Tax Issues When You Live in a Community Property State
How Your State's Community Property Laws Can Affect Your Tax Returns
By law, married couples jointly own their property, assets, and income in community property states. If you earn $80,000 a year, that's your spouse's income as much as it is yours. If you incur $100,000 in debt during the marriage, your spouse is legally obligated to repay it even if you contracted for it in your sole name. If you buy a $350,000 home and title it in your name alone, it doesn't matter—your spouse owns it right along with you.
Needless to say, these rules can really complicate things at tax time, at least if you don't file a joint married return. Who owes what and who can claim what?
Which States Follow Community Property Law?
There are only nine community property states as of 2020:
- New Mexico
Alaska is something of a hybrid. You can elect to treat your assets and debts as community property if you live here by signing a joint agreement to do so.
Depending on the community property state in which you live, the following rules might not apply to you exactly. There can be slight variances from state to state, and the IRS defers to state law in this situation. Married couples must follow their specific state's rules for community property at tax time.
Separate vs. Married Returns
Filing a joint married tax return simplifies things a great deal. Filing separate married returns forces both spouses to analyze their incomes to find out how much belongs to the marital community and how much, if any, belongs to each spouse separately.
Remember, income is considered earned by both spouses equally. Likewise, community deductions are considered owned by each spouse equally.
But there's a downside to filing a joint married return as well. The IRS can and will hold both spouses "jointly and severally liable" for any errors or omissions on that return. This means that if your spouse intentionally "goofs" when reporting certain information, you're just as guilty as she is according to federal law.
Rules for Community and Separate Income
The general rule when preparing a separate tax return is that spouses report half their community income on each, as well as all their separate income. This would generally be income derived from premarital investments. They would each claim half of their community deductions plus all their separate deductions.
Let's say you purchased a home years before you were married. This would be considered your separate property, assuming you didn't take any actions to "commingle" it, such as by making mortgage or property tax payments on it with money earned after the date of the marriage. That money was community money, so you've effectively blemished the separate property status of the home by adding community money to the pot.
Remember, these rules can vary slightly from state to state. If you decide to rent that property out, the rental income becomes community property in Texas, Wisconsin, Idaho, and Louisiana, even if you didn't commingle the asset. It might be your separate, premarital property, but if it earned income while you were married, that income must be divided between you and your spouse if you file separate married returns.
What About Deductions?
It's generally believed that fewer taxpayers will itemize on their tax returns beginning in 2018 due to the passage of the Tax Cuts and Jobs Act (TCJA). The TCJA has more or less doubled standard deductions. For many taxpayers, they're now more than all their itemized deductions added together, especially with new TCJA restrictions placed on some itemized deductions.
That said, what if you do decide to itemize? Who gets which deductions related to community assets if you live in a community property state?
Maybe your home is jointly owned. You want to claim the mortgage insurance deduction but you're filing separate married returns. Do you just scissor the deduction down the middle, each of you claiming half of it? Not unless both your Social Security numbers appear on the Form 1098 you received from your lender. You must be contractually liable for any deduction you want to claim on your separate return.
And if one of you decides to itemize your deductions on your separate tax return, you must both do so. Federal tax law prohibits one spouse from itemizing while the other claims the standard deduction, even if you don't live in a community property state.
Another Consideration—Your Dependents
There might be other complications as well depending on your personal situation. For example, you and your spouse can't both claim the same dependents if you have children unless you file a joint married tax return. Each dependent can only be claimed by one taxpayer per year.
Of course, if you have more than one child, you can "split" them at tax time. You could claim your son while your spouse claims your daughter. This is perfectly legal. But if you have three children, who can claim the third?
Filing separate married returns can also disqualify you from claiming certain tax perks and credits, including the Earned Income Tax Credit, the Child and Dependent Care Tax Credit, the student loan interest deduction, the American Opportunity Tax Credit, the Lifetime Learning Tax Credit, and the Adoption Tax Credit. Special rules may apply, however, to the Child and Dependent Care credit for spouses living separately, in some circumstances.
You Might Want to Get Professional Help
Again, these are general rules. The Internal Revenue Service offers guidance in Publication 555 Community Property and a special worksheet in Form 8958 to help couples who live in community property states.
But even the IRS cautions that you might want to at least consult with a professional as you prepare separate tax returns. This is particularly true if you own income-producing property or if you're thinking you might want to itemize. If you decide to enlist the help of a professional, he'll probably want to run your tax returns both ways, assessing your tax liability or refund if you file jointly versus your tax situation if you file separate returns.
IRS. “25.18.1 Basic Principles of Community Property Law: Community Property Law.” Accessed June 3, 2020.
IRS. “Publication 555, Community Property,” Page 2. Accessed June 3, 2020.
Justia. “Sec. 34.77.030. Classification of Property of Spouses.” Accessed June 3, 2020.
IRS. “Publication 555, Community Property,” Page 3. Accessed June 3, 2020.
IRS. “25.18.1 Basic Principles of Community Property Law: Tax Assessment and Collection Under Community Property Laws.” Accessed June 3, 2020.
IRS. “Publication 555, Community Property,” Pages 10-11. Accessed June 3, 2020.
IRS. “Publication 555, Community Property,” Pages 3-4. Accessed June 3, 2020.
IRS. “25.18.1 Basic Principles of Community Property Law: Income From Separate Property Received During Marriage.” Accessed June 3, 2020.
IRS. “Publication 555, Community Property,” Pages 5-6. Accessed June 3, 2020.
IRS. “Publication 555, Community Property,” Pages 6-7. Accessed June 3, 2020.
IRS. “25.18.1 Basic Principles of Community Property Law: Mixing or Commingling Community Property With Separate Property." Accessed June 3, 2020.
IRS. “25.18.1 Basic Principles of Community Property Law: Comparison of State Law Differences in Community Property States." Accessed June 3, 2020.
IRS. “Publication 5307, Tax Reform Basics for Individuals and Families,” Page 4. Accessed June 3, 2020.
IRS. “Publication 936, Home Mortgage Interest Deduction,” Page 9. Accessed June 3, 2020.
IRS. “Topic No. 501 Should I Itemize?” Accessed June 3, 2020.
IRS. “Qualifying Child of More Than One Person.” Accessed June 3, 2020.
IRS. “Married Filing Separately.” Accessed June 3, 2020.
IRS. “Publication 503, Child and Dependent Care Expenses,” Pages 8-9. Accessed June 3, 2020.