Discussion:California Community Property Ruling

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Discussion Forum Index --> Advanced Tax Questions --> California Community Property Ruling

Discussion Forum Index --> Tax Questions --> California Community Property Ruling

Amtax (talk|edits) said:

4 January 2009
I have a client - married couple whom, in 2006, lived separately in California and Michigan for the entire year. I filed a joint federal return and joint California and Michigan returns exluding the income and exemption in respective states. There have been no issues with the Federal return or Michigan returns. However, the State of California has contacted them informing them that all of the spouses income, who lived and worked in Michigan for the entire year, is taxable in California because California is a Community Property state.

When I filed the joint CA return I prepared it carrying the entire joint AGI from the Federal return and Excluded the spouses income (I also excluded all applicable itemized deductions and backed out the personal exemption). When I spoke to the state they argued that the only reason I couldn't file the return this way is because "California is a community property state."

I am not sure I understand why this matters? I can see that interest, dividends, mutual funds, etc. in both names are community property, but how is individually earned income community property? The spouses income from Michigan was all wages and he paid taxes to the state of Michigan.

The only option they are suggesting I have is to claim a credit for tax paid in Michigan on the California return. However, California's tax rate is much higher than Michigans. How can an a resident of Michigan be subject to California income tax even if California is a "Community Property" state?

Riley2 (talk|edits) said:

4 January 2009
50% of the Michigan income would be community property if the spouse working in Michigan was domiciled in a community property state. Otherwise, I see no way for California to tax the Michigan income. What is the state of domicile for both spouses?

KatieJ (talk|edits) said:

4 January 2009
As Riley suggests, it all depends on the DOMICILES of the spouses, which is not the same thing as residence for tax purposes. It is likely that both spouses are domiciled in either California or Michigan, depending on all of the facts, which we don't have here. Under California law it is clear that spouses may have different domiciles, and frequently they do. It's more likely, though, that the true "family home" is in one state or the other, and both spouses are domiciled there; the nonresident spouse was absent from the domicile during 2008 but intends to return there. If there are minor children, it is generally the case that both spouses are domiciled in the state where the children live and attend school.

The division of income between spouses is determined by the laws of each spouse's domicile (not the same as residence, necessarily). If the Michigan resident spouse is domiciled in Michigan, his or her earnings are not community income (Michigan being a separate property state). However, if both spouses are domiciled in California, then the Michigan resident spouse's earnings are community income and the California resident spouse's community 1/2 is included in California income (Schedule CA-540NR, Col. E). In addition, the Michigan resident spouse's community 1/2 of the California resident's earnings are probably subject to Michigan tax. (See, e.g., Keller v. Dept. of Revenue, Oregon Tax Court, No. 1394, 9 OTR 67 (1981): Oregon, a separate property state, taxed a resident spouse’s community 1/2 of her nonresident husband’s earnings because he was domiciled in Washington, and under Washington law, 1/2 of his earnings immediately vested in his wife.)

In that case, each state would allow credit for the tax paid to the other on the resident spouse's 1/2 of the other spouse's earnings sourced in the other state.

If both spouses are domiciled in Michigan, then each spouse's earnings are his or her separate income and none of the Michigan resident's earnings are subject to California tax.

Domicile is a common-law concept, generally described as the place of true, fixed home and permanent establishment; the place to which one intends to return when absent; place where a person has voluntarily fixed habitation of self and family with the intention of making a permanent home. Cf. 18 Cal Code of Regs. Sec. 17017(c). A person has only one domicile at a time, and once a domicile is established it remains until another domicile is established; the burden of proof for state tax purposes is generally on the party that wants to argue a change of domicile. Changing domicile generally requires all of three steps: (1) abandonment of the previous domicile; (2) moving to and residing in a new location; and (3) an intent to remain in the new location permanently or indefinitely. Until all three of those requirements have been met, the prior domicile continues even if the individual has severed all ties to that place.

Married individuals who are not estranged usually have the same domicile, but that is not always the case. For example, suppose that this couple, one domiciled in California and the other in Michigan, met and married, but for economic or other reasons neither spouse moved to live with the other, but they continued to reside separately for some (perhaps fairly extended) period of time. Until one spouse moves to the other spouse's domicile, or they settle together in some third location with the intention of remaining there indefinitely, each spouse retains his or her own domicile. On the other hand, if both spouses had lived together and established a domicile in one state or the other, and one spouse went to the other state for employment purposes with the intention that the other spouse would eventually follow, or that the departing spouse would be absent only for a temporary period (which could be years), no change of domicile would have occurred. So it just depends on all of the facts and circumstances.

KatieJ (talk|edits) said:

4 January 2009
P.S. One more point: The only way California could reach 100% of the Michigan resident spouse's earnings would be if that spouse is domiciled in California and his or her absence is for a temporary purpose. In that case, he or she is a California resident taxable on all income, regardless of source. (See CRTC Sec. 17014.) California would allow credit for the tax paid to Michigan on Michigan earnings.

Amtax (talk|edits) said:

4 January 2009
Thanks for the excellent information. To clarify, both spouses were Michigan residents in 2005 when the wife was transferred to California. She rented an apartment in California while the husband stayed in Michigan where they own a home, with a mortgage, and he continued to work for all of 2006. It is obvious to me that he is domiciled in and is a resident of Michigan. In addition, based off of your explanation, it sounds to me like the wife is still domiciled in Michigan even though she rented in California for the entire year. Would you agree then that I should amend and file a non-resident California return? If this were the case I should also amend Michigan, claim all of her income in Michigan, and claim a credit for tax paid to California on the Michigan return?

They did not decide to make their permanent residence in California until late 2007 when he started a new job in California and she moved out of the rented apartment and into their new, permanent residence. In this case I should file a part year return for California and Michigan?

KatieJ (talk|edits) said:

4 January 2009
California defines a resident as a person who is either (a) present in the state for a purpose that is not temporary or transitory (regardless of domicile), or (b) domiciled in California and absent from the state for a temporary or transitory purpose. A resident remains a resident during any temporary absence. CRTC Sec. 17014.

If W is a common-law employee, her employment status in California is open-ended and her presence in California is not temporary. As a result, she became a California resident when she moved here to take that job. That doesn't necessarily mean her domicile changed to California; she may still be domiciled in Michigan. In any event, it's clear that H's domicile has not changed; he is still domiciled in Michigan. As a result, California has no claim on any of H's earnings.

Michigan defines a resident to include all domiciliaries, and makes no provision for a domiciliary to be a nonresident under any circumstances. Mich. Comp. Laws Ann. §206.18(1)(a) ; Mich. Admin. Code R206.5(1) .] The Michigan regulation provides that a change of domicile requires (1) an intention to abandon the previous domicile; (2) an intention to establish a domicile in a new location; and (3) actual physical presence in the new location. If W's domicile remained in Michigan until late 2007, she was a Michigan resident subject to tax on all of her income until that time. Of course, she is also a California resident, regardless of her domicile, because she was present in California for a purpose that was not temporary or transitory.

You cannot change her California residence status; she is a California resident regardless of her domicile. As for Michigan, I would let that sleeping dog lie. It seems pretty clear to me that H's domicile remained in Michigan until he moved to California, and that his income during his wife's absence was his separate income, none of it taxable in California.

In 2007, she was a full year California resident and he was a part year resident of Michigan and a part year resident of California.

EZTAX (talk|edits) said:

5 January 2009
KatieJ - Thank you for taking the time to provide such a thorough answer. I am sure I am not the only one that continues to learn so much from posts such as yours.

Happy New Year and may you have a smoothe tax season!

Okie1tax (talk|edits) said:

5 January 2009
That is a great big AMEN. I think she should be giving CPE when she answers a question. I usually get more than I do from some classes I have taken.

KatieJ (talk|edits) said:

5 January 2009
Sometimes I DO give CPE -- I teach several times a year for the Interstate Tax Corporation (http://www.interstatetaxcorp.com/). But of course you have to come to the seminar and pay the fees <G>. And of course I teach at San Diego State University and at the UC Davis Summer Tax Institute.

Thanks for the compliments, guys. Since I'm semi-retired and have time, a little esoteric expertise, and resources (thanks to the University) that are not available to the average tax bear, I enjoy hanging out here and on other forums and helping out when I can. A note of thanks here and there certainly makes the effort worth while. And I have learned a great deal here from other practitioners, especially Riley, Kevin, JR, D&T, and others too numerous to mention, to all of whom I am most grateful.

Joanmcq (talk|edits) said:

6 January 2009
OOOH, I have never heard of the UC Davis Summer Tax institute. I am very close (in Sacramento) but I'm sure it is tre expensive! I do so much multistate....I want your knowledge!!!

Belle (talk|edits) said:

January 6, 2009

Sounds very interesting....especially the Wed evening excursion.

KatieJ (talk|edits) said:

6 January 2009
Oh, yes, the winery dinner is the highlight of the week at UC Davis. I have been involved in that program since I was on the committee that originally developed it in 1991. Or maybe it was 1992. Who remembers?

I had always thought of Davis as the "cow college" and pictured it as a cluster of barns and corrals in the flat treeless hot dusty Central Valley. Was I surprised when I first went there! The campus is beautiful and the town is charming. I look forward to it every year, and not just because it is my annual opportunity to hobnob with my fellow wizards -- some of the leading lights of state and local taxation, e.g. Rick Pomp, Bruce Daigh, Ben Miller, Randy Ferris, etc. Usually we can get Randy to bring his guitar and regale us with a performance of "Dotcomerado" -- his parody on "Desperado" pleading with the dotcom retailers to come in from the cold and register to collect use tax ....

I'll be glad to answer any questions about any of these programs via e-mail (katiej_1958@yahoo.com) or on my talk page.

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