you file separate returns, you must claim your own exemption amount for that year. (See your tax package instructions.)

You cannot divide the amount allowed as an exemption for a dependent between you and your spouse. When community funds provide over half of the support for more than one person who otherwise qualifies as a dependent, you and your spouse may divide the number of dependency exemptions as explained in the following example.

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.

Self-employment tax. If any income from a trade or business other than a partnership is community income under state law, it is subject to self-employment tax as the income of the spouse carrying on the trade or business.

Partnership income. If you are a partner and your distributive share of any income or loss from a trade or business carried on by the partnership is community income, treat the share as your net earnings from self-employment. No part is treated as net earnings from self-employment by your spouse. If both you and your spouse are partners, each of you must claim your share when figuring net earnings from self-employment for self-employment tax purposes.

Child tax credit. 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.

Limit on credit. The credit is limited if your modified adjusted gross income (modified AGI) is above a certain amount. The amount at which the 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 package instructions for more information.

Earned income credit. You may be entitled to an earned income credit (EIC). Compute your earned income without regard to community property laws. You cannot claim this credit if your filing status is married filing separately.

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

Withholding tax. 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.

Overpayments. Overpayments are allocated under the community property laws of the state in which you are domiciled.

• If 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 community property is not subject to premarital or other separate debts of either spouse, 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.

Estimated tax. 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, 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.

Example

Walter and Mary Smith are married and domiciled in a community property state. Their two children (18-year-old twins) and Mary's mother live with them and qualify as their dependents. Amounts paid for their support were paid out of community funds.

Walter received a salary of $38,160. Income tax withheld from his salary was $3,360. Walter received $94 in taxable interest from his savings account. He also received $155 in dividends from stock that he owned. His interest and dividend income is his separate income under the laws of his community property state.

Mary received $140 in dividends from stock that she owned. This is her separate income. In addition, she received $3,000 as a part-time dental technician. No income tax was withheld from her salary.

The Smiths paid a total of $3,850 in medical expenses. Medical insurance of $700 was paid out of community funds. Walter paid $3,150 out of his separate funds for an operation he had.

The Smiths had $6,842 in other itemized deductions, none of which were miscellaneous itemized deductions subject to the 2%-of-adjusted-gross-income limit. The amounts spent for these deductions were paid out of community funds.

To see if it is to the Smiths' advantage to file a joint return or separate returns, a worksheet (shown next) is prepared to figure their federal income tax both ways. Walter and Mary must claim their own exemptions on their separate returns.

The summary at the bottom of the worksheet compares the tax figured on the Smiths' joint return to the tax figured on their separate returns. By filing separately under the community property laws of their state, the Smiths save $184 in income tax.

If the Smiths were domiciled in Idaho, Louisiana, Texas, or Wisconsin, the result would be slightly different because in those states income from separate property generally is treated as community income. If they lived in one of those states, the interest on Walter's savings account and the dividends from stock owned by each of them would be divided equally on their separate returns.

In figuring your tax, use the amounts from your current tax forms instruction booklet for items such as the standard deduction, exemption allowance, and Tax Table tax. The amounts used in this example apply for 1999 only. The example shows how filing separate returns under community property tax laws can result in lower tax than filing jointly; you must figure your own tax both ways to know which works better for you.

Table 2. Worksheet - Walter and Mary Smith.

Table 3. Allocation Worksheet.

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