IRS Makes Major Domestic Partnership Ruling

On May 28, 2010, the IRS disclosed that the IRS has determined that registered domestic partners in California may receive many, but not all, of the tax benefits available to married couples. The change is retroactive to 2007, but has less legal weight than a full fledged tax regulation. It consists of a private letter ruling and two chief counsel advice memorandums. The determination reverses a ruling made in 2006 on the issue on the grounds that California property law changed in 2007.

This is the biggest non-statutory pro-gay rights step under federal tax law in U.S. history. Previous statutory changes to the tax law have been far more timid.

The logic of the ruling is that the extension of full community property treatment to domestic partners in 2007 splits all income and expenses of the couple for tax purposes. In a community property regime all of one spouse's earnings become 50% the property of the other spouse at the moment they are earned.

In contrast, in non-community property states, like Colorado, a spouse's interest in property is generally inchoate. It arises only in the context of divorce proceedings or at death, absent special statutory and common law rules like those that apply to retirement accounts or statutory presumptions that the non-titled personal property of married couples is owned jointly.

Historically, joint return treatment for married couples was also effectively forced by IRS efforts to deal with community property rights of married couples. The key U.S. Supreme court case in that episode in tax history, Poe v. Seaborn, 282 U.S. 101 (1930), which is now largely irrelevant due to statutory changes in the tax law, was applied by the IRS to domestic partners with community property rights.

In some cases, this causes California registered domestic partners to receive better tax treatment than a comparable married couple would, mostly because they do not have to use less favorable married filing separately income tax brackets.

The change in IRS treatment may have limited applicability outside California, however. Generally, the separate or community property character of newly acquired property is determined in the place where it is acquired. If a married couple lives in California for fifteen years the property acquired in that phase of their marriage would be community property, but if they then move to Ohio (a separate property state) the property acquired thereafter would not be community property.

Under that reasoning, California registered domestic partners who move to Colorado would not be able to split their new income under the IRS ruling. The ruling also points the way towards a legislative strategy that can be used to end most of the discriminatory effects of federal tax laws on same sex couples even in states where marriage is prohibited by state constitutions.