IRS reverses DoMA-style interpretation of community property rights of registered partners

by on June 2, 2010  •  In DoMA, Family law

By Guest Blogger Patricia A. Cain, Inez Mabie Distinguished Professor of Law, Santa Clara University

One of my pet peeves over the past decade or so has been that the IRS has not been willing to give same-sex couples any guidance on tax issues.  That complaint has deepened as more and more states recognize same-sex relationships, accord couples property rights akin to married couples, and impose obligations of support. Property rights and support obligations are state law rules that have federal tax consequences. Spousal community property rights, for example, have had tax-favored status ever since the United States Supreme Court in 1930 agreed that community income rights, if imposed by the state, rather than by private contract, would be honored for federal tax purposes. As a result each spouse reports as income only half of the total community earnings, even if the earnings are attributable to the personal services of only one spouse. In fact, this rule is what led us to the adoption of joint returns in 1948. The effect of the joint return was to treat all married couples the same, whether they lived in community property or non-community property states. Similarly, state-imposed support obligations are recognized at the federal level and have gift tax consequences. A husband who supports a wife is not making a taxable gift. An adult child who supports a dependent parent does make taxable gifts if the support exceeds the annual exclusion. State law matters for federal tax purposes.

On January 1, 2005, California Registered Domestic Partners (RDPs) were accorded many rights and obligations equivalent to spouses. Most important, RDPs were suddenly made subject to the state’s community property regime.  This was no surprise. Californians had advance notice of this change. Assembly Bill 205 was passed in 2003, but not effective until 2005. RDPs, who were able to register statewide as early as 2000, were notified of this change and given the opportunity to decide whether they wanted to remain registered – and, if they did, were given until June of 2005 to opt out of the community property system with no adverse consequences at the state level.  California tax attorney Don Read and I were concerned about how the IRS would treat these community property rights, newly vested in RDPs, especially since the law provided that all property acquired during the registration would be retroactively classified as community property unless the couple elected the opt out provision.  With the interests of the 30,000 or so registered partners in mind, we asked Treasury to issue a revenue ruling, preferably before June 2005, that would advise California RDPs whether there might be any adverse tax consequences inherent in this new community property regime. Who would be taxed on current income? What about past income that was now reclassified? Would the reclassification result in a taxable gift? Should couples opt out to avoid taxable gifts or simply sign an agreement avoiding the retroactive application of the rule?  It would have been nice to know the answers to these questions, but we were met with silence.

The next step was to request a private letter ruling on behalf of a registered domestic partner couple. The availability of private letter rulings is a pro-taxpayer service, based on the notion that when tax law is unclear, a taxpayer ought to be able to ask the IRS for a clear rule before engaging in a transaction that might have unintended consequences.  The request is made on behalf of a particular taxpayer and the answer from the IRS is only good for that taxpayer. But in the absence of any clear rules, a single PLR would at least provide some guidance – and, we had hoped, it might lead to a public ruling that other taxpayers could rely on. That request was made in early 2005 and the IRS answer in 2007 was that it would not rule on any of the questions asked.  It did, however, in 2006 issue a Chief Counsel Advice memorandum (CCA 200608038) stating that community income from the personal services of RDPs would not be covered by the 1930 Supreme Court ruling in Poe v. Seaborn.  Instead a special rule, just for RDPs, would be applied: the income would be taxed to the earner even though under state law it belonged equally to both partners.

For four years now, tax academics and practitioners have discussed this CCA and tried to figure out how it should be applied to various situations involving same-sex RDPs. Most commentators have criticized the conclusion in the CCA as being out of line with established federal tax principles. Federal tax law does recognize state property rights and assesses tax burdens accordingly. Yes, the taxpayers in Seaborn were married under state law, but the court’s analysis was about the vesting of property rights and not about marital status.

Finally, in large part due to the persistent efforts of Don Read on behalf of his clients, the IRS has broken the silence. On May 5, in a private letter ruling, the IRS agreed that Poe v. Seaborn applies to California RDPs. And, on May 28, that ruling was made public. See PLR 201021048. The IRS also issued a Chief Counsel Advice memorandum on May 28, coming to the same conclusion, that Poe v. Seaborn applies to California RDPs. See CCA 201021050.  There are, in my view, problems with the CCA. A CCA is not authority. It is not precedent that can be cited. It seems to conclude that tax years 2005 and 2006 may be covered by a different rule than 2007 because California state income tax law taxed community earnings before 2007 to the earner (even though the earnings were otherwise treated as community property).  And the CCA does not address gift and estate tax issues or division of property at divorce issues, all of which should have a different outcome if they are fully covered by the Seaborn case.

But in the end, this is a good story. This is a change from the prior position of the IRS. And it is a change in the right direction. This is an indication that at long last the IRS is willing to acknowledge that same-sex couples exist in this country and to recognize that in some states, the rights and obligations accorded such couples are real and have real tax consequences.


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