IRS Issues Favorable Tax Ruling for Domestic Partners

In a dramatic change of course, the IRS has finally issued two rulings that declare that the federal tax authorities will honor the community property aspects of California’s domestic partnership registration status. Because California’s registration is a marriage-equivalent status, income earned post-registration by either partner is considered community property, and is co-owned 50/50 by the two partners. Because the federal government generally does not recognize same-sex marriages or partnerships, there has been great uncertainty as to how to handle the sharing of such income between same-sex partners. This can be a problem while the couple is together (when they file their income tax returns), but also if the couple breaks up (and divides up the community property savings) or if one partner dies and the other one inherits the community property savings.

In a private letter ruling and a subsequent Chief Counsel Advisory, the IRS has ruled that federal tax law respects state law property and asset determinations, and so state-registered partners should each report and pay taxes on 50% of the community property income – just as is the case for straight married couples, and just as it is handled by the California tax authorities. And, because the non-working partner “acquires” his or her 50% by operation of law, it is not considered to be a gift or a second “earning” that would trigger any additional tax obligation.

While these rulings do not expressly deal with the issues of dissolution or death, partners should be confident that the IRS will continue to defer to California law when community property assets are transferred in these situations — and thus will not impose any additional tax burdens on the non-earning partner.

There are still many tax-related issues that have not been resolved. For example, these rulings do not deal with couples that married (either before or after Proposition 8 was passed) but did not state-register as domestic partners — though it is most likely that they will be protected by the same legal doctrine that was relied upon in these rulings. The rulings also do not address the more complicated problems of payment of spousal support after a dissolution, or the division of savings or an asset that was acquired prior to registration and thus is not community property. And, the rulings do not deal with the problems couples in non-community property states may face in the event of a dissolution or death of a partner.

However, the encouraging rulings that have recently been issued give us reason to be optimistic about these complicated situations. It is likely that there will be additional rulings emerging in the next year or so; and if the Defense of Marriage Act is repealed by Congress, most of these lingering discriminatory policies will be history.

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