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2003 Tax Help Archives |
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Tax Help Archives > 2003 > Publications > Publication 555
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Table 1. General Rules — Property and Income: Community or Separate?
Spouses living apart all year.
If you are married at any time during the calendar year, special rules apply for reporting certain community income. You must meet all the following conditions for these special rules to apply.
If all these conditions are met, you and your spouse must report your community income as discussed next. See also Certain community income, earlier. Earned income.
Treat earned income that is not trade or business or partnership income as the income of the spouse who performed the services. Earned income means wages, salaries, professional fees, and other pay for personal services. Earned income does not include any social security or social security equivalent of tier 1 railroad retirement benefits you receive during the year. Trade or business income.
Treat income and related deductions from a trade or business that is not a partnership as those of the person carrying on the trade or business. Partnership income or loss.
Treat income or loss from a trade or business carried on by a partnership as the income or loss of the spouse who is the partner. Separate property income.
Treat investment income from the separate property of one spouse as the income of that spouse. Social security benefits.
Treat social security benefits received during the year, including the social security equivalent portion of tier 1 railroad retirement benefits, as the separate income of the spouse who received them. Other income.
Treat all other community income, such as dividends, interest, rents, royalties, or gains, according to the community property laws of your state or country. Example. Daniel and Sharon were married throughout the year but did not live together at any time during the year. Both were domiciled in Texas, a community property state. They did not file a joint return or transfer any earned income between themselves. During the year their incomes were as follows:
Under Texas community property laws, all of Daniel and Sharon's income is considered community income. Sharon did not take part in Daniel's consulting business. Ordinarily, Daniel and Sharon would each report half the total community income, $30,500 [($26,500 + $34,500) ÷ 2], on their separate returns. But because they meet the four conditions discussed earlier, they must disregard community property law when reporting their income, except the interest from community property. They should report on their separate returns only their own earnings and other income and their share of the interest from community property. Daniel reports $26,500 and Sharon reports $34,500. The marital community may end in several ways. When the marital community ends, the community assets (money and property) are divided between the spouses. Death of spouse.
In community property states, each spouse usually is considered to own half the estate (excluding separate property). If your spouse dies, the total fair market value (FMV) of the community property, including the part that belongs to you, generally becomes the basis of the entire property. For this rule to apply, at least half the value of the community property interest must be includible in your spouse's gross estate, whether or not the estate must file a return. For example, Bob and Ann owned community property that had a basis of $80,000. When Bob died, his and Ann's community property had an FMV of $100,000. At least half their community interest was includible in Bob's estate. The basis of Ann's half of the property is $50,000 after Bob died (one half of the $100,000 FMV). The basis of the other half to Bob's heirs is also $50,000. For more information about the basis of assets, see Publication 551, Basis of Assets. Divorce or separation.
The division of community property in connection with a divorce or property settlement does not result in a gain or loss. For information on the tax consequences of the division of community property under a property settlement or divorce decree, see Publication 504. Each spouse is taxed on half the community income for the part of the year before the community ends. However, see Spouses living apart all year, earlier. Any income received after the marital community ends is separate income. This separate income is taxable only to the spouse to whom it belongs. An absolute decree of divorce or annulment ends the marital community in all community property states. A decree of annulment, even though it holds that no valid marriage ever existed, usually does not nullify community property rights arising during the so-called “marriage.” Check your state law. A decree of legal separation or of separate maintenance may or may not end the marital community. The court in the state issuing the decree may terminate the marital community and divide the property between the spouses. Check your state law. A separation agreement may divide the community property between you and your spouse. It may provide that this property along with future earnings and property acquired will be separate property. Such an agreement may end the community. In some states, the marital community ends when the husband and wife permanently separate, even if there is no formal agreement. Check your state law. 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. If you file separate returns:
Figure your tax both on a joint return and on separate returns under the community property laws of your state. You can then 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 an optional method of figuring the tax on the distribution. For the 10-year tax option, you must disregard community property laws. (A 5-year option was 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, 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:
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) and Coverdell Education Savings Accounts (ESAs).
There are several kinds of individual retirement arrangements (IRAs). They are traditional IRAs (including SEP-IRAs), SIMPLE IRAs, and Roth IRAs. Community property laws do not apply to IRAs or Coverdell ESAs. See Publication 590, Individual Retirement Arrangements (IRAs), for the rules that govern IRAs. See Publication 970, Tax Benefits for Education, for the rules that govern Coverdell ESAs. 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 one-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. If separate returns are made by a husband and wife domiciled in a community property state, and only one spouse is a member of the partnership, the part of his or her distributive share of any item (not considered net earnings from self-employment), which is community property or which is derived from community property, should be reported by the husband and wife in equal shares. 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 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 package instructions for more information. Earned income credit.
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), 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 it is treated as belonging to your spouse under your state's community property laws. For more information about the EIC, see Publication 596, Earned Income Credit (EIC). 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.
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:
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. 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 2002 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
You can get help with unresolved tax issues, order free publications and forms, ask tax questions, and get more information from the IRS in several ways. By selecting the method that is best for you, you will have quick and easy access to tax help. Contacting your Taxpayer Advocate.
If you have attempted to deal with an IRS problem unsuccessfully, you should contact your Taxpayer Advocate. The Taxpayer Advocate represents your interests and concerns within the IRS by protecting your rights and resolving problems that have not been fixed through normal channels. While Taxpayer Advocates cannot change the tax law or make a technical tax decision, they can clear up problems that resulted from previous contacts and ensure that your case is given a complete and impartial review. To contact your Taxpayer Advocate:
For more information, see Publication 1546, The Taxpayer Advocate Service of the IRS. Free tax services.
To find out what services are available, get Publication 910, Guide to Free Tax Services. It contains a list of free tax publications and an index of tax topics. It also describes other free tax information services, including tax education and assistance programs and a list of TeleTax topics.
Personal computer. With your personal computer and modem, you can access the IRS on the Internet at www.irs.gov. While visiting our web site, you can:
You can also reach us with your computer using File Transfer Protocol at ftp.irs.gov.
TaxFax Service. Using the phone attached to your fax machine, you can receive forms and instructions by calling 703–368–9694. Follow the directions from the prompts. When you order forms, enter the catalog number for the form you need. The items you request will be faxed to you. For help with transmission problems, call the FedWorld Help Desk at 703–487–4608.
Phone. Many services are available by phone.
Walk-in. You can walk in to many post offices, libraries, and IRS offices to pick up certain forms, instructions, and publications. Some IRS offices, libraries, grocery stores, copy centers, city and county governments, credit unions, and office supply stores have an extensive collection of products available to print from a CD-ROM or photocopy from reproducible proofs. Also, some IRS offices and libraries have the Internal Revenue Code, regulations, Internal Revenue Bulletins, and Cumulative Bulletins available for research purposes.
Mail. You can send your order for forms, instructions, and publications to the Distribution Center nearest to you and receive a response within 10 workdays after your request is received. Find the address that applies to your part of the country.
CD-ROM. You can order IRS Publication 1796, Federal Tax Products on CD-ROM, and obtain:
The CD-ROM can be purchased from National Technical Information Service (NTIS) by calling 1–877–233–6767 or on the Internet at www.irs.gov. The first release is available in mid-December and the final release is available in late January. IRS Publication 3207, Small Business Resource Guide, is an interactive CD-ROM that contains information important to small businesses. It is available in mid-February. You can get a free copy by calling 1–800–829–3676 or visiting the IRS web site at www.irs.gov. Publications Index | 2003 Tax Help Archives | Tax Help Archives | Home © 2005, UncleFed.com
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