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California Taxing Income of Non-California Spouse – Community Property

California and the Franchise Tax Board appear to have a new target on their radar – situations where one spouse lives in California, one spouse does not, and a separate return is filed.

Overview

Community property laws dictate how property between a married couple is shared. In the U.S. these rules differ from state to state. For tax purposes, the states can be divided into two categories, community property states and common law states. There are several community property states, including California.

In a community property state, absent a pre-nuptial or post-nuptial agreement, all property and income are shared equally between spouses. These rules are not only relevant to the division of assets in the case of divorce; community property laws also affect how taxpayers must report their income on their tax return if they are married and file separate returns. In a community property jurisdiction, you must report half of all community income and all of your separate income on your return.

For couples both living in California, these rules can be straightforward.  However, these rules are equally relevant, and a bit more complicated, to married couples where one spouse is living and working out of state, and the other spouse is in California. Whether the other country follows a community property legal regime may be relevant to whether the U.S. resident spouse must report half of the foreign earned income on their U.S. return.

One Spouse Living Outside California

The law of the state or foreign country where the non-California spouse is domiciled will determine if they have community property or not.  Domicile has a special meaning in a legal context and a person’s domicile can be different from the place they reside. There are several factors that are evaluated to determine domicile.  Generally, spouses live together, so a spouse proving that they have a separate domicile faces an uphill battle.  One the domicile is determined; the laws of each relevant jurisdiction must be considered.  This is not always an easy analysis and may require assistance from a family law attorney.

If spouses have different domiciles, the amount of community property or income of the spouses will generally be determined by the law of the jurisdiction which has the most significant relationship to the spouse and the property. If, one spouse domiciles in a community property jurisdiction and the other does not, the wages of the spouse residing in the community property jurisdiction would likely be community income, but those of the other spouse would likely be separate income under the law of the other jurisdiction.

Conclusion

For many taxpayers who are married and file separate returns, community property laws are an aspect of tax law that can be easily overlooked. If one spouse is living and working abroad or in another state, the resident spouse may assume that the income does not need to be reported. However, community property laws may allocate 50% of the income to the resident spouse. Understanding the impact of these rules is essential to proper tax planning for married couples who file separate returns. Taxing authorities can, and do, audit taxpayers because of unreported community property income even when one spouse is living abroad. It is not safe to assume that because your spouse is out of state or out of country that the taxing authorities won’t notice. Careful planning and reporting are essential to this aspect of taxation.

 

 

Disclaimer: Hone Maxwell LLP articles and blogs are not intended as legal advice. Additional facts, facts specific to your situation or future developments may affect subjects contained herein. Seek the advice of an attorney before acting or relying upon any information herein.

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