taxes

Community property effects on taxes

young couple reviewing documents with advisor
Highlights
  • Nine states, including Arizona, California and Nevada, have community property laws.
  • Separate returns and divorce complicate federal filings in community property states.
  • Same-sex couples also must deal with community property issues when filing taxes.

Mark Zuckerberg was either very lucky or got very good tax advice earlier this year when Facebook went public the day before he married his longtime girlfriend, Priscilla Chan.

Under California's law, Zuckerberg's ownership stake in the popular social media site is his alone since the initial public offering occurred while he was still a bachelor.

California is one of nine community property states. The others are Arizona, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin.

Although each state's law is slightly different, the general rule is that anything you bring to a marriage is your separate property, and anything acquired by either partner after marriage belongs equally to husband and wife as community property. Exceptions typically are made to allow spouses to separately retain property that is specifically given to each as a gift or inheritance.

This "what's yours is mine" post-wedding ownership approach affects not only income, real property holdings and investment earnings, but it also could make a difference in federal tax filings and, if things don't work out, divorce settlements.

Say it 'taint' so

While it might seem simple to keep property separate, real-life actions and transactions can muddy the situation.

"You can have separate property and it can change forms," says David Rosenhouse, CPA and principal of Rosenhouse Group PC in Dallas. "Say you came into a marriage owning shares of IBM in a brokerage account that was in your separate name. You could sell those shares and buy Apple shares with the proceeds that still are separate property."

But if you moved those IBM shares into a joint brokerage account you hold with your spouse and then sold them and used that community property money to buy Apple shares, you have now, in legal terms, tainted the separate property, says Rosenhouse. The new stock purchase has in effect become community property.

"The best thing to do if you want to maintain separate property is to maintain separate property," says Rosenhouse.

That's not always easy to do, but you can help preserve an asset's separate status by keeping good records, says Leslie Dawson, CPA and partner at Glenn Dawson and Burak LLP in Walnut Creek, Calif. The documentation must be very good, says Dawson, because courts and laws favor equal ownership. "If there's any doubt, the community wins," she says.

Or you could have a prenuptial or postnuptial agreement in which both spouses specifically agree that assets that otherwise would be considered community property are separately owned by one or the other.

Uncommon, but possibly costly, tax effects

When it comes to taxes, a happily married couple in every state probably files a joint tax return. Joint filing typically produces a better tax outcome for the couples, and community property laws aren't a factor with joint filings.

If, however, you and your spouse decide to submit separate Form 1040s, look out.

"Filing separately is a miserable way to file," says Dawson, "and it's more miserable in a community property state."

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