PLR 1021048: California domestic partners must split community income and withholding credits

Plain-English summary

The IRS ruled that a California registered domestic partner must report one-half of the combined community income earned by the partners, including compensation for personal services and income from community-property assets. The taxpayer was also entitled to one-half of the federal income tax withholding credits from the partners' wages. The IRS further ruled that California's community-property treatment of the taxpayer's earnings did not create a federal gift for gift tax purposes because the partner's ownership arose by operation of law. The ruling relied on California's treatment of registered domestic partners and the federal rule that generally respects state property-law characterizations.

Ruling snapshot

• Question: How must a California registered domestic partner report community income and wage withholding, and does the income vesting create a gift?
• Outcome: Approved
• Key authorities: IRC §§ 31, 61, 3402, and 2501; C.A. Fam. § 297.5; Poe v. Seaborn, 282 U.S. 101 (1930)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201021048 Third Party Communication: None
Release Date: 5/28/2010 Date of Communication: Not Applicable
Index Number: 31.00-00, 61.00-00, 61.30-
01, 2501.00-00 Person To Contact:
------------------------, ID No. ------------------
-------------- ----------------------------------------------------
------------------------------------- Telephone Number:
--------------------------------- ---------------------
Refer Reply To:
CC:ITA:B04
PLR-149319-09
Date: May 5, 2010

Legend

Taxpayer = --------------
Domestic Partner = -----------------
Date 1 = ----------------

Dear -----------:

This letter responds to your -------------------------, request for rulings regarding your
federal income and gift tax reporting status.

FACTS

Taxpayer uses the cash method of accounting and files federal income tax returns on a
calendar year basis.

Since 1999, California law has granted certain civil and property rights to domestic
partners who register their partnership with California. California has maintained a
registry of domestic partnerships since 2000. On Date 1 (after 2000), Taxpayer and
Domestic Partner registered with California as registered domestic partners by filing a
Statement of Domestic Partnership. Their registration is still valid.

On September 19, 2003, California enacted Assembly Bill 205, the California Domestic
Partner Rights and Responsibilities Act of 2003 (AB 205), adopting California Family
Code (CFC) Section 297.5, which became effective on January 1, 2005. AB 205
significantly expanded the rights and obligations of persons entering into a California
domestic partnership. In relevant part, CFC Section 297.5 provides as follows:
PLR-149319-09 2

  (a) Registered domestic partners shall have the same rights, protections, and
      benefits, and shall be subject to the same responsibilities, obligations, and
      duties under law, whether they derive from statutes, administrative
      regulations, court rules, government policies, common law, or any other
      provisions or sources of law, as are granted to and imposed upon spouses.

  (e) To the extent that provisions of California law adopt, refer to, or rely upon,
      provisions of federal law in a way that otherwise would cause registered
      domestic partners to be treated differently than spouses, registered domestic
      partners shall be treated by California law as if federal law recognized a
      domestic partnership in the same manner as California law.

However, CFC section 297.5(g) provided that “[e]arned income may not be treated as
community property for state income tax purposes.”

On September 29, 2006, California enacted Senate Bill 1827. Senate Bill 1827,
effective January 1, 2007, repealed CFC section 297.5(g), which provided that earned
income was not to be treated as community property for state income tax purposes.
Consequently, as of January 1, 2007, California treats the earned income of registered
domestic partners as community property for both property law purposes and state
income tax purposes.

Finally, California gives registered domestic partners the right to enter into agreements
identical to premarital agreements between prospective spouses, to modify or avoid the
application of the community property laws. Taxpayer and Domestic Partner have not
entered into such an agreement.

LAW AND ANALYSIS

Issue #1

Whether Taxpayer must report on his individual federal income tax return one-half of the
combined income that Taxpayer and Domestic Partner earn from the performance of
personal services and one-half of the combined income derived from their community
property assets.

Section 61(a)(1) of the Internal Revenue Code provides that gross income includes all
income from whatever source derived including compensation for services, including
fees, commissions, fringe benefits, and similar items.

Federal tax law generally respects state property law characterizations and definitions.
U.S. v. Mitchell, 403 U.S. 190 (1971), Burnet v. Harmel, 287 U.S. 103 (1932). In Poe v.
Seaborn, 282 U.S. 101 (1930), the Supreme Court held that for federal income tax
purposes a wife owned an undivided one-half interest in the income earned by her
PLR-149319-09 3

husband in Washington, a community property state, and was liable for federal income
tax on that one-half interest. Thus, the Court concluded that husband and wife must
each report one-half of the community income on his or her separate return regardless
of which spouse earned the income. U.S. v. Malcolm, 282 U.S. 792 (1931), applied the
rule of Poe v. Seaborn to California’s community property laws.

California community property law developed in the context of marriage and originally
applied only to the property rights and obligations of spouses. The law operated to give
each spouse an equal interest in each community asset, regardless of which spouse is
the holder of record. d’Elia v. d’Elia, 58 Cal. App. 4th 415 (1997).

By 2007, California had extended full community property treatment 1 to registered
domestic partners. Applying the principle that federal law respects state law property
characterizations, the federal tax treatment of community property should apply to
California registered domestic partners. Consequently, Taxpayer, a registered domestic
partner in California, must report one-half of the community income, whether received in
the form of compensation for personal services or income from property, on his federal
income tax return.

Issue #2

Whether Taxpayer is entitled to half of the credits for income tax withholding from the
wages of Taxpayer and Domestic Partner.

Section 3402 of the Code provides that every employer making a payment of wages
must deduct and withhold income taxes from wages (commonly referred to as federal
income tax withholding).

Section 31 provides that the amount withheld under the withholding provision shall be
allowed to the recipient of the income as a credit against the income tax imposed on
such income.

Section 1.31-1(a) of the Income Tax Regulations provides that the recipient of the
income is the person subject to the tax imposed under the income tax provisions upon
the wages from which the tax was withheld. In an example, the regulation states that if
a husband and wife domiciled in a community property state file separate returns, each
reporting for income tax purposes one half of the wages received by the husband, each
spouse is entitled to one half of the credit allowable for the tax withheld at source with
respect to such wages.

1
Prior to January 1, 2007, the earned income of a registered domestic partner was treated as community
property for state property law purposes but not for state income tax purposes.
PLR-149319-09 4

Because Taxpayer is the recipient of half of the community property income, Taxpayer
is entitled to half of the amount withheld as a credit against the income tax imposed on
the income.

Issue #3

Whether the requirement under California law, effective January 1, 2007, to treat, for
state property law and income tax purposes, Taxpayer’s earnings as community
property, and thus half of Taxpayer’s earnings as vested in his partner, results in a
transfer of property by Taxpayer to his partner for federal gift tax purposes.

Effective January 1, 2007, taxpayer’s earnings are treated as community property under
California law for state income tax and property law purposes. The Supreme Court has
concluded that when earnings are treated as community property under state law, such
earnings vest one-half in each spouse for federal tax purposes. See Poe v. Seaborn,
supra, and U.S. v. Malcolm, supra. This vesting occurs by operation of law. There is no
transfer, deemed or otherwise, by one spouse to another of community earnings.

In Poe and Malcolm, the taxes at issue were income taxes. However, the Supreme
Court’s rationale regarding the effect of state law on the characterization of Taxpayer’s
earnings applies equally to gift taxes. Therefore, the vesting of half of Taxpayer’s
earnings in his partner does not result in a transfer of property by Taxpayer to his
partner for federal gift tax purposes under § 2501 of the Code.

CONCLUSIONS

  1. Taxpayer must report on his individual federal income tax return one-half of
  the combined income that Taxpayer and Domestic Partner earn from the
  performance of personal services and one-half of the combined income derived
  from their community property assets.

  2. Taxpayer is entitled to half of the credits for income tax withholding from the
  wages of Taxpayer and Domestic Partner.

  3. The requirement under California law to treat Taxpayer’s earnings as
  community property, and thus half of Taxpayer’s earnings as vested in his
  partner, does not result in a transfer of property by Taxpayer to his partner for
  federal gift tax purposes under § 2501 of the Code.

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter.
PLR-149319-09 5

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code
provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

A copy of this letter must be attached to any income tax return to which it is relevant.
Alternatively, taxpayers filing their returns electronically may satisfy this requirement by
attaching a statement to their return that provides the date and control number of the
letter ruling.

The rulings contained in this letter are based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. This office has not verified any of the material submitted in
support of the request for rulings, but it is subject to verification on examination.

                                   Sincerely,



                                   Michael J. Montemurro
                                   Branch Chief, Branch 4
                                   Office of Associate Chief Counsel
                                   (Income Tax & Accounting)

cc: ----------------------