Community Income

[willow26]

I went through an amicable divorce with my spouse last year in California which is a community property state. I am the high earner. We didn't split the finances until the dissolution date which was very late in the year. While doing taxes for TY2018, this is what I ended up doing after reading IRS Publication 504 (Divorced or Separated Individuals) and IRS Publication 555 (Community Property) documents. Here is the procedure I used:

1) Income, Federal tax withheld and State tax withheld was divided in half until the date of dissolution and then rest was considered separate
2) The same division was performed for dividend and capital gains
3) Property Tax deduction was taken by each on separate property

In order to accomplish this, I filled out a married filing jointly return and then filled out both our returns with the numbers divided as stated above. I filed single and spouse filed Head of Household. I attached both W2's to the Federal returns. Spouse followed the same method. We attached a single page of explanation to our return stating our method.

I am wondering if this was the right approach or not? If it was correct, this post will help someone in the future. If not, I would like to hear some opinions about it and prepare for an audit.

 

[LdiJ]

I went through an amicable divorce with my spouse last year in California which is a community property state. I am the high earner. We didn't split the finances until the dissolution date which was very late in the year. While doing taxes for TY2018, this is what I ended up doing after reading IRS Publication 504 (Divorced or Separated Individuals) and IRS Publication 555 (Community Property) documents. Here is the procedure I used:

1) Income, Federal tax withheld and State tax withheld was divided in half until the date of dissolution and then rest was considered separate
2) The same division was performed for dividend and capital gains
3) Property Tax deduction was taken by each on separate property

In order to accomplish this, I filled out a married filing jointly return and then filled out both our returns with the numbers divided as stated above. I filed single and spouse filed Head of Household. I attached both W2's to the Federal returns. Spouse followed the same method. We attached a single page of explanation to our return stating our method.

I am wondering if this was the right approach or not? If it was correct, this post will help someone in the future. If not, I would like to hear some opinions about it and prepare for an audit.

In my opinion, that wasn't even remotely correct. For tax purposes your marital status as of 12/31 of the calendar year is your marital status for the entire year. Since it appears that your divorce was final before 12/31, then for tax purposes you had no community income. You really should have asked for advice before you filed, rather than after filing.

 

[willow26]

Thanks for your opinion. Please refer to examples in IRS Publication 555 (Community Property). My assumption was directly based on the two documents I mentioned. We will find out soon enough and I will keep you guys updated.

 

[Zigner]

Thanks for your opinion. Please refer to examples in IRS Publication 555 (Community Property). My assumption was directly based on the two documents I mentioned. We will find out soon enough and I will keep you guys updated.

That publication mentions multiples times in the introduction alone that it is for married couples who file separate returns. You weren't married.

 

[willow26]

Please evaluate this in Publication 504, page 25:

Ending the Marital Community: When the marital community ends as a result of divorce or separation, the community assets (money and property) are divided between the spouses. 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. Income received after the community ended is separate income, taxable only to the spouse to whom it belongs.

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.

1.You and your spouse lived apart all year.
2.You and your spouse didn’t file a joint return for a tax year beginning or ending in the calendar year.
3.You and/or your spouse had earned income for the calendar year that is community income.
4.You and your spouse haven’t transferred, directly or indirectly, any of the earned income in (3) between yourselves before the end of the year. Don’t take into account transfers satisfying child support obligations or transfers of very small amounts or value.

We get disqualified from seperate income due to point 4 above.

 

[Zigner]

The point is that you referred to Pub 555 which doesn't even apply to you.

 

[willow26]

Thanks for your opinion. Looks like you've not evaluated the above-mentioned documents completely as I have. Here is a quote from Pub 555 (Page 9) upon which my assumptions were based:

Divorce or separation.
If spouses divorce or separate, the (equal or unequal) division of community property in connection with the divorce or property settlement doesn't result in a gain or loss. For registered domestic partners, an unequal division of community property in a property settlement may result in a gain or loss. For information on the tax consequences of the division of property under a property settlement or divorce decree, see Publication 504. Each spouse (or each registered domestic partner) 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 community ends is separate income. This separate in-come is taxable only to the spouse (or the registered do-mestic partner) 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 doesn't nullify community property rights arising during the “marriage.” However, you should check your state law for exceptions.A decree of legal separation or of separate maintenance may or may not end the marital community. The court issuing the decree may terminate the marital community and divide the property between the spouses.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. This agreement may end the community.In some states, the marital community ends when the spouses permanently separate, even if there is no formal agreement. Check your state law.If you are a registered domestic partner, you should check your state law to determine when the community ends.

 

[Taxing Matters]

In my opinion, that wasn't even remotely correct. For tax purposes your marital status as of 12/31 of the calendar year is your marital status for the entire year. Since it appears that your divorce was final before 12/31, then for tax purposes you had no community income. You really should have asked for advice before you filed, rather than after filing.

You are correct that for federal tax purposes marital status is determined as of the last day of the tax year (12/31 in most cases). As it appears that the divorce was final before the end of the year they will each file as a single or head of household, assuming neither remarried before the end of the year. But even though they file as single, state law still determines what community income they had during the year prior to the divorce being final. Federal tax law looks to that state law determination for deciding what is community income for reporting on the return. So here, even though they file as single, they will still have community income. The fact that their filing status is now single does not wipe out the characterization of their income before the divorce as community income.

 

[willow26]

Exactly right TM. I had to educate myself by reading those two documents multiple times before coming up with my conclusions. There is hardly any discussion about my situation on the web and I hope this helps someone else too. Nevertheless, I will wait until i hear back from IRS or until refunds are processed and will update this thread.

 

[willow26]

Just want to update everyone that what I mentioned in the original post is exactly what IRS accepted. There has been no questions about how the income was split and our tax returns were accepted as filed.

 

[willow26]

Update again. IRS accepted the return without any questions. California tax authority questioned the capital gains amount for both my ex and myself. We both disputed the charge and it was dropped after community property explanation. Hope this is helpful to everyone. Don't pay taxes which are not really due to you and your ex.

 

[Taxing Matters]

Update again. IRS accepted the return without any questions. California tax authority questioned the capital gains amount for both my ex and myself. We both disputed the charge and it was dropped after community property explanation. Hope this is helpful to everyone. Don't pay taxes which are not really due to you and your ex.

Good to hear you had a positive outcome. Certainly I agree that if the tax authority gets it wrong one ought to challenge that decision. You should only pay the tax that you are legally obligated to pay.