Common law is the dominant property system in the United States and has been adopted by 41 states.

The theory underlying common law is that each spouse is a separate individual with separate legal and property rights. Thus, as a general rule, each spouse owns and is taxed upon the income that he or she earns.

The community property system has been adopted by nine states: Arizona, California, Idaho, Louisiana, New Mexico, Nevada, Texas, Washington, and Wisconsin.

Alaska has a community property election that may be made in writing.

The theory underlying community property is analogous to that of a partnership. Each spouse contributes labor (and in some states, capital) for the benefit of the community, and shares equally in the profits and income earned by the community. Thus, each spouse owns an automatic 50% interest in all community property, regardless of which spouse acquired the community property. Spouses may also hold separate property, which they solely own and control, but the law in the community property states does not favor this.

Spouses are also considered to share debts. Depending on state law, creditors of spouses may be able to reach all or part of the community property, regardless of how it is titled, to satisfy debts incurred by either spouse. State laws vary greatly on what property can be reached.

As common law is the dominant legal system in the United States, there has been a tendency for the courts, the government and the public to apply common law principles and concepts to community property issues. Unfortunately, because community property and common law are based on different theories of property ownership, analyzing a community property case under a common law framework usually produces erroneous results. Additionally, the natural inclination to think in terms of "his" and " hers" must be discarded with regard to community property. It is inaccurate to refer to community property acquired by the wife as "the wife’s income" or to community property acquired by the husband as "the husband’s income." These terms have no meaning under community property law and instead reflect the inappropriate application of common law principles. Community property is simply property that both spouses share equally, just as partnership income is income that all partners share equally, regardless of which partner was responsible for acquiring the income on behalf of the partnership.

For income tax purposes, if spouses file separate returns, each spouse is taxed on 50% of the total community property income regardless of which spouse acquired the income. Poe v. Seaborn, 282 U.S. 101 (1930). In addition, each spouse is taxed upon 100% of his or her separate property income. Community property may also affect basis in property.

For collection purposes, the Service (depending on state law) may collect taxes owed by only one spouse entirely from community assets or a portion thereof. This includes community property earned by or titled in the name of the other spouse.

Whether property is characterized as community property becomes less important if a joint filing election is made. Spouses filing a joint return, as a matter of federal law, are jointly and severally liable for the tax on all of the income of both spouses reportable on the joint tax return, whether it is community property or separate property.

There are differences in the community property laws adopted in the nine community property states. Exhibit 25.18.1-1 is a table summarizing the differences. However, the table is not a substitute for consulting state law when appropriate. It may also be necessary to discuss an issue with Counsel. In addition, the local Counsel offices in each of the community property states have created a Revenue Officer’s Guide to Local Law for each of the fifty states. Each of the guides for the community property states contains a detailed discussion of the local community property law, including discussions of common community property tax issues. It is recommended that these guides be consulted. The guides are available on Chief Counsel’s SB Website on the IRS Intranet.

The guides can be accessed at: http://casecn01.irscounsel.treas.gov/intranet_new/sbse/research/state_law.asp

For federal tax purposes, a taxpayer’s rights and interest in property are determined under the laws of the taxpayer’s state of domicile. United States v. Mitchell, 403 U.S. 190 (1971); Morgan v. Commissioner, 309 U.S. 78 (1940). The examiner must determine domicile at the time that property or the right to property was acquired. Since a taxpayer’s domicile may change over the period being examined, it may be necessary to allocate property and determine tax consequences under the laws of more than one state. A similar situation can arise with regard to the collection of federal tax. A revenue officer must determine domicile at the time that property subject to collection was acquired.

The words "residence" and "domicile" do not necessarily mean the same thing for legal purposes. A person may have several places of residence, but only one domicile. A temporary place of abode may be a residence, but domicile is based on where the taxpayer intends his or her permanent home to be located. In general, the taxpayer’s residence may be treated as his or her domicile unless the taxpayer asserts otherwise, or this is contrary to other facts in the case. Where a question regarding domicile arises, objective facts reflecting the taxpayer’s intention to maintain a permanent home should be examined, including, but not limited to:

Once domicile is established, it is presumed to continue unless it is proven to have changed. Whitmore v. Commissioner, 25 T.C. 293 (1955); Myers v. Commissioner, 11 T.C. 447 (1948), acq.,1949-2 C.B. 3. Therefore, if, after weighing the facts and evidence, doubt remains regarding the correct domicile, the domicile of origin prevails. Whitmore v. Commissioner, 25 T.C. 293 (1955), acq., 1956-2 C.B. 9; Webb v. Commissioner, T.C. Memo. 1996-550.

Occasionally, spouses reside in different states. Under traditional community property laws, the marital community, consisting of both spouses, could only have one place of domicile, which was determined by the domicile of the husband. Today the domicile of the marital community should be determined by the state with the most significant relationship to the spouses and to their earnings. Lane-Burslem v. Commissioner, 659 F.2d 209 (D.C. Cir. 1981).

Some state laws recognize that spouses can have different domiciles. For example, Wisconsin does not subject either spouse to community property unless both domicile in that state. Wis. Stat. § 766.01(5). Louisiana also recognizes that spouses may have different domiciles and will only subject property acquired by the spouse domiciled in Louisiana to its community property laws. See Lane-Burslem v. Commissioner , 659 F.2d 209 (D.C. Cir. 1981); See also Layman v. Commissioner, T.C. Memo. 1999-218 (reaching a similar result under Arizona law); Commissioner v. Cavanaugh, 125 F.2d 366 (9th Cir. 1942) (reaching a similar result under California law).

In addition to domicile in a community property state, there must also be a valid marriage between spouses. States generally will recognize a marriage performed in another state. Thus, spouses may be married in a common law state and later domicile in a community property state and become subject to that state’s community property laws. See, e.g., La. Civ. Code Ann. § 2401; Wis. Stat. § 766.01(5).

Marriages are usually created by a legal ceremony. Some states, however, recognize common law marriage. A common law marriage established in a state recognizing this type of marriage satisfies the marriage element to make community property laws applicable to spouses. United States v. Raudry , 82-1 U.S.T.C. ¶9231, 49 A.F.T.R.2d ¶82-595 (W.D. Tex. 1981); Schmidt v. Commissioner, T.C. Memo. 1981-38.

Eight of the nine community property states presently do not allow common law marriages to be established in them. The only exception is Texas. Idaho abolished such marriages in 1996, but it still recognizes common law marriages established in Idaho before then.

All nine community property states recognize common law marriages established in other states allowing such marriages. If spouses establish a common law marriage in a state recognizing such marriages and subsequently domicile in a community property state, they become subject to community property laws. See, e.g., In re Estate of Lamb, 99 N.M. 157, 655 P.2d 1001 (1982); People v. Badgett, 10 Cal. 4th 330, 41 Cal. Reptr. 635, 895 P.2d 877 (1995). For a comparison of the treatment of common law marriage by the various community property states, See Exhibit 25.18.1-1.

In Texas, a valid common law marriage is not presumed under law, and the burden of proof is upon the party asserting that a valid common law marriage has been created. White v. State Farm Mutual Auto Ins. Co. , 907 F.Supp. 1012 (E.D. Texas 1995). The elements of a common law marriage in Texas are:

The community estate may be terminated in a number of ways including the following.

Death. A community property estate, having been created, is terminated on the date that one spouse dies.

Change in Domicile. A community property estate, having been created, is terminated when spouses change their domicile from a community property state to a common law state.

Divorce or Legal Separation. Seven of the nine community property states (all except Washington and California) hold that the community property estate is terminated by a final decree of divorce or legal separation. This is frequently referred to as dissolution. In these states, spouses living apart or even filing a petition for divorce will not result in a termination of the community property estate. Termination does not occur until the final decree of divorce is entered. A final divorce decree cannot be made retroactive to a prior completed tax year for Federal income tax purposes. Brent v. Commissioner , 630 F.2d 356 (5th Cir. 1980).

Physical Separation. California and Washington hold that the community property estate is terminated when spouses physically separate and both spouses intend to permanently end the marriage. This mutual intent must be established through the actions and conduct of the spouses. This requires an examination of the facts and circumstances of each case, with the burden of proof placed on the party asserting that the community property estate was terminated. Siezer v. Sessions, 132 Wash. 2d 642, 940 P.2d 261 (1997), citing Wash. Rev. Code § 26.16.140; In re Marriage of Hardin, 38 Cal. App. 4th 448, 45 Cal. Reptr. 2d 308 (Ct. App. 1995), citing Cal. Fam. Code § 771. In these states, the Service should continue to apply community property laws to separated spouses unless both spouses have affirmatively alleged that they do not intend to resume the marriage and their conduct supports this.

For a comparison of what constitutes a termination of the community property estate in the various community property states , See Exhibit 25.18.1–1.

An annulment means that the spouses were never subject to community property laws. Income should not be reported on a community property basis for the period of the putative marriage. Barr v. Commissioner , 10 T.C. 1288 (1948). Courts may impute "putative" community property rights to ensure an equitable division of property between the parties, but this does not create community property rights under state law.

Given a property’s physical location, questions can arise concerning which state’s laws govern the categorization of a piece of property as separate or community property. The general rules on this issue are as follows:

The most common situation is, where spouses domicile in a community property state and earn wages in a common law state. In this circumstance, the wages are classified under the law of the community property state, because wages are personal property.

After it is determined that community property laws apply (i.e., the taxpayers are married and domicile in a community property state), the next step is to determine the taxpayer's rights and interest in the property under state law. This process is known as characterization.

Characterization is important, because it will determine the tax consequences. As it relates to separate tax returns filed by married individuals domiciled in a community property state, federal income tax is assessed on 100% of a taxpayer's separate property income, and 50% of the total community property income acquired by either spouse. In some cases, property may be partially community property and partially separate property, requiring an allocation. In addition, the reach of the tax lien depends, in part, on the character of the taxpayer’s property. As a result, the Service must characterize the taxpayer’s property before it can correctly determine and collect tax.

Spouses living in community property states may own two distinct types of property: community property (also known as marital property in some states) or separate property (also known as individual property in some states). The characteristics of each type of property are as follows:

For probate and other purposes, some states characterize certain separate property as quasi-community property. For example, some states treat property acquired during marriage but before spouses were subject to a community property regime as if it were community property for purposes of probate or dissolution of marriage. This gives the surviving spouse rights against the property that he or she would not otherwise have. This characterization of property has little or no impact on basic principles of income taxation of community property or collection, because quasi-community property is not community property. It is therefore not taxed as community property or subject to collection as community property.

Community property is generally, and broadly, defined as all property acquired during marriage that is not established to be separate property. Community property is the default characterization of all marital assets. It is highly favored by the laws of the Community Property States. Community property typically includes salary, wages and other compensation for work performed during marriage, the fruits resulting from the labor and skills of each spouse, income derived from community property assets, and separate property that has been changed ( "transmuted" ) into community property.

Separate property is all property acquired before the creation or after termination of the community property estate and property acquired by one spouse during marriage through gift, inheritance, or an award for personal injury damages.

Management and control is a community property concept referring to the right to manage, control, use or otherwise dispose of community property. In Texas, management and control is important for federal tax purposes, because it determines the Service's collection remedies against community property. In Texas, community property is either joint management property or the management property of one of the spouses. If property is classified as the " sole management" community property of a particular spouse, that spouse has the right to control or otherwise dispose of the property despite the other spouse’s interest in the property. If community property is joint management property, both spouses must participate. Sole management property is the property the spouse would have owned if single. If one spouse incurs a tax liability, the Service may have different remedies against sole management community property as opposed to joint management community property. See IRM 25.15.4.5(5)

In addition, there is a presumption that community property titled or held in the name of a spouse is his or her sole management property. For example, a spouse’s wages are his or her sole management property. All community property that is not sole management property of a spouse is joint management property.

A basic principle of community property law is that the initial character of property is determined on the date of acquisition. Under the " inception of title" rule followed by most community property states, property is deemed acquired on the date that the right to interest, title and possession arises. See, e.g., Estate of Cavenaugh v. Commissioner, 51 F.3d 597 (5th Cir. 1995). As a result, the date that property is physically received is not relevant in determining character. Certain forms of income reflect delayed payment, such as pensions, lottery winnings, or installment sales. Under this rule, these are characterized when the right to receive them is earned, not when they are received. Additionally, when rights to property are acquired over a period of time, vested allocation issues can arise. For example, assume a person who is working and vested in a pension gets married. If the person continues to work at the same place and accrues additional pension benefits, the retirement income accrued before the marriage would be characterized as separate property, while retirement income accrued after marriage would be characterized as community property. For a discussion of the pension allocation rule See IRM 25.18.1.2.16.

Income from separate property generally consists of dividends, interest, and rents. The community property states are not consistent in their characterization of this income. Some states follow the "American rule," while others follow the "Spanish rule."

Under the American rule, income generated during marriage from separate property is separate property, except to the extent that the income is generated from community property skills and labor. This rule is followed by Washington, Nevada, California, Arizona and New Mexico.

Under the Spanish rule, income derived from separate property, whether attributable to community labor or a return on separate property capital, is characterized as community property. States following this rule include Louisiana, Wisconsin, and Texas.

In all nine states, income from community property is community property.

Community property states uniformly have laws creating a rebuttable presumption that property owned by spouses is community property. In many community property states, unless otherwise proven, property in the possession of spouses during the marriage is presumed acquired during marriage, thus triggering application of the community property presumption. See, e.g., Mortenson v. Trammell , 604 S.W.2d 269 (Tex. Civ. App. Corpus Christi 1980).

Property received in exchange for separate property of a spouse is separate property. For example, if a spouse owns stock and sells the stock for cash and then uses the cash to buy different stock, the new stock is separate property.

Special rules apply to characterizing certain life insurance policies (e.g., whole life) and deferred employment benefits. Generally, they will be characterized based on the period of participation in the pension while subject to community property over the total period of participation in the pension. For example, a spouse works for 40 years and earns a pension. For 20 years she is married and subject to community property. Fifty per cent of the pension is community property (20/40= 50%). See, e.g. Wis. Stat. §§ 766.61 & 766.62 Taggart v. Taggart, 552 SW 2d, 422 (Tx 1977). These rules may vary somewhat between states, so it is important to consult the law of the applicable state or with local Counsel.

Spouses sometimes acquire property and title it in a manner that suggests that they are trying to hold it as either joint tenants or tenants in common. All community property states except Louisiana allow property to be held in this manner. Some states, however, do not favor these estates and require specific language in the deed reflecting the intent of the spouses to create these estates. Some even require extrinsic proof that the spouses intended to hold the property in joint tenancy or tenancy in common instead of as community property. For example, if spouses wish to convert community property into joint tenancy property in Washington, they are both required to sign a document indicating a clear intent to make this conversion. See, e.g., Rogers Walla Walla, Inc. v. Ballard, 16 Wash. App. 81, 553 P.2d 1372 (Ct. App. 1977), review denied 88 Wash.2d 1004 (1977). If the required proof is lacking, the property is characterized as community property. Texas requires a written agreement to partition. Other community property states recognize these forms of ownership and will treat the asset as separate property of the spouses held in joint tenancy. A summary of each of the community property states' treatment of property purportedly titled in joint tenancy or tenancy in common is shown in Exhibit 25.18.1–1. The rules vary greatly on this issue and it is important to consult the applicable state law or with local Counsel.

Property acquired during marriage by gift or inheritance of one spouse is normally separate property of that spouse. Property gifted to both spouses is community property.

Under community property law, title to property generally carries relatively little weight in determining whether property is separate or community property. The property is presumed to be community property in spite of the form in which title is held. When property is acquired as community property, each spouse acquires an automatic half interest. No special acts are required to vest interest in the non-acquiring spouse, such as conveyance of title, or obtaining dominion and control over the property. Thus, the fact that title is held solely in the name of the spouse who acquired the property, by itself, is insufficient to rebut the community property presumption. The community property presumption could only be rebutted by evidence that the property was acquired with the separate property of the titled spouse with the specific intention of holding the property as separate. A notable exception to this rule exists in states where a joint tenancy presumption arises when title to real property is held in joint tenancy, such as California or Nevada. In addition, in New Mexico, property titled in the name of one spouse is presumed to be separate property. A comparison of the treatment of title by the various community property states is shown in Exhibit 25.18.1-1.

Although title generally does not determine whether property is held as community or separate property, title may establish whether property is sole management property of a spouse.

In all of the community property states, appreciation in value of separate property is separate property, unless the appreciation in value is attributable to the personal services of one of the spouses or due to the application of community property funds. For example, market appreciation of publicly traded stocks held as separate property is also separate property. If, on the other hand, a house is owned as separate property, and one of the spouses is a carpenter and builds an addition with materials acquired with community property, any increase in value due to the addition is either community property or creates a right to reimbursement of the community. The community property states vary in their treatment of these issues. A comparison of the treatment of this issue by the various community property states is shown in Exhibit 25.18.1-1.

Transmutation is a term which refers to changing the character of property, usually from separate property to community property. As will be discussed below, transmutation can take place by specific agreement of the spouses or unintentionally.

Mixing or commingling separate property with community property will transmute the separate property into community property unless the separate property component can be traced. If community property is used to assist in the purchase of a separate property asset, or if community property substantially benefits or improves separate property, a community property right to reimbursement is presumed. The right is "pro tanto," meaning that it follows appreciation, interest, and profits attributable to the community property contribution. It is generally not applicable for routine upkeep and living expenses, such as payment of property taxes or maintenance. It often arises, for example, where one spouse owns a house prior to marriage, and after marriage, uses wages (a community property asset) to continue paying a mortgage.

As discussed above, commingled property becomes community property unless the separate property portion can be traced. Tracing is done by allocating withdrawals, deposits or payments between community property funds and separate property funds. The burden of proof is usually on the party attempting to rebut the community property presumption created under state law.

Community property states have created laws allowing spouses to contract out of the application of normal community property laws. The states have different rules concerning when this may occur and how notice of these agreements is given to affected third parties, such as creditors. These rules vary greatly between the community property states. A summary of the treatment of these contracts by the various community property states is shown in Exhibit 25.18.1-1. Refer to the applicable state law for each state for a more detailed discussion of these rules.

Validity of marital agreements is often an issue. Ensure that state law formalities regarding writing, acknowledgment and recording have been complied with. If an agreement is received, the following factors should be considered:

Some states require either actual or constructive notice to creditors before they are bound by a marital agreement. In the context of tax collection, the Service will assert these statutes as a defense to a marital agreement if proper notice was not given. Notice is not usually required for income reporting purposes.

If one spouse uses his or her separate property funds to purchase a community property asset, or substantially benefit the community, a gift to the community is presumed.

Generally, spouses do not have to enter into a written marital agreement to transmute separate property into community property or community property into separate property. This can be done by deed. As discussed previously, some states recognize oral agreements. See, e.g., Lucia v. Commissioner, T.C. Memo 1991-77. Any claim of an oral agreement should be closely scrutinized.

In some circumstances, the federal interest is deemed more important than state property rights, and specific types of income and liabilities are not taxed in accordance with state community property laws. These federal preemptions include IRA withdrawals, self-employment taxes, earned income credits, railroad retirement benefits, U.S. savings bonds, social security benefits, and ERISA funds. All are treated as separate property of a spouse. See, e.g., Free v. Bland , 369 U.S. 663 (1962); Boggs v. Boggs, 520 U.S. 833 (1997); Hisquierdo v. Hisquierdo, 439 U.S. 572 (1979); Bunney v. Commissioner, 114 T.C. 259 (2000); In re Marriage of Hillerman, 109 Cal. App. 3d 334, 167 Cal. Rptr. 240 (1980). This area of law is complicated, as courts will strive not to find a conflict between a federal interest and state community property laws and carve out specific exceptions to federal preemption. No federal preemption exists for military retirement, Medicaid benefits, or the federal copyright act.