Tax Season is tricky but what if You are Gay Couple?
Tax season often delivers more than the usual set of headaches for same-sex couples. But it’s about to get incredibly more complicated for couples living in California, Nevada and Washington. There is an upside, though. Many of them will save thousands of dollars in federal income taxes.
Here’s what’s happening: Same-sex couples who are living in the three states that have both community property laws and recognize registered domestic partnerships or same-sex marriage must now follow their state’s community property laws on their federal tax returns (if they’re officially partnered). In community property states, generally all income and property acquired during a partnership or marriage is treated as equally owned by both individuals.
So that means couples must add up their combined “community income,” split it in half, and each report their half on their own federal returns (as well as any separate income). Before the Internal Revenue Service changed its interpretation of the law last May, each partner simply reported his or her own income on the federal tax return.
The new rule is likely to generate nice refunds for couples who have one high earner and a lower earner, and particularly couples in which one partner is a stay-at-home parent with no income. In those instances, splitting their income means they’ll fall into a lower tax bracket. In fact, most couples will benefit or break even, said Karen Stogdill, an enrolled agent and president of KKS Tax Associates in San Francisco, who has many same-sex couples as clients.
“I call this the income tax gravy train,” Ms. Stogdill said. “It couldn’t really get better for the community as a whole.”
Consider a couple where one partner earns about $82,000 and the other partner stays at home. Under community property rules, both individuals would report income of $41,000 on their federal returns. Splitting their income would generate about $4,800 in tax savings on their federal returns because that qualifies them for a lower tax bracket, Ms. Stogdill said.
Heterosexual married couples in these states usually file joint returns, which doesn’t provide an opportunity to split their income and qualify for a lower tax bracket, Ms. Stogdill added. In this instance, the I.R.S. is simply recognizing gay couples’ community property rights, not their union.
But the new rules won’t help all gay families — couples who earn similar incomes will generally owe the same taxes and some people who now qualify for tax credits may end up paying more.
Regardless of how it affects you, figuring out the new system will be a challenge for the very same reason many couples will benefit: same-sex couples can’t file their returns jointly, which means couples with combined finances will need to untangle what is deemed community property and what is separate.
Even Nina E. Olson, the national tax advocate who acts as an ombudsman for the I.R.S., has called the situation “ridiculously complex.”
“Taxpayers in this position must either be extremely knowledgeable about taxes or pay high fees to tax preparation experts to jump through the right hoops,” she said. “These rules place an unreasonable burden on taxpayers, and they need to be fixed.”
Indeed, getting professional help can be costly. Ms. Stogdill, for instance, charges each partner $900 per return, given the increased time it takes to complete their tax forms, compared with $600 for a married couple who files jointly.
Below, we compiled some tips for same-sex couples in the three affected states:
Figure out the state of your union. You will be subject to the new rules if you have a registered domestic partnership in Washington, Nevada or California or if you were legally married in California (during the brief window when you could marry there) and live there, or if you were legally married somewhere else and live in California.
Figure out what’s community property. Same-sex couples already must follow community property rules at the state level, but that’s easier since they can file jointly and don’t have to differentiate between what’s community and what’s separate. But on their federal returns — where they must file as single or head of household — they will need to determine which is community property and which is separate. That is difficult because there isn’t a special form to do so. Instead, couples will have to attach a spreadsheet to their return, using the guidance offered in I.R.S. Publication 555, which provides information on what qualifies as community property and income. Still, experts said there were many open questions on what qualified.
Generally speaking, community property and income need to have been acquired or earned during your partnership. So any interest income earned from, say, a certificate of deposit bought with community income must be split in half. The same logic applies to deductions (if the mortgage is paid with community income, then both partners must split the mortgage interest deduction). To do all of this, couples will need to go back and trace what’s been acquired with community money — dating back to your date of registration or marriage, whatever is earlier — and what hasn’t.
“The tricky part will be figuring out what is your separate property from before and what was added after,” Deb Kinney, an estate planning attorney in San Francisco, said on a webcast explaining the issue. For people who were recently married, she suggests taking snapshots of all accounts and then perhaps starting a separate account for community property, to keep your records clean. Then you’ll know that all interest income from those accounts are community income and must be split.
Couples with valid prenuptial agreements, however, should follow the rules outlined in that document. It might say that a certain percentage of wages will remain separate, for instance.
Are you self-employed? Self-employed people are going to run into some unique challenges. Since these individuals typically prepay their estimated tax each quarter, all of the tax payments will be made by one partner, yet the other partner will be required to report half of the income. The result? One partner will end up with a big refund, while the other partner will have a giant tax bill, Ms. Stogdill said. “We really need the I.R.S. to view these tax returns as related,” she added. “That is creating all sorts of correspondence with the I.R.S. and it’s generating penalty letters that don’t make any sense.”
She recommends writing back to the I.R.S. explaining your circumstances. And in many cases, it may help to get an expert’s help.
Consider filing an extension. If you think it’s going to take more time to file your taxes correctly, experts said couples should not be afraid to file an extension using I.R.S. Form 4868, which will give them an additional six months to file.
“If we had the option of filing jointly, it would be so much easier to comply with the federal income tax law,” Ms. Stogdill said. “ On the other hand, many of us are getting a much better deal now.”
Consider amending previous returns. Couples have the option of amending previous tax returns, which makes sense for families who expect refunds. In California, couples can amend their returns as far back as 2007, though you must generally file the amended return within three years of your original filing date. Nevada residents received community property rights in October 2009, so taxpayers can amend their 2009 returns. Washington State residents received these rights in June 2008, so returns can be amended for 2008 and 2009.
Getting help. Even people with relatively straightforward situations — perhaps where both partners collect a paycheck from an employer — might want to get a professional’s help, or at least attend a seminar or listen to awebcast offered by professionals with expertise in these issues. Several gay and lesbian organizations are also publishing their own guidance.
But even well-regarded tax programs like TurboTax are recommending that gay couples seek professional help, at least for the first year. (The TurboTax software is up to date with the new rules, but it is not equipped to provide thedetailed hand-holding that users are used to).
“This is a very complicated area in taxes and there are currently several interpretations” to the new rules, said Ashley Kirkendall, a spokeswoman for TurboTax. “Given this, we understand that many taxpayers will want and need more guidance than tax software is able to provide at this time. Because of this, we recommend couples with investments, property, pensions, rentals or a business seek professional guidance from a certified public accountant or enrolled agent.”
Here’s hoping your refund isn’t wiped out by the cost of receiving it.
If you’re in this situation, please share some of the major questions that arose when filling out your return.
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