When a married couple files taxes separately, the issue of community and separate property may arise. Here, you'll learn more about property division if you choose the married filing separately option.

Separate property includes property owned by either spouse before marriage or acquired afterward by a gift, bequest, devise, or descent, together with the rent, profits and income derived from this property (Winship, (1947) 8 TC 744). Some states characterize income from separate property as community income. These states include Idaho, Louisiana, Texas, and Wisconsin.

Community property is all property (other than separate property) acquired after marriage by either spouse, including all real and personal property within the state, and personal property situated outside the state but acquired while the parties were domiciled within the state. It includes property acquired by purchase. However, a decree of separation or divorce will turn community property into separate property. Earnings from community property assets retain their character as community until such time as the asset is awarded to one spouse.

Personal Property Acquired in a Non-community Property State - If a spouse acquires personal property while domiciled in a non-community property state, it remains the separate property of that spouse even though the couple thereafter moves to CA (Shea v. Com., (1936, CA9)).

Wages – Earned income from personal service received by a husband and wife domiciled in a community property state is generally community income during the period the community is in existence. Thus wages are community income during the period the community is in existence and must be split evenly.

Credit for Tax Withheld on Wages - Reg § 1.31-1(a) - If a husband and wife domiciled in a State recognized as a community property State for Federal tax purposes makes separate returns, each reporting for income tax purposes one-half of the community wages received during the tax year, the credit for tax withheld on the community wages that are reported on separate returns is taken one-half by each spouse.

Wage FICA Withholding – The FICA withholding cannot be allocated. It has already been reported to the Social Security Administration and credited under the SSN of the individual who actually earned it.

Net Earnings from Self-Employment – Where the net self-employed earnings of a taxpayer is community property, then:

Estimated Tax Payments

Multi-Year Compensation - Where compensation is paid for several years' services, the part attributable to services while the taxpayer was a resident of a non-community property state is separate income (Loew (1946) 7 TC 363, acq.).

Unemployment Income – Since unemployment income is a substitute for current earnings it is treated as community income.

Disability Income – Since disability income is a substitute for current earnings it is treated as community income.

Dividend & Interest Income – Interest and dividend income can be either separate or community income depending whether the underlying investment that produces the income was acquired with joint or separate funds and the domicile at the time of acquisition.

Social Security and Equivalent Railroad Retirement Benefits - Are treated as the income of the spouse who receives the benefits (IRS Pub No. 555, (3/2020), pg 9).

Pension Income – Income from qualified plan distributions can be either community income or separate income based upon the amount of separate and community income used to fund the pension account. One possible proration scenario would be prorating by the respective periods of participation in the pension while married and domiciled in a community property state or in a noncommunity property state during the total period of participation in the pension.

IRA & SEP Accounts – Traditional IRAs, Roth IRAs, SIMPLE IRAs, and SEP IRAs are separate property by law, thus:

Lump Sum Distributions – Community property rules are disregarded for qualifying lump sum distributions where the 10-year averaging option is utilized.

Federal Civil Service Retirement – Whether a civil service annuity is separate or community income depends on the employee’s marital status and domicile when the services were performed for which the annuity is paid. Even if the taxpayer now lives in a non-community property state and receives a civil service annuity, it may be community income if it is based on services performed during the period married and while domiciled in a community property state.

Partnership Income – Income from a partnership is based upon if:

Tax-Exempt Income - Community income exempt from federal tax generally keeps its exempt status for both spouses. For example, under certain circumstances, income earned outside the United States is tax exempt. If either spouse met the conditions that made the income exempt, the income retains its exempt status for both.

Military Compensation

When determining the domicile of a servicemember and the servicemember’s spouse keep in mind two laws pertaining to their domicile:

“Election—For any taxable year of the marriage, the spouse of a servicemember may elect to use the same residence for purposes of taxation as the servicemember regardless of the date on which the marriage of the spouse and the servicemember occurred.”

The election “shall apply with respect to any return of State or local income tax filed for any taxable year beginning with the taxable year that includes the date of the enactment of this Act.” Thus, this provision is effective for 2018 and future years.

The benefit of this election is that a spouse of a servicemember stationed in a high-income tax state can elect the state of residency of the servicemember whose resident state has no or low state income tax and then will not be subject to the state taxes where his or her spouse is stationed. Previously, under the Military Spouses Residency Relief Act of 2009, a military spouse could claim the same resident state as the servicemember only if the spouses had the same domicile and the nonmilitary spouse moved to be with the servicemember.

Gains & Losses – Gains and losses are classified as separate or community depending on if the gain or loss was from separate or community property.

Income Derived from Capital – Capital can be either separate or community property and income derived from capital follows ownership. Thus community property generates community income and separate property generates separate income.

Coverdell Education Savings Account (ESA) Distributions – ESAs, like IRAs, are by law separate property, and the distributions are reported to the individual who owns the account.

Cancellation of Debt – Treatment generally follows state law. Generally personal debt will be community debt and business debt depends upon whether the debt is secured by community or separate property such as a business or rental.

Alimony - Note: For federal tax purposes, alimony from divorce decrees entered into after 2018 is not taxable to the recipient nor deductible by the payer (a TCJA change). This treatment also applies to pre-2019 agreements that are modified after 2018 and incorporate the TCJA change.

Pre-2019 Agreements (unmodified):

• Received from Former Spouse - Alimony arising from a previous marriage is treated as separate income of the spouse who receives the alimony.

• Paid to a Former Spouse

Entity Income – Where an entity produces both earned, personal services income and investment income, such as an S corporation, the earned income is community income and the investment income can be either community or separate based upon whether the ownership of the corporation is community or separate.

Marriage Voided - Where a taxpayer's marriage is void, his or her income isn't community income (Barr (1948) 10 TC 1288).

Drug Trafficking – Income derived from illegal sources by one spouse, even without the knowledge of the other, is community income (Costa, TC Memo 1990-572).

Stock Options - A stock option for services rendered while a taxpayer was domiciled in a non-community state, and amounts, under a profit-sharing contract, earned by the taxpayer while a resident of a non-community state, are separate property (Veit, (1947) 8 TC 809, acq.).

Dependency – When community funds are used to provide support, the spouses can agree to claim dependencies in any manner they can agree upon. Where the spouses are separated and one spouse has legal custody of a child, then the custodial parent would need to formally waive the dependency to the noncustodial parent for the noncustodial parent to be able to claim the child as a dependent.

Deductions – Generally deductions are allocated by whether they were paid for with community or separate funds. Deductions paid from jointly held accounts are allocated as paid from community funds.

Personal Expenses – Expenses that are paid out of separate funds, such as medical expenses, are deductible by the spouse who pays them. If these expenses are paid from community funds, divide the deduction equally between the spouses.

Business and Investment Expenses - Expenses incurred to earn or produce community business or investment income are generally divided equally between the spouses. Expenses incurred by a spouse to produce separate business or investment income is deductible by the spouse who earns the corresponding separate business or investment income. Note: prior to 2018, investment expenses were deductible as miscellaneous itemized deductions subject to 2% of AGI reduction; for years 2018-2025 these miscellaneous deductions are suspended for federal tax purposes per the TCJA.

Child Tax Credit - Only one parent can claim the child tax credit with respect to a qualifying child, and that would be the parent who claims the child as a dependent. Where the spouses are separated and one spouse has legal custody of a child, then the custodial parent would need to formally waive the dependency to the noncustodial parent. In either case, if married filing separately the AGI phase-out is half that of married filing jointly.