Reporting Community Property Income on Federal Taxes
Spouses living in community property states must classify their incomes as either community income or separate income when they're preparing their federal income tax returns. They must generally follow their state's laws to determine whether a particular source of income is separate or community.
Federal law has historically deferred to state law in this regard, with some notable exceptions.
Defining Community Property States
Community property law dictates that anything acquired during the course of a marriage is owned equally between spouses, with the exception of assets or income that are received as an inheritance or are otherwise gifted to just one spouse.
Nine states recognize community property law as of 2020:
- New Mexico
Three additional states allow couples the option of electing community property law: Alaska, Tennessee, and South Dakota. Federal law doesn't distinguish between same-sex and opposite-sex married couples, but it doesn't draw a line between registered domestic partnerships or civil unions and marriages. Federal law doesn't recognize domestic partnerships or civil unions.
State community property laws aren't necessarily identical. Each can and often does put its own unique spin on certain provisions.
General Rules for Identifying Community Income
By law, community income is considered to be equally shared by a married couple regardless of who earns it. Community property is that which is acquired while married and while the couple resides in a community property state. The property can't be otherwise identified as separate property. Community income is also the income generated by such community property.
General Rules for Identifying Separate Income
Separate income is that which is considered by law to belong to one spouse or the other. This might be property that was owned separately prior to marriage, property bought with separate funds or exchanged for separate property, or property that both spouses have agreed to convert from community property to separate property through a legally valid spousal agreement. This process is referred to as transmutation.
Each spouse will report one-half of the total community income plus that spouse's separate income when they're preparing a separate federal tax return.
Separate income is income generated by separate property. There are special rules for compensation income and retirement income.
This rule can vary somewhat by state, however. Income generated by separate property is still considered community income in Idaho, Louisiana, Wisconsin, and Texas, so the only income that will be classified as separate income would be distributions from an IRA, Social Security benefits, and alimony in these states.
By contrast, income from separate property is considered separate income in Arizona, Nevada, New Mexico, and Washington.
Wages, Salaries, and Self-Employment Income
Compensation in the form of wages, salaries, commissions, and self-employment are always treated as income belonging to the marital community in community property states. Each spouse will report one-half of the total compensation income and one-half of the withholding on that compensation income when spouses file separate federal tax returns.
Investment Income Could be Community Income
Interest, dividends, rent, capital gains, and other income from investments can be either community or separate income. The answer depends on the character of the property generating the income.
The income generated by separate property is separate income, whereas the income would be community income of the property is community property, subject to the exceptions noted above. The income would be allocated as community property in the same proportion as the underlying property is community property when a property is a mix of separate and community property.
Rules for Retirement and Pension Income
Income from IRAs and IRA-based plans such as SEP-IRAs and SIMPLE-IRAs is always separate income and is allocated to the spouse who owns the IRA. Similarly, Social Security benefits are always separate income and are allocated to the spouse who receives the benefits.
Income from 401(k) plans, 403(b) plans, and other types of pensions can be a mix of separate and community income. Distributions from a retirement plan other than an IRA are characterized depending on the respective periods of participation in the pension while a couple is married and living in a community property state. The ratio is based on the time you were participating in the retirement plan or pension.
Alimony and Community Property
Alimony is taxable to the extent that the payments exceed 50% of imputed community income if one spouse is paying alimony or separate maintenance to another spouse, but only prior to their divorce being finalized.
The Tax Cuts and Jobs Act eliminated the requirement to report alimony received as income and the ability to deduct alimony from the payer's taxable income as of 2019, but this rule applies only to post-divorce alimony transactions.
Each spouse is considered to already own half the community income, so transfers of those amounts are non-taxable. Amounts in excess of the community income allocations are income to the receiving spouse and deductible to the paying spouse.
D.L. Rice, A.L. Taylor, and W.S. Ryden. "Community Property—The Rules and Their Impact on Income Tax and Estate Tax Return Reporting." Page 49. Accessed July 10, 2020.
Cornell Law School Legal Information Institute. "Community Property." Accessed July 10, 2020.
IRS. "Part 25. Special Topics, Chapter 18.8 Community Property." Accessed July 10, 2020.
IRS. "Publication 555 (03/2020), Community Property." Accessed July 10, 2020.
IRS. "Topic No. 452 Alimony and Separate Maintenance." Accessed July 11, 2020.