Tuesday, April 19, 2011

New Tax Rules for Same-Sex Couples

If you're a same-sex married couple or in a RDP (Registered Domestic Partnership) in a community property state such as California, the IRS has instituted new tax rules in 2010. It's a positive change from an equality standpoint but it does mean extra work when filing. After finishing, I wanted to share what we did. First, I'm not an accountant nor a lawyer, just a marriage equality proponent with a desire to help others navigate complex rules. For brevity, I will use spouse below to mean spouse or RDP.

I used TurboTax Premier to create a joint California state return and two federal returns. First start with the state return by importing the data from your previous year's return if you have one. Next, we want to get to the "Were You Married?" screen to select same-sex marriage or RDP. Unfortunately, this screen is somewhat hidden, but can be accessed via the "Personal Info->You & Your Family" tab and selecting the first "Edit/Start" button and then "Continue" on the following screen. Continue by creating a mock federal "married filing jointly" return, enter data for both spouses, and then complete the state tax return.

At this point, we are ready to work on the two federal returns using the completed state return as a base. Copy the data from the state return into a community property allocation worksheet. I extended one I found at class5tax.com. For the next part, there are instructions on the Intuit website. Use "Save As" to create a new return file for each spouse which is based on the state return. For each spouse, start with the "Personal Info" tab and change the filing status to "Single". Enter the adjustment amounts for wages and taxes withheld using the TurboTax instructions mentioned before. This should cause the wage adjustment to be correctly entered on 1040 line 21.

The next steps are not part of the published instructions but are based on other information I compiled. Enter the adjustments for the other parts of the return. Go to the "Forms" view and look for items such as 1099-DIVs and W-2s that are a result of the other spouse which need to be deleted. You probably need to switch back to "EasyStep" mode to delete the data. At this point, the return will only contain data for one spouse. Switch back to "Forms" view and enter the other adjustments on the appropriate forms. For example, for Schedule D, enter the short-term capital gains adjustment in Part I on a new row. Enter the long-term capital gains on a new row in Part II. Note, the negative of the adjustment value will need to be used for Spouse 2. If there isn't an extra row to enter the adjustment on, add the adjustment to the original value outside the program, then enter it into the appropriate spot on the form. In TurboTax, there is an Edit->Override menu item that allows you to change values on forms.

The California state return can be filed electronically. However, the federal returns must as of 2011-04-18 be filed by mail since TurboTax does not yet support e-filing. Each spouse's federal return should include a copy of the community property worksheet. At the top of form 1040, I added "Prepared under CCA 201021050".

One more thing I did not mention yet is separate property. I have taxable assets that are mixed in with community property and so I needed to estimate the portion which is separate property. I rebalance my portfolio each year after filing taxes in April and so I projected an estimated value of my taxable assets minus stock at the beginning of my RDP into the present. I divided this projected value by the current value of the same kind of assets. That gives a rough percentage of current separate to community assets which I used to multiply any income generated from those assets on the property allocation worksheet. To make the projection, I used the S&P 500 total return figure for the last 10 years which is around 3%. Since I have been an RDP for about 11 years, the value is (1.03)^11 - 1.

I also needed to report capital gains from stock sales. In my case, this portion of income was from the sale of my ESPP shares which can be identified as separate or community property by the purchase date of each lot.

The reason for calculating the separate property is because, unlike a heterosexual couple, the federal government does not recognize same-sex married couples so any transfer of assets would be subject to gift tax. A lawyer friend has since told me that the rule is really only enforced for super wealthy people who try to evade paying inheritance taxes. So it may be easier just to treat everything as community property like most heterosexual couples do.

Links to useful resources:

2 comments:

Peter Reilly said...

You also may want to consider filing amended returns for ealier years which the CCA made optional.

http://riles52.blogspot.com/2011/04/deadline-passes-for-some-but-not-all.html

The interesting question is whether you can just amend the return that would get a refund.

Edwin said...

Yes, it can make sense to amend previous returns. As I understand it, the deadline for 2007 has passed but that would still leave 2008 and 2009. Thanks for your comment.