In 2010, the IRS made drastic changes to the filing requirements for Registered Domestic Partners (RDPs) in Washington State. Didn’t know about these changes? You are not alone. It was a scramble for many in 2011. Some learned of the changes just before the filing deadline, while others remained unaware until after they had filed their returns.
During the 2010 tax year, the IRS began to acknowledge the community property rights granted to Washington RDPs under state law. At first, a federal agency recognizing same-sex relationships sounded exciting. It soon became clear however that the IRS is certainly not recognizing these relationships. Rather, they are simply allocating and taxing income according to who Washington says it belongs to. This is not to say that the new rules are a bad thing. While they still fail to provide the same tax protections afforded spouses, the new rules are beneficial to many RDP taxpayers. The trouble is that they are confusing and burdensome to follow.
For spouses, who are able to file jointly, community property does not pose a problem. Everything is combined onto one return so it doesn’t matter whose is whose. For RDPs, who cannot file jointly, recognition of community property is a big problem. In a community property state, the old adage “what’s mine is yours, what’s yours is mine” is true, and it applies to income. The question then becomes how to report this income for tax purposes.
Let’s start from the beginning. This is not the first time that taxpayers have been faced with this problem. The community property concept dates back to early Germanic tribes, long before the advent of joint tax returns. Community tax reporting issues first arose in the 1930s when a man by the name of Seaborn, coincidentally from Washington, reported only half of his wages to the IRS. Seaborn reasoned, and rightly so, that he should only have to pay tax on half of the income since, according to state law, only half of it was his. The IRS disagreed and assessed interest and penalties on his return. A series of legal battles then began and the US Supreme Court eventually ruled in Seaborn’s favor. As a result, Congress amended the tax code and created joint tax returns.
Once spouses were able to combine income onto one return, the issue was largely forgotten. Then, seventy five years later, California became the first state to grant community property rights to same-sex couples and a similar tax reporting problem arose. The first arguments for RDP community property recognition began in 2005. When the IRS responded, one year later in 2006, they said that the precedence created by the Seaborn case only applied to spouses and that RDPs are not spouses as defined by the Defense of Marriage Act (DOMA). After several court cases in the state of California, culminating in May of 2010, the IRS finally changed its position. Now, same-sex spouses in California, and by default RDPs in Washington and Nevada, are required to file according to community property rules.
Unfortunately, there is very little IRS instruction on how to follow these rules. To date, the only guidance is an FAQ page and a publication that was originally written for spouses who are married filing separately. The IRS merely inserted “Or RDP/Same Sex Spouse in California” throughout the text of the publication and, thanks to DOMA, much of it is inapplicable as it is filled with explanations of rules that only apply to spouses.
Luckily, once you figure out how to file the return, and what numbers to put on it, the end result may be a larger refund. Those who benefit most are couples in which one partner is a significantly higher earner than the other, or those in which one partner does not work at all. In these situations, when the incomes are combined and split, because most income is community income, the income is taxed at a lower rate. For example, if one partner makes $100,000 and the other $0, and it is all community income, each partner will report $50,000. The tax rate is lower at $50,000 than it is at $100,000. This means that the entire $100,000 is taxed at a lower rate, resulting in less tax owed. In the example above, even a 2% drop in tax rate could mean a $2,000 savings.
Additionally, the IRS is allowing, but not requiring, taxpayers to amend prior year returns in order to apply the rules retroactively. You may want to consider amending your 2009 and 2010 returns. If the new rules would have resulted in a larger refund in one of these years, amending may get you a check from the IRS, with interest.
The new rules can be complex and there are many issues I have neglected to go into here. I’ll be posting more entries discussing these issues in more detail, along with various methods of handling them. Until then, take solace in the confusion. Many believe that these uncertainties will lead to a new federal filing status option for Registered Domestic Partners. As unsatisfying and incomplete as the new rules are, they just may be a stepping stone to marriage equality.