Question about community properties and taxation

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Question about community properties and taxation

Postby redstreet » Sat Jun 15, 2013 10:59 pm

If I made money from capital gains (say, by selling stock) in say, August 2012, and then got married in December 2012 in a community property state (CA), I would have to file both federal and state income taxes as married for 2012. However, is it true that the capital gains I made in August is mine, and is not community property (assuming I keep it separately)? Edit: I'm interested in the "married filing jointly" case (both federal and state) as that results in a lower overall tax burden.

I'm asking because it seems a little weird that I would pay taxes on it jointly, but that this would not be community property. The seeming discrepancy arises from the fact that taxes consider your marital status on December 31 of the year to apply to that entire year, while community property characterization commences on the date of marriage.

Reference:
http://www.irs.gov/irm/part25/irm_25-018-001.html
Last edited by redstreet on Sat Jun 15, 2013 11:22 pm, edited 1 time in total.
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Re: Question about community properties and taxation

Postby bsteiner » Sat Jun 15, 2013 11:13 pm

You are correct that if you're married at the end of the year, you're considered as married for the entire year for income tax purposes. While most married couples file joint returns (since the tax on a joint return is usually less than the tax on separate returns), you can file separate returns if you want.

In most cases, if you file a joint return, both spouses are liable for the entire tax. However, as between the spouses, you can apportion the tax on the joint return between the spouses by figuring what each spouse's tax would be if they filed separate returns, and then prorating the tax on the joint return in proportion to what the tax would have been on separate returns. For example, if H's tax on a separate return would have been $60,000, and W's tax on a separate return would have been $40,000, but they file jointly and the tax on the joint return is $90,000, then H's share of the tax is 60% of $90,000, or $54,000, and W's share of the tax is 40% of $90,000, or $36,000. Treas. Reg. § 20.2053-6(f): http://www.gpo.gov/fdsys/pkg/CFR-2010-t ... 2053-6.pdf .

As a practical matter, most couples usually don't go through this exercise. However, some couples (mainly in second marriages) keep their finances sufficiently separate that they do, especially after one spouse dies and it's the executor of the deceased spouse and the surviving spouse.
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Re: Question about community properties and taxation

Postby BolderBoy » Sat Jun 15, 2013 11:15 pm

You can file "married filing separately" on your federal return and apportion income and deductions to whom each accrued what. I presume California has some sort of similar filing provision.
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Re: Question about community properties and taxation

Postby redstreet » Sat Jun 15, 2013 11:29 pm

bsteiner wrote:While most married couples file joint returns (since the tax on a joint return is usually less than the tax on separate returns), you can file separate returns if you want.

In most cases, if you file a joint return, both spouses are liable for the entire tax. However, as between the spouses, you can apportion the tax on the joint return between the spouses by figuring what each spouse's tax would be if they filed separate returns, and then prorating the tax on the joint return in proportion to what the tax would have been on separate returns.


Very interesting, thanks for the info! I am mainly interested in the question of whether the income gained prior to the marriage is considered community property if the taxes on that income (along with all income for the year, before and after marriage) were filed married, filing jointly. Do you know if it is required to apportion the tax on the joint return in order for it to not count as community property?
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Re: Question about community properties and taxation

Postby Frengo » Sat Jun 15, 2013 11:31 pm

The two things are covered by different statutes.
Community property concerns possession.
Taxation covers income.
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Re: Question about community properties and taxation

Postby redstreet » Sun Jun 16, 2013 12:09 am

BolderBoy wrote:You can file "married filing separately" on your federal return and apportion income and deductions to whom each accrued what. I presume California has some sort of similar filing provision.


It does, but I was mainly concerned about the case where the filing is done jointly. Sorry, I edited the OP to include this now.
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Re: Question about community properties and taxation

Postby nonnie » Thu Jun 27, 2013 5:45 pm

redstreet wrote: I am mainly interested in the question of whether the income gained prior to the marriage is considered community property if the taxes on that income (along with all income for the year, before and after marriage) were filed married, filing jointly. Do you know if it is required to apportion the tax on the joint return in order for it to not count as community property?


The answer is no-- income earned prior to the marriage is considered separate property UNLESS it is comingled with community funds--put into joint bank accounts, used to pay community debt, etc. . In a community property state you need to be careful with separate property to ensure it remains separate property. This means not comingling the funds with community funds, not paying community debt with separate property which means it is no longer separate property (there is an exception under FC 2640 in CA but you need to keep meticulous records-- see link below *), etc. In the case of income taxes, if you use separate funds to pay income taxes all that means is these funds (funds used to pay taxes) are considered community funds.

Property acquired before marriage is considered individual property. Inheritance received while married is separate property. In the case of divorce, the portion of your retirement fund earned prior to marriage is yours. Courts take the value at time of separation, deduct it from value at time of marriage and the difference becomes community property to be divided. Salary earned during the term of the marriage is community property. I would think, however,-- and you'd need to get a legal opinion on this--that bonuses received while married given for work prior to the marriage would be considered separate property.

I am not a lawyer and you shouldn't take advice from strangers on the internet but here are some links so you can do your own research.

*http://www.thurmanarnold.com/Practice-Areas/Family-Law-Statutes-Page/FC-section-2640-Reimbursements-for-Acquisition-o.aspx

http://www.courts.ca.gov/1039.htm

http://www.avvo.com/legal-guides/ugc/be ... y-property

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Re: Question about community properties and taxation

Postby redstreet » Thu Jun 27, 2013 5:59 pm

Thanks very much, Nonnie. I'm reading through the links your provided right now.

One question about your post:
nonnie wrote:In the case of income taxes, if you use separate funds to pay income taxes all that means is these funds (funds used to pay taxes) are considered community funds.


I'm a bit confused. If I have a separate banking account "A", and my spouse has a separate banking account "B", if I wrote a check from A and my spouse from B to pay our income taxes (filed jointly), are you saying that the amount on the checks is treated as community property? I assume accounts A and B are still separate property, right? Thanks again!
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Re: Question about community properties and taxation

Postby ResearchMed » Thu Jun 27, 2013 6:53 pm

redstreet wrote:Thanks very much, Nonnie. I'm reading through the links your provided right now.

One question about your post:
nonnie wrote:In the case of income taxes, if you use separate funds to pay income taxes all that means is these funds (funds used to pay taxes) are considered community funds.


I'm a bit confused. If I have a separate banking account "A", and my spouse has a separate banking account "B", if I wrote a check from A and my spouse from B to pay our income taxes (filed jointly), are you saying that the amount on the checks is treated as community property? I assume accounts A and B are still separate property, right? Thanks again!


Will you have a checking account (and possibly savings and other accounts) for A, for B, and for "both" (for mortgage, vacations together, or other shared expenses)?
That way, the "AB" account is clearly joint, but you can each contribute as much or as little as needed to cover the expenses, and you can deposit into it either 50/50 or apportioned some other way that suits both of you.

Have you considered a pre-nup?
It sounds like that is where this is heading, although it can be a rather tension generating exercise.
Are you both in agreement about all of this? If it's been discussed and both of you agree, then you are way ahead already. But that's while the courtship is still going on, and IF any problems arise along these lines, by definition things wouldn't be nearly as cordial or cooperative.

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Re: Question about community properties and taxation

Postby nonnie » Thu Jun 27, 2013 9:23 pm

redstreet wrote:Thanks very much, Nonnie. I'm reading through the links your provided right now.

One question about your post:
nonnie wrote:In the case of income taxes, if you use separate funds to pay income taxes all that means is these funds (funds used to pay taxes) are considered community funds.


I'm a bit confused. If I have a separate banking account "A", and my spouse has a separate banking account "B", if I wrote a check from A and my spouse from B to pay our income taxes (filed jointly), are you saying that the amount on the checks is treated as community property? I assume accounts A and B are still separate property, right? Thanks again!


It is a bit confusing--sorry.. The accounts themselves remain separate property as long as they are separate accounts. What I'm trying to get at is that once you pay a "community" debt using separate funds, you've relinquished the funds used to pay the debt. Make sense? For instance, if you used funds from your checking account "A" to pay a joint credit card bill (CC in both of your names) or even a spouse's individual CC bill, it's assumed you are "contributing" those funds to the community or to your spouse. You can find examples of "danger" areas in the links I sent and there are plenty more online-- sometimes it's the little things you don't think about.

Any more questions-- ask away. I''m a double divorce veteran as is my partner (four between us but this time we're getting it right :-) although I'm still not ready to take the marriage plunge. He was able to take advantage of FC 2640 to get back 50% of his separate inheritance he had contributed to the community. In his case it was fairly easy to track because it had gone toward a huge house remodel that happened only a year before the divorce.

Advice you haven't asked for :happy -- you may very well want to get a pre-nup or a post-nup. You may find that separate bank accounts and credit cards are sufficient for you. That's what we do plus we have several joint credit cards we use for joint expenses. I have a spreadsheet to track expenditures for monthly expenditures that can't be paid by credit card and are paid by one or the other of us--some utility bills, insurance, property taxes or miscellaneous stuff that comes up from time to time plus payment on our joint credit card and we settle up at the end of the month. It takes less than 15 minutes to track. We find it easier to do it this way than each of us writing a check for one-half of these bills. Yes, the person that writes the whole check for the property taxes or the joint credit card is "hanging out there" until reimbursed but for us, it's a matter trust and convenience.

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Re: Question about community properties and taxation

Postby Kevin M » Thu Jun 27, 2013 9:38 pm

Note that earnings on separate property are also separate property as long as they are not commingled. So if you go into a marriage with a savings or investment account, or inherit money and put it in a separate account, the dividends, interest, and capital gains are separate property.

I personally wouldn't worry about where your tax payments come from as long as you both are OK with it. If you pay taxes from a separate property account, that account remains separate property.

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Re: Question about community properties and taxation

Postby nonnie » Thu Jun 27, 2013 10:22 pm

Kevin M wrote:Note that earnings on separate property are also separate property as long as they are not commingled. So if you go into a marriage with a savings or investment account, or inherit money and put it in a separate account, the dividends, interest, and capital gains are separate property.

Kevin


But for tax purposes the earnings if you live in a community property state, are only *separate" (again, just for tax purposes) if you don't file a joint return, right? Otherwise, my head will explode!
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Re: Question about community properties and taxation

Postby Alan S. » Fri Jun 28, 2013 12:29 am

nonnie wrote:
Kevin M wrote:Note that earnings on separate property are also separate property as long as they are not commingled. So if you go into a marriage with a savings or investment account, or inherit money and put it in a separate account, the dividends, interest, and capital gains are separate property.

Kevin


But for tax purposes the earnings if you live in a community property state, are only *separate" (again, just for tax purposes) if you don't file a joint return, right? Otherwise, my head will explode!


No, not correct. Filing a joint return will not result in otherwise separate property being changed to CP. Otherwise, in a CP state a spouse that inherited assets could never file jointly again and maintain the separate status. If you want separate property to remain so, it helps to title the accounts as "name, as his sole and separate property". It helps to keep things straight so you don't commingle things by mistake, but is not legally conclusive should it later be proven that the "separate" titling was improper.
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Re: Question about community properties and taxation

Postby frugaltype » Fri Jun 28, 2013 12:50 am

ResearchMed wrote:Have you considered a pre-nup?
It sounds like that is where this is heading,


Actually it sounds like there's a Mrs. redstreet who is about to become an ex-Mrs. redstreet.
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Re: Question about community properties and taxation

Postby nonnie » Fri Jun 28, 2013 2:51 am

Alan S. wrote:
nonnie wrote:

But for tax purposes the earnings if you live in a community property state, are only *separate" (again, just for tax purposes) if you don't file a joint return, right? Otherwise, my head will explode!


No, not correct. Filing a joint return will not result in otherwise separate property being changed to CP. Otherwise, in a CP state a spouse that inherited assets could never file jointly again and maintain the separate status. If you want separate property to remain so, it helps to title the accounts as "name, as his sole and separate property". It helps to keep things straight so you don't commingle things by mistake, but is not legally conclusive should it later be proven that the "separate" titling was improper.

Please note I was only talking about the earnings. I didn't say anything about separate property
being changed to CP merely by declaring earnings on a joint return.

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Re: Question about community properties and taxation

Postby ResearchMed » Fri Jun 28, 2013 9:45 am

frugaltype wrote:
ResearchMed wrote:Have you considered a pre-nup?
It sounds like that is where this is heading,


Actually it sounds like there's a Mrs. redstreet who is about to become an ex-Mrs. redstreet.


Forgot that, by the time I entered a reply. :oops: Thanks!

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Re: Question about community properties and taxation

Postby Kevin M » Fri Jun 28, 2013 7:04 pm

nonnie wrote:
Kevin M wrote:Note that earnings on separate property are also separate property as long as they are not commingled. So if you go into a marriage with a savings or investment account, or inherit money and put it in a separate account, the dividends, interest, and capital gains are separate property.

Kevin


But for tax purposes the earnings if you live in a community property state, are only *separate" (again, just for tax purposes) if you don't file a joint return, right? Otherwise, my head will explode!

I'm not an accountant, but I simply wouldn't worry about it at all from a tax perspective. I'd just report all income, whether from CP or separate assets, the same way on the joint return.

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