Double tax trouble for same-sex couples

San Jose Mercury News - Double tax trouble for same-sex couples

Double tax trouble for same-sex couples
REGISTERED PARTNERS MUST FILE STATE, U.S. RETURNS UNDER DIFFERENT RULES
By Mark Schwanhausser
Mercury News
Article Launched: 10/07/2007 02:01:50 AM PDT


California's registered partners face uncharted tax territoryWinners and losers under California's new rules for domestic partners
As if filling out your federal tax forms isn't bad enough, imagine how you'd feel having to do it twice.

That's essentially what California's 90,000 registered domestic partners face April 15 next year because state and federal tax laws are on a head-on collision course. A landmark state law will require them to file their taxes as married couples for the first time - but federal tax laws don't recognize such unions.

"I can't remember anything that has created so much confusion and so many land mines," said Lynn Freer, owner of Spidell Publishing, which released a 35-page planning guide geared for tax professionals last month. "The unknown is the worst."

After months of studying the mess in consultation with tax professionals, attorneys and tax-software experts, California's Franchise Tax Board recently released the first draft of an instruction booklet to help partners work through their state returns. The agency also is seeking a legal ruling from the state attorney general that could clarify the tax impact on non-resident gays and lesbians who have financial ties to the state.

But critics charge that the Internal Revenue Service largely has remained silent about how registered partners should sort through a raft of confounding inconsistencies. They say the IRS has refused to provide private letter rulings and has not issued any guidance about how the agency is likely to interpret sticky issues.

Now, with less than three months left to plan and adjust their finances in 2007, registered partners find themselves in uncharted territory when weighing the tax implications of donating to charity, saving for retirement, buying or selling homes, managing investments - basically, issue after issue that heterosexual married couples can take for granted.
For example, Shannon Schwartz and Calvin Kuan of Mountain View must puzzle through the tax ramifications every time they write a check for the mortgage, property taxes and other routine bills. Simply deciding which partner pays the mortgage involves projecting who will get the bigger benefit from the interest deduction on his separate federal return.

Other transactions that would be routine non-taxable events between married couples - such as splitting a partner's income under California's community property laws - could trigger gift taxes between domestic partners.

'My money or his?'

"So we have to pretend, 'Is it my money or his money?' - when in reality, it's our money," Schwartz said. "I guess the IRS doesn't care about that reality."

Conversely, Patrice Reid says she and her partner maintain separate finances and have structured their investments to minimize their taxes as single taxpayers. That's likely to cost them state taxes because their incomes will be combined on their California return, but it would be more costly to unwind her portfolio at this stage.

"We're really being treated as second-class citizens on the federal level," the 42-year-old Campbell resident said. "I think California is trying to be progressive, but the federal government is lagging."

The problem has been building for years. In 1999, California became the first state to create a registry for domestic partners, which comprises both same-sex couples and heterosexual couples with at least one partner older than age 62. Later laws gave registered partners many of the rights and responsibilities of married couples, but through 2006 they were treated as single on their state and federal tax returns.

That will change under a state law signed in 2006. Though state Proposition 22 defines marriage as a union only of a man and a woman, starting with their 2007 state returns the law will require registered partners to file their California taxes as married couples, either on a joint return or by filing separately. They no longer may file as single or head-of-household taxpayers.

Debate over the bill triggered shouting matches in the Legislature. At one point Assemblyman Jay La Suer, R-La Mesa, called the measure "part of the homosexual agenda," causing Assemblywoman Jackie Goldberg, D-Los Angeles, to claim offense, saying he was "castigating me and mine."

The law was a symbolic breakthrough for domestic partners, but it created a raft of practical problems because the IRS maintains that they cannot file as married couples on their federal returns. Beyond that, however, the IRS has remained virtually silent, critics say.

"I consider it discrimination in the form of legal complexity," said Frederick Hertz, an Oakland attorney and co-author of "A Legal Guide for Lesbian and Gay Couples." "It is really cruel to ask people to make decisions about their lives when the law is so uncertain and so complex. For the IRS to say, 'We don't make rulings, let the courts work this out,' is not very helpful because people can't wait five to seven years to make life decisions."

State issues

In the meantime, on the state level tax officials and lawmakers have been trying to clarify the tangled tax issues that are within its control:

• Any day now, Gov. Arnold Schwarzenegger is expected to sign SB 105, a bill designed to sidestep a number of unintended consequences the new state law could create for domestic partners with pensions, savings plans such as IRAs and education savings accounts, and certain kinds of businesses known as S corporations.

• The tax board asked the state attorney general last month to identify other states or jurisdictions that have comparable rules. The legal opinion would help the tax board determine how to tax same-sex couples in those areas if they own property in California or earn income here. That opinion is expected by year's end.

• Last month, the tax board released a draft of Publication 737, a 14-page instruction booklet that outlines how registered partners will essentially need to calculate two versions of their federal 1040 form, which is the starting point for determining how much state tax they'll owe.

Each partner will fill out the first 1040 as they've done in the past - typically as a single taxpayer - to calculate how much to pay Uncle Sam. Then they'll essentially fill out another 1040 as if they were married and were allowed to file joint or separate returns. The results from the second 1040 will provide the jumping-off spot to calculate what they will owe California as a married couple.

Taxpayers or tax pros can download the proposed instruction booklet at www.ftb.ca.gov and e-mail comments to the agency by Oct. 15 at RDP@ftb.ca.gov.

Despite such efforts, registered partners face a quagmire during the filing season. It's unclear how tax software will lead do-it-yourselfers through the mess. Many registered partners will throw up their hands and seek out tax preparers.

Advice for partners

Some tax pros are encouraging registered partners to hire the same preparer to ensure the returns mirror one another. Lynn Freer, editor of Spidell's California Taxletter, advises registered partners to consider filing extensions to buy time for tax issues to be resolved.

Kris Hill, a tax professional and a registered partner who lives in Berkeley, said she tries to think of such headaches as an inevitable "political price you pay when things begin to change." Still, she can't hide her impatience. The gulf between state and federal tax rules reminds her of Jim Crow laws in the South that prohibited blacks from sipping at water fountains reserved for whites.

"You have rights one place, and then you go someplace else and don't have rights any more," Hill said. "We don't have progress everywhere and at the same rate."