Discussion:Community vs. separate S-corp income
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Discussion Forum Index --> Tax Questions --> Community vs. separate S-corp income
| 22 August 2007 | |
| My client is domiciled in California and owns an S-corporation. The corp was purchased several years ago with commmunity assets prior to their separation in late 2005. The husband operates the very profitable business and draws a reasonable salary. The spouse has no involvement in the business.
My question is whether the 2006 S-corp income (other than his salary which is separate income) is reportable 50/50 by both spouses. I'm confused by IRS Pub 555 (re Community Income) which says that special rules apply to married taxpayers who lived apart all year and had earned community income. It says that income from a trade or business "that is not a partnership is the income of the person carrying on the trade or business." It then says to treat "income from a trade or business carried on by a partnership as the income of the spouse who is the partner." Where does this leave income from an S-corp located in a community property state, where the spouses were separated all year, the stock is in the name of the husband and is operated solely by him, but which was definitely acquired with community assets? Has anybody had a similar situation? | |
| 22 August 2007 | |
| In California, the amount received by the husband after separation that represents a fair return for his services is separate property. The amount of business profits that represent a return on community capital would be community property. See Witaschek v. Witaschek (App. 2 Dist. 1942) 56 Cal.App.2d 277, 132 P.2d 600. | |
| 22 August 2007 | |
| If the spouses have separated with no intention to resume the marital relationship, the husband's salary from the S corporation is his separate income under California law (Cal. Family Code Sec. 771).
I just hate IRS publications because they make all kinds of statements without citing any authority for them, which makes it hard to know where to start to figure out the answer to the NEXT question that wasn't addressed in the pub. However, here goes: IRC Sec. 66 applies the rules of IRC Sec. 879 (having to do with the division of income between spouses when one or both are nonresident aliens) to the income of spouses domiciled in a commmunity property state who are separated for the entire year and meet other requirements. Sec. 879 says income from a trade or business, or income from a partnership, is divided in accordance with IRC Sec. 1402(a)(5), which has to do with the imposition of self-employment tax. That appears to be the source of the two items on page 7 of Pub 555 (top of the right-hand column), which assign that income to the spouse who is the partner or conducts the trade or business. The distributive share of income from an S corporation, however, is not subject to self-employment tax and doesn't come under those rules. And it is not "earned income" in the sense of IRC Sec. 911(c), either (see IRC Sec. 66(d)(1). So my conclusion is that the distributive shares of S corporation income must be divided in accordance with state community property law. | |
