Property rights are determined by state law and, historically, federal tax law has respected state property rights. California is one of nine community property states that have treated married couples as having equal ownership of income and assets derived there from during their marriage.

Until recently, we had little or no explicit guidance on how Registered Domestic Partners (“RDPs”) accumulation of community property would be treated by the IRS. The only utterance from the IRS was in a Chief Council Advisory (“CCA”) issued in 2006 that indicated each earner would be responsible for income tax owed on earnings during the relationship. Many practitioners felt that this CCA was issued in error, yet it was all we had to go by until May 28, 2010, when the IRS issued CCA 2010210.

In CCA 2010210, the IRS has affirmed that they will respect the state law characterization of community property for RDPs, so that, like opposite-sex married couples, when each RDP earns money, the other has an automatic vested right to one-half of the income. Moreover, the CCA affirmed that this shared ownership is, rightfully, neither a gift nor income between partners.

In light of this recent CCA, California RDPs must now report one-half of the community income, whether earned or unearned, on her or his federal tax return. Those who are on extension for 2009 and who have not filed as of June 1, 2010, must comply with the new regulations. In addition, those RDPs who choose to do so may amend their previous filings (2007-2009). People on extension, may split income this year or file as they always have.

For many RDPs this may be advantageous, as they may fall into lower federal tax brackets when the income is split on the returns, and it may even help some couples avoid having to pay alternative minimum tax (AMT).

RDPs will continue filing separate federal returns, as RDPs may not (yet) file a joint federal return, which has advantages and disadvantages particular to each family and its circumstances. Generally, separate returns tend to be taxed at a slightly higher rate (sometimes referred to as the “marriage penalty”). On the other hand, taxpayers filing separate returns can take separate deductions, whereas a joint filers are limited to one set of deductions.

For example, RDPs with mortgages greater than $1M may each deduct one-half of the mortgage interest deduction up to $1M. Other adjustments to the returns may include greater use of previously suspended passive activity losses from rental real estate, and greater use of capital losses, up to $3,000 each. In addition, couples with two (or more) children who have previously qualified as heads of household may presumably be able to continue to take that deduction for each RDP.

Absent a pre-nuptial or pre-registration domestic partnership agreement, assets acquired with earned income during a Registered Domestic Partnership are Community Property (“CP”),and are presumed to be owned equally by both partners. Without the unlimited martial deduction, however, RDPs may still not be able to share previously owned assets or inheritances without incurring a gift tax liability because changing Separate Property (“SP”) to CP, or vice versa, is a “transmutation” of its character, and may still be a taxable event for RDPs.

Because it is now clear that the decedent only owns one-half of a community property asset at her or his death, this CCA does, however, support the position we have been advocating with our clients, and gives us legal basis to exclude one-half of the community property from a decedent’s estate. This will become even more important if the amount exempt from estate taxes decreases to $1,000,000 in 2011.

Because of the complexity caused by the unequal treatment of same sex couples, we have been doing forensic accountings, when necessary, to identify and determine which assets are in fact SP, and which are CP. and, therefore, are not owned entirely by the decedent or her or his estate. For RDPs who have been registered and accumulating CP for 10 years, at most, but have been in a relationship for multiple decades, such a process can be laborious, but it is certainly better than paying a 55% estate tax on the one-half of CP assets that are truly the surviving partner’s property. Opposite-sex married couples pay no estate tax at the first death.

The CCA does not address the issue of how same sex couples who are not RDPs but who are also accumulating CP during their relationship should file or how their respective property rights might be treated. There is some who would argue that DOMA (the Federal Defense of Marriage Act) precludes the IRS from being able to recognize same sex couples for tax purposes. However, based on the reasoning in this most recent CCA, one could easily infer that the IRS should also recognize CP rights of same sex married couples, as these are property rights determined by the state itself, which is different from the IRS recognizing or condoning a same sex marriage.

If you are married and not registered, please feel free to contact our office to discuss the possible implications- tax and otherwise. More questions, some without obvious answers, are bound to arise in the near future, but we are hopeful that the IRS will continue to find ways to be consistent with state law and, eventually, to put all LGBT legally recognized families truly on par with their opposite sex counter parts, making tax reporting, asset accumulation, estate planning, and even allocation at divorce, much easier to understand and without the “tax penalties” that continue to be imposed simply because of unequal treatment. No doubt, the dial is going in the right direction.