While this might not have been on everybody’s radar, the IRS kicked down a huge decision for California same-sex couples. But PLR-149319-09 (PDF) has some big importance to California registered domestic partners and same-sex married couple. Long story short, the IRS is now recognizing California’s community property rules. And that’s big. Really big.

Let’s start from the beginning. I’m no accountant, but bear with me as I try to recall my tax class in law school.  Basically, California, like many Western states, has a default rule for marriage that any property acquired (other than through inheritance) is treated as “community property” between the two married spouses.  For California same-gender couples that got married in 2008, these community property rules apply unless you have opted out through contract (a “pre-nup”).  Also, in 2006 and 2007, the legislature passed, and the Governor signed, two pieces of legislation that granted registered domestic partnerships the same rights and responsibilities of marriage, with community property first being excluded for tax purposes in 2006, and then being completely folded in to the RDP in 2007.  

Of course, the problem here is that under the so-called “Defense of Marriage” Act, the federal government was not supposed to recognize any marriage not between a man and a woman. Thus, we had a real pickle on our hands. Under California property law, the property was community property, half belonged to both partners.  But how that property got there was anybody’s guess.  Just off the top of my head, there are a number of ways the federal government could have handled the issue:

1) Ignored community property between same gender couples entirely. Sure, it would cause conflicts with state tax issues, but who cares, according to the Yes on 8 folks, this is a future of civilization thing here.

2) Acknowledge the community property, treating  it as a gift between two unrelated partners for federal tax purposes. This would have been very bad for same-gender couples. Basically, couples would have had to pay gift tax on any difference in income over $13,000 (or so, depending on what the gift tax is that year). That would get pricy fast.

3) Acknowledge the community property, but treat it as earned jointly. Basically, each partner, for tax purposes, earned half of the income. This would be far more favorable and basically treat community property the same for all couples.

I’ll let you read PLR-149319-09 (PDF) on your own if you’d like to, but long story short, the IRS went for #3.  Once they went over the law, it seems obvious, but these things rarely are obvious before hand. And that’s the case here.  The IRS first relied on past precedent to first say that the federal goverment defers to the states to determine property law  (U.S. v. Mitchell) and then to say that California community property law determines who owns what for California couples (US v Malcolm).  Finally, the IRS simply stated that once California treated property as community property, the IRS would do so as well.

Now, in practical terms, what does this mean? Well, say you are a couple where one partner earns substantially more than the other.  You’ll have noticed that your California tax bills went down with community property. Now the same will apply to the federal government. For example, say “Adam” earns $50,000 as a public school teacher.  His husband “Bill” earns $150,000 as a investment hot-shot or something.  (No comment on our society’s priorities there.) Under this new law, each would report income of $100,000. For a variety of reasons in the tax code, that’s going to be advantageous. Now, I’m not a tax lawyer, and this isn’t specific advice.  If this is something that might apply, ask whomever prepares your taxes or some other tax professional.

There is one wrinkle in here. Technically, the IRS “private letter ruling” specifically addresses registered domestic partnerships, and uses that language. However, the ruling is entirely directed at the concept of community property, which applies in the same way for the 2008 marriages.  In theory, it should be handled the same way, but theory often gets you audited by the IRS.