IRS Improving Domestic Partner Status

In late May, the Internal Revenue Service adopted a new position regarding taxation of registered domestic partners in its Private Letter Ruling 201021048 (the “PLR”).   See Pender, Kathleen, “IRS adopts state domestic-partner property law,” San Francisco Chronicle (June 3, 2010) available at SFGate.com.   Previously, the IRS did not apply California community property principles to registered domestic partnerships in terms of federal tax law since “[t]he relationship between registered domestic partners under the California Act is not marriage under California law.”  See IRS Chief Counsel Advice 200608038.

However, now the IRS will treat the income earned by California registered domestic partners as community property income for federal income tax purposes.   This means that each partner must report to the IRS one half of the total income earned between the two partners, not just his or her separate income.   While this does not change the format in which the domestic partners must file their California state taxes, it may have significant federal tax benefits for partners with very disparate incomes.

Furthermore, the two main areas of the federal transfer tax system affecting registered domestic partnerships—gift taxes and estate taxes—could also change.   Due to the federal government’s disallowance of a marital deduction between domestic partners, domestic partners’ ability to use many commonplace estate planning vehicles was stymied.  For example, because of an unlimited marital deduction, heterosexual married couples avoid gift taxes when they transmute their separate property into community property.  However, this ease is not available to domestic partners.   By a strict reading of the code provisions, any lifetime transfer or payment by one same sex domestic partner to the other, above the annual exclusion (currently at $13,000), would be a taxable transfer.  Also, any transfer at death by a same sex partner would be subject to estate tax without an offsetting deduction.

Now, the logical next step would be for the IRS to expand its policy to these types of transfers with regard to domestic partnerships.  In such a case, transfers of community property assets from one partner to another will not be considered taxable transfers (like in a marriage).

For now, however, the ruling only applies to income earned.   In other words, if domestic partners have been keeping separate bank accounts to avoid the threat of taxation lest the funds be mingled, this will not be necessary any longer.  Partners now have more freedom to transfer half of earnings during the partnership to the other partner without the fear that they will be considered a taxable transfer.  The decision is a significant step for domestic partners, but still only applies to future earnings and those since 2007.   Also, significant ambiguity persists regarding how the ruling will affect gay couples who married in California when it was legal to do so but did not register as domestic partners.

The Janssen Law Firm encourages domestic partners in Humboldt County to keep abreast of the changes to these tax laws.   A good attorney is essential for sorting out the current laws and planning the best strategies for you, your family, and your estate plan.

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