Community Property Laws by States
How Your State's Community Property Laws Affect Your Tax Return
You probably know the basics if you're married and live in one of the community property states. Married persons legally own their property, assets, and income jointly in these 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.
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?
Perhaps fortunately, there are only nine community property states where couples have to deal with certain issues if they want to file separate married returns: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.
Alaska is something of a hybrid. You can elect to treat your assets and debts as community property if you live there by signing a joint agreement to do so. Few residents do so, however.
What Does Community Property Law Mean to Your Tax Return?
The rules in all nine community property states are not absolutely identical. There are subtle variances, although some general rules apply. Married couples must follow their specific state's rules for community property at tax time.
Filing a joint married tax return simplifies things a great deal, but both spouses must analyze their income to find out how much belongs to the marital community and how much belongs to each spouse separately when they decide to file separate married returns. Remember, community income is considered to be earned by both spouses equally.
Likewise, community deductions are considered owned by each spouse equally.
The general rule when preparing a separate tax return is that the spouses report half of their community income on each, as well as all of their separate income. This would generally be income derived from premarital investments. They would each report half of their community deductions plus all of their separate deductions.
It all sounds basic enough, but it can get tricky.
Rules for Community and Separate Income
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" the asset, such as by making mortgage or property tax payments on it with money earned after the date of the marriage. That money was community property so you've effectively blemished the separate property status of the home by adding that community money to the pot.
Now what happens if you decide to rent that property out? Is the rental income community property even if you didn't commingle the asset? It is if you live in Texas, Wisconsin, Idaho or Louisiana. It might be your separate, premarital property, but if it earned income while you were married, that income must be divided between you if you file separate married returns.
What About Deductions?
It's generally believed that the introduction of the Tax Cuts and Jobs Act in 2018 will mean that fewer taxpayers itemize on their returns. After all, the standard deductions have more or less doubled. For many taxpayers, they're now more than all their itemized deductions added together.
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.
This Might Not Be Something You Want to Handle Alone
Again, these are general rules. They might not apply to you exactly depending on where you live. The Internal Revenue Service offers a special worksheet for couples who live in community property states in to help guide you.
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.
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.
Here's something else you might want to consider: If one of you decides to itemize your deductions on your separate tax return, you both must do so. Federal tax law prohibits one spouse from itemizing while the other claims the standard deduction.
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. You might find that it's really not worth all the trouble to file separate returns, particularly because this can disqualify you from certain tax perks and credits.