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In the be-careful-what-you-ask-for realm, many gay and lesbian couples around the country may be kicking themselves for their efforts to win the right to file joint state income tax returns with their partners.
Now that tax season is upon us, more and more couples are discovering what a mess it can be when the federal government and the states have starkly different rules. Here’s help to guide you through the latest tax maze.
In Massachusetts (where same-sex couples can marry) and in California, Connecticut, the District of Columbia, New Jersey and Vermont (which recognize civil unions or registered domestic partners), qualifying couples can file joint state income tax returns. That's still verboten at the federal level.
In California, unmarried, opposite-sex cohabiting couples of which at least one partner is at least age 62 may also register as domestic partners and file joint state tax returns. That's prohibited by Uncle Sam, too. Since the states start their computations with a joint federal return, same-sex couples basically must complete a total of four tax returns.
• First, each partner must complete an individual federal Form 1040 (or 1040-A or 1040-EZ) to file with the IRS;
• Then, the couple must create a mock or dummy joint federal return combining income, adjustments, deductions and credits;
• Finally, they use that fantasy return as the jumping off point to prepare a joint state tax return.
Tricky areas abound
Same-sex couples in Connecticut, Massachusetts and Vermont have been allowed to file joint returns in previous years, but the 2007 crop of returns being filed this spring is the first to permit joint returns for domestic partners and civil union members in California, the District of Columbia and New Jersey. For an idea of the kinds of mine fields you might have to traverse, consider:
• Capital gains and losses. On individual federal returns, each partner’s gains and losses are netted separately. Let’s say Pat has $20,000 of net long-term gain and Chris has $20,000 of net long-term losses. On individual federal returns, Pat would owe tax on $20,000 of gain. Chris would get to deduct $3,000 of loss against other income (the maximum deduction in any one year). On a mock joint return, however, Chris’s loss would offset Pat’s gain and no tax would be due (and that’s what would carry over to the real state joint return). Let’s say, however, that both Pat and Chris suffered losses in 2007. On individual returns, each would be allowed to deduct up to $3,000 against other income. On the joint return, however, they would be limited to a single $3,000 loss. Understanding Capital Gain and Losses
• Real estate losses. Federal law allows taxpayers (either married or single) with incomes under certain thresholds to deduct up to $25,000 of passive real estate losses. Let’s say Pat and Chris each took a drubbing in real estate in 2007 and each suffered $25,000 of qualifying losses. On their individual federal returns, each could deduct $25,000. But on a mock joint return only a single $25,000 loss would be allowed.
• Mortgage interest deduction. On a federal return, a homeowner—whether married or single—can deduct interest on up to $1 million of debt used to buy a home and up to $100,000 of additional debt secured by a home used for any other purpose. If Pat and Chris each have $750,000 of qualifying debt, they can each deduct all of the interest on individual federal returns. On a dummy joint return, however, the write-off would be crimped by the $1 million and $100,000 limits. Home Ownership Tax Deductions
• Miscellaneous expenses. This category of itemized deductions includes things like the cost of investment and tax advice and unreimbursed employee expenses. And, you get a deduction here only to the extent that the total of qualifying expense exceeds 2% of your adjusted gross income (AGI). By combining both partner’s income and expenses on a fantasy joint return, the write-off might be bigger—or smaller—than the combination of two individual returns. Miscellaneous Deductions
• Roth IRA. This is the most mind-boggling anomaly we’ve come across. Under federal law, the right to contribute to a Roth IRA for 2007 is phased out as AGI rises from $99,000 to $114,000 on a single return and from $156,000 to $166,000 on a joint return. If Pat and Chris each have $90,000 of AGI, each can contribute $4,000 to a Roth for 2007. But, on a joint return, the combined income of $180,000 prohibits the contribution. On the bright side, California has no penalty for excess contributions, so there would be no penalty (as there is at the federal level). But, California says the couple would have to keep track of all income attributable to that excess contribution. While payouts from the Roth will be tax-free on the federal level, California says income attributable to the excess contribution will be taxed by California. Investment and Retirement Savings
What to do
If you are forbidden to file a joint federal return but required to file the equivalent of a married-filing-jointly or married-filing-separately return in your state, the first step is to be sure you understand the rules in your state. Here are the web sites for your state's tax department.
Tax software, such as TurboTax (for which Kiplinger provides in-product and Web content), will greatly simplify the process of completing the mock federal return. Should you send that return to the state? That depends on where you live. Vermont, for example, wants to see it; the District of Columbia does not. TurboTax has special instructions to help domestic partners, those in civil unions and married same-sex couples complete their state returns.
Win or lose?
A big question, of course, is whether filing a joint return on the state level will save or cost you money. So much as been written about the so-called marriage tax penalty at the federal level-the possibility that a married couple pays more tax than the combined total that husband and wife would owe if they were still single-that you might assume you'll pay more by filing jointly. That's not necessarily so. (Even at the federal level, for example, more couples enjoy a marriage tax bonus than suffer a marriage tax penalty.)
A study by California's tax agency found that about 60% of registered domestic partners will save an average of nearly $500 by filing jointly, for example, about 12% will pay more (averaging about $750) and the rest will basically pay the same as if they continued filing as single taxpayers.
At the federal level, most married couples pay less tax by choosing to file jointly rather than taking the married-filing-separately route. At the state level, however, married-filing-separately often pays off in a lower tax bill. So, you'll probably want to tackle another extra tax form: the equivalent of married-filing separately. It might save you money. And, if you're using software, like TurboTax, it shouldn't be too onerous.
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POSTED BY: Ralph (March 06, 2008 12:50 PM)
As registered domestic partners in California we decided to file separately for state returns. Turbotax was unable to efile our state returns and after two hours on the phone with Turbotax support, was given a refund for the program. Very disppointing. We ended up filing for free at the state website, so we got our almost $50 back for the program and saved $36 in efiling fees. Have used Turbotax for many years. This is the first time they have disappointed me. Let's hope they can fix this problem for 2008 tax returns.
POSTED BY: Tori (March 01, 2009 09:29 PM)
It's a year later and Turbo Tax has the same problem. It won't let you e-file you state taxes (at least in California). :-(
POSTED BY: MarkL (April 15, 2009 01:53 AM)
We have just spend hours struggling with the same problem. Very frustrating, and the fact that the same problem existed in last year's version only adds insult to injury.
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