COMMUNITY PROPERTY STATES.
Community Property States
Community property states treat marital income differently than other states (which are sometimes
called common law states). As a result, the tax law has special rules for community income. The IRS
Restructuring and Revision Act of 1998 revised the treatment of spousal liability, and includes rules for
community property states.
Special rules apply to spousal property and income in the community property states:
• New Mexico
You can learn more about tax
reporting in community property
states by obtaining IRS Publication
Some or all income earned by one spouse may be community income in these states. As a general rule,
that means the tax rules will treat this income as if each spouse earned half of it. If you and your spouse
file separate returns, each of you has to report half of the community income. In addition, you would
report half of the income produced by any property that's treated as community property (for example,
savings bonds that are purchased with community income). You would also report the entire amount of
any income you have that's treated as your separate income under the laws of your state.
If you live in a community property state you'll be subject to somewhat different rules for spousal
liability (and relief from spousal liability).
Joint Tax Returns
If you file jointly with your spouse, you'll generally obtain relief from spousal liability under the same
rules that apply to taxpayers in common law states (states that do not have community property laws).
The new law provides:
"Any determination under this section shall be made without regard to community property laws."
This means that any item that would otherwise be attributable to your spouse won't be split between
you because it happens to relate to community income. However, as we understand this provision, it
doesn't prevent you from being taxable on your half of the income produced by community property.
Example: Your spouse fails to report some of the income from your spouse's business. In addition, your
return doesn't include the income from mutual fund shares your spouse bought with community
income. Under the rules providing relief from spousal liability, you don't have to treat half of the
business income as your own. But half of the income from the mutual fund is yours, because the
income was produced by property you own jointly with your spouse.
Apart from splitting income that's produced by property you own jointly with your spouse by virtue of
the community property laws, you should apply the rules described in other pages of this guide to relief
from spousal liability as if you lived in a common law state, not a community property state.
Liability on Separate Returns
Normally you aren't liable for tax relating to your spouse's income if you file separate returns
(assuming there's no fraudulent transfer of assets from your spouse to you). But if you live in a
community property state, you're required to report half of the community income earned by your
spouse on your return. If the IRS determines that the community income earned by your spouse was
greater than you thought it was, you can be liable for tax on your share of that income even though you
filed a separate return.
The tax law provides relief from liability for tax on community income on separate returns under
rules similar to the Innocent Spouse Rule. The tax law also provides that the IRS can impose tax solely
on one spouse if that spouse treats community income as his or her own and fails to notify the other
spouse of the amount and nature of the income before the due date of the return for that year. The 1998
tax law added a new provision under which the IRS can grant relief where it would be inequitable to
collect the tax even though the taxpayer doesn't qualify for relief under the general rule.
We don't expect the IRS to use this rule in every instance where the taxpayer feels that the law is
unfair. Yet there are likely to be situations where the facts are particularly appealing and the IRS
actually wants to provide relief. Before the 1998 tax law, the IRS had little choice but to enforce the
law as it was written. Now the IRS can exercise discretion in appropriate cases.
by Kaye Thomas
May 12, 2002