This was originally published on PAOO on July 3, 2010.
CCA 201021050 may provide a significant windfall for some unmarried couples. It is directed toward registered domestic partners in California and some commentators indicate that it is logically applicable to California same sex married couples. The ruling emphasizes the point that state law determines ownership of property and that the taxation of income follows the ownership of that income. California is a community property state and effective in 2007 the community property laws were amended so that registered domestic partners were required to file joint California returns even though they would not be considered married for federal income tax purposes.
I've thought a bit about the tax advantages that an unmarried couple might have even prior to this ruling. I find it easier to refer to a hypothetical couple I call Robin and Terry. How exciting is this ruling ? It really depends on how high Robin and Terry's income is and also how unequal. For the sake of simplicity I'm going to assume that neither Robin nor Terry itemize (probably unrealistic since the California income tax alone might put one of them over the threshold) and have a total gross income of $250,000. Computations are for 2009 If all the income is earned by Robin the total federal tax would be $64,830. This compares to $54,150 if they were allowed to file a join return. Under the new interpretation they are each deemed to have income of $125,000 resulting in a tax of $26,102 each for a total of $52,204. If one of them can qualify as head of household the total becomes $49,205.
Unlike the filing of a joint return by a married couple, the ruling indicates that this income splitting is not elective. It also indicates that people who have already filed do not need to amend their returns, but that they are permitted to. The ruling is applicable to years after 2006. The amended return option is the part that I find very interesting. Suppose Robin had grossed $200,000 and Terry $50,000. Their total tax would be $54,150, slightly less than a married couple with the same income, but still a bit more than they would pay income splitting with one another. What if Robin amends to claim a refund of $22,068 ? Is there a mechanism to force Terry to amend. I don't think the IRS even has the right to tell Terry what Robin did. This gets somewhat less exciting if Robin is an employee, since withholdings track to community property income so Robin's amended return would show reduced withholding.
It will be interesting to see if the IRS issues more formal guidance on this issue. In the mean time all those Robins and Terries out there might want to dust off their returns and crunch some numbers. They have until April of 2011 to amend their 2007 returns, but have a heart for your tax professionals and don't go asking them to amend old returns during crunch time.
I'm planning on my next post to be about the tax opportunities that "unmarried" couples have generally. It will be titled "Just Because They Won't Let You Do It Doesn't Make It a Good Idea".(It's now available.)