Purpose. This IRM provides technical guidance regarding income reporting considerations in community property states, or cases otherwise raising community property issues.

Audience. This guidance applies to all Service employees working cases involving income reporting considerations in community property states, or cases otherwise raising community property issues.

Policy Owner. The Director, Examination - Field and Campus Policy, who is under the Director, Headquarters Examination.

Program Owner. Field Examination General Processes (FEGP), which is under the Director, Examination - Field and Campus Policy.

Contact Information. To recommend changes or make any other suggestions related to this IRM section, see IRM 1.11.6.6, Providing Feedback About an IRM Section - Outside of Clearance.

If joint returns are filed, there is little or no impact from reporting community property income. All income of both spouses is reported on the return. If separate returns are filed, each spouse reports half of each income item that is community property. Poe v. Seaborn, 282 U.S. 101 (1930). Income that is not community property is reported by the spouse who earned or accrued it.

Therefore, the characterization of income items will determine how they are reported. In the context of income items, the characterization rules are not always simple to apply. The following is a brief list of income items and their characterization. For additional information on the characterization of income see IRM 25.18.1, Basic Principles of Community Property Law.

Form 8958, Allocation of Tax Amounts Between Certain Individuals in Community Property States, is used to determine the allocation of tax amounts between married filing separate spouses or registered domestic partners (RDPs) with community property rights, as follows:

The Supreme Court, in Poe v. Seaborn, 282 U.S. 101 (1930), held that spouses receiving income that is community property and filing separate returns are each required to report half of each community property income item. This case required a spouse to report half of community property income even if the spouse had not received or benefited from any of the income. Congress enacted IRC 66 to address this problem. See S. Rep. No. 96-1036, at 8 (1980). IRC 66 grants spouse’s (or spouses’) relief from the community property income splitting requirements in certain circumstances.

Sole Proprietorship. Net income from a trade or business (other than a partnership) is treated as income of the spouse who exercises management and control over the trade or business. 26 CFR 1.1402(a)-8(a). Heidig v. Commissioner, T.C. Memo. 1986-411; Tolotti v. Commissioner, T.C. Memo. 1987-13. Management and control means actual management and control, not management and control imputed from husband to wife under community property laws. 26 CFR 1.1402(a)-8. Therefore, the self-employment tax is imposed on the spouse actually carrying on the trade or business.

Partnership. The distributive share of each married partner's income or loss from a partnership trade or business is attributable to the partner for computing self-employment tax, even if a portion of the partner's distributive share of income or loss is otherwise attributable to the partner's spouse for income tax purposes. If both spouses are partners, the self-employment tax is allocated based on their distributive share. 26 CFR 1.1402(a)-8(b).

There is limited impact of community property laws on the claiming of deductions if joint returns are filed. If separate returns are filed, in some circumstances a deduction may be required to be split between the spouses’ separate returns. The following are rules with respect to deductions claimed on separate returns:

Alimony or separate maintenance payments made prior to divorce are deductible by the payor and taxable to the payee only to the extent they exceed 50% of the reportable community property income. This is so because the payee spouse is already required to report half of the community property income, and will already be taxed on the payments. Hunt v. Commissioner, 22 T.C. 228 (1954).

If the payments exceed the payee spouse’s 50% share of the community property income, the excess is treated as being paid first from the payor spouse's share of the current community property income (which is 100% taxable to the payee spouse), and then from the couple's accumulated community property (which is 50% taxable to the payee spouse). Furgatch v. Commissioner, 74 T.C. 1205 (1980).

Withholding credits. Withholding credits from community property income are allocated 50% to each spouse. 26 CFR 1.31-1(a); 26 CFR 1.32-2(c)(2), Gilmore v. United States, 290 F.2d 942 (Ct.Cl. 1961), rev'd on other grounds, 372 U.S. 39 (1963).

Estimated Tax Payments. Estimated tax payments made in a separate declaration of estimated tax are the separate property of the spouse making the declaration. Janus v. United States, 557 F.2d 1268 (9th Cir. 1977); Morris v. Commissioner, T.C. Memo. 1966-245. These payments are separate property even if the source for them is community property. If spouses file a joint declaration of estimated tax and file separate returns, they may allocate the payments in any consistent manner that they may agree upon. If they cannot agree, and the source of the payment is known to be community property, the payment should be split. Usually, the source of the payment will not be known, however. Under these circumstances, the payments should be allocated in proportion to the tax liability reported on the returns as follows:

Earned Income Credit. Community property income splitting is disregarded in calculating the amount of earned income for purposes of the earned income credit. See IRC 32(c)(2)(B)(i). However, community property income splitting is considered in determining adjusted gross income for purposes of income limitations under IRC 32(a)(2) and IRC 32(b), if a taxpayer qualifies to file as head of household and is subject to community property laws. It should be noted, however, that these limitations are the greater of adjusted gross income or earned income. IRC 32(a)(2)(B).

There are potential disclosure problems in sharing income information between spouses filing separate returns. Generally, it is a potential disclosure violation to provide income information of one spouse to the other spouse even if it relates to community property. Exceptions exist to this general rule. For example, in the context of an audit of a husband's return, the wife's return information may be disclosed if the information is directly related to the resolution of an issue in the husband's audit. IRC 6103(h)(4)(B).

When making third-party contacts, follow direction in IRM 25.27.1, Third-Party Contact Program, which provides guidance for third-party contact notice and reporting provisions contained in IRC 7602(c) and 26 CFR 301.7602-2. These rules do not apply to contacting spouses where they have filed a joint return. Where spouses filed separate returns or no returns, contacting a spouse with respect to the determination or collection of the tax liability of the other spouse is a third-party contact for purposes of IRC 7602(c). Absent taxpayer authorization or some other exception, IRS employees must comply with the third-party contact notice and reporting provisions contained in IRC 7602(c) and 26 CFR 301.7602-2.

Allocation of income. Where spouses are living in a community property state and have not filed returns or filed separate returns and failed to report income, the Service is faced with the issue of how to allocate the income between the spouses. If the income is community property, it should be split between the spouses, and if the income is separate property, it should be taxed to the spouse who earned or accrued it.

Uncooperative Nonfilers. Often, in the case of nonfilers, the Service will have no specific information establishing whether income is community property, because the spouses are not cooperating and no other information is available. In this circumstance, state law presumes that the income is community property. For purposes of allocating income between the spouses for an examination report or a notice of deficiency, the Service will follow the state law presumption that the income is community property. All income should be split equally between the spouses, unless there is a federal preemption that requires treatment of an item as separate property (e.g., IRA withdrawals, social security benefits, etc.). In the case of an uncooperative nonfiler, where his or her spouse has filed a separate return reporting income without regard to community property, the filing spouse should be contacted to determine if community property reporting rules apply. However, if the filing spouse also does not cooperate, the state law presumption that the income is community property should be followed. If the statute of limitations on assessment is open with respect to the separate return of the filing spouse, and it appears that the return did not report income correctly, the filed separate return should also be considered for examination.

Income adjustments – filed returns. Where spouses have filed separate returns and failed to report an item of income, the Service can usually determine whether the unreported item is community property by contacting the spouses. If the spouses are uncooperative, the Service should follow the presumption that the item is community property and split it between the returns. If the spouses' returns were not filed on a community property basis, it may be necessary to adjust the returns to put them on the correct basis.

Whipsaws. In some cases, spouses will disagree about whether an item is community property, and the Service will not be able to make a determination with any certainty. In other cases, a spouse may seek relief under IRC 66. In these or any other circumstances where there is a realistic possibility that revenue will be lost if a protective position is not taken, the Service should whipsaw the income against both spouses. The whipsaw should not be set up simply because the Service has no information about the spouses' position on the issue. However, if the Service does set up a whipsaw, 100% of the item should be allocated to the spouse who earned or accrued the income as separate property, and 50% to the other spouse as community property. Since this would result in taxing more than 100% of the income, if the spouses subsequently agree to a consistent allocation or if a court imposes one, the inconsistent portion of the adjustment should be conceded. Any item whose treatment as separate property is mandated by federal law should be treated accordingly (e.g., IRA withdrawals, earned income credit, social security benefits).

Lost Revenue. Following the state presumption that income is community property can sometimes result in lost revenue. For example, assume a husband and wife do not file returns. The only income is wages in the husband's name. The Service treats the income as community property and issues notices of deficiency to each spouse allocating half of the wages to each spouse. The husband does not respond to the statutory notice and his case is closed. The wife files a petition with the Tax Court and produces a marital agreement that the husband's wages are his separate property. In that case, the adjustment to the wife would be conceded. The half of the income allocated to the wife, but actually taxable to the husband, could go untaxed. If this occurs, consideration should be given to reopening the other spouse's return to include the other half of the income. Whether the loss of revenue justifies reopening the other spouse's liability will depend on whether the failure to reopen would be a "serious administrative omission." This will depend on the same factors applicable to any other reopening, including whether there is an open statute for assessment and whether the lost revenue is sufficient to justify the administrative expense of reopening the liability. Note: If the other spouse has not filed a return, the statute of limitations for assessing the deficiency would not have begun to run. See IRC 6501(c)(3). For the criteria applicable to determining whether a tax liability can be reopened, see Policy Statement 4-3, reprinted in IRM 1.2.1.5.1, Cases Closed by District Directors or Service Center Directors Will Not Be Reopened Except Under Certain Circumstances.

If Bureau of Labor Statistics (BLS) are used in a community property state as the basis for a reconstruction of income, the appropriate family figure for the cost of living (not the BLS income figure) for the spouses and any dependents should be used. This figure should be split and half allocated to each spouse. Before BLS can be used in any case, the Service should be able to demonstrate (1) that the taxpayer did not cooperate in the audit, and (2) that there is evidence of taxable income, but no information can be readily acquired to ascertain the amount of such income.

Where a limited liability company (an “LLC”) is wholly owned by a husband and wife as community property under the laws of a state, the Service will respect the taxpayers’ treatment of the entity as either a partnership or disregarded entity. Rev. Proc. 2002-69, 2002-45 I.R.B. 831; IRM 5.1.21.10.2, Community Property Considerations.