Chasing domestic bliss

If this tax season felt crazy, wait until you see what’s up ahead for California’s registered domestic partners next tax season. The state recently passed a new law designed to grant domestic partners the same tax status as married couples in California. But, come next April, registered domestic partners will have to claim one income on their state returns and another on their federal returns. Stakeholders are looking for ways to keep these discrepancies from triggering audits for the state’s 74,000 domestic partners.

The state moved another step closer to providing equal rights for gay couples with SB 1827—authored by state Senator Carole Migden and signed into law by Governor Arnold Schwarzenegger last fall. The law requires registered domestic partners to file using one of two filing statuses: married filing jointly or married filing separately. These are the same choices available to married couples in California, a community property state.

Married couples filing jointly combine their two incomes to calculate the adjusted gross income, on which California tax burden is based. Married couples filing separately combine their two incomes, total their adjusted gross income and then split that total in half. Each partner pays taxes on half the adjusted gross income.

It seems simple enough. But California taxes are based on federal taxes, and the federal government does not recognize registered domestic partnerships.

“The problem here is that the very foundation of the tax return is the filing status,” said Bronwyn Hughes, a legislative staffer for the California Society of Enrolled Agents, a group made up of professional tax preparers, including accountants and tax attorneys. “Everything else is derived from that in calculating the tax and completing the return.”

“With the federal tax return, [registered domestic partners] will be required to file single, as they do now,” said Holly McDonnell, a public-affairs spokeswoman with the California Franchise Tax Board. “Trying to take two single incomes and combining those into one single income for the state taxes is the problem.”

The FTB began working on the discrepancies between state and federal tax codes shortly after the law was passed and has held several meetings with “interested parties”—tax preparers, accountants, attorneys, GLBT activists, tax-preparation software makers and, yes, the Internal Revenue Service.

At the first meeting last December, according to news reports, participants produced 16 pages of questions about how to implement the law in a little less than four hours. Tax preparers had concerns about how to calculate deductions for IRAs, the necessity of attaching federal returns with state returns, whether e-filing would still be possible, how to handle corporate or business returns, how to adapt tax-preparation software, how to deal with domestic partners who move in and out of state and how to educate domestic partners about the changes.

Considering the number of taxpayers affected, that’s a lot of questions. According to the secretary of state’s office, there are slightly more than 37,000 registered domestic partnerships in the state.

Hughes said that the intent of the law was equality—“an equal distribution of advantages among taxpayers”—but that SB 1827 is in conflict with federal tax law. “Because of the way the adjusted gross income is calculated, there will be a discrepancy between the California returns and the federal returns. So, in certain circumstances, the intent of the law isn’t being met,” she said.

Hughes estimated that about 90 percent of registered domestic partners will pay roughly the same amount of tax as a married couple in similar circumstances. “But about 5 percent of registered domestic partners will have an unfair disadvantage.”

The FTB has come up with four possible ways of resolving the problem caused by using a different filing status for state and federal tax returns. One of them requires partners to include something like a fake federal return, a pro forma return, with their state return. This would let partners calculate adjusted gross income that is equivalent to that of married couples, but it would also involve extra paperwork because the domestic partners would have to complete two federal returns: an official “filing single” return for the federal government and a fake “filing married” return for the state.

William E. Taggart Jr., a tax attorney in Oakland, thinks the new law causes more problems than just extra paperwork. “There is no benefit in most instances to being able to file jointly,” he said. “I have a heterosexual domestic partner because it was to our benefit to have those rights and continue to file taxes singly. To file jointly will cost us extra tax to the state of California and also extra money for preparation of taxes.” Taggart said that in order to save money, he and his partner will terminate their partnership if SB 1827 isn’t repealed.

Filing jointly doesn’t automatically decrease one’s tax burden, as some assume. In some situations, the so-called “marriage penalty” is still in play. Filing singly may allow some couples to qualify for larger deductions than married couples get.

Further, Taggart claimed that any benefit was outweighed by the financial costs of SB 1827. “From an administrative and use-of-funds standpoint,” Taggart said, “the money the state is spending figuring out how to do it and the money all the taxpayers are going to have to spend to get their taxes done is going to outweigh any benefit they might receive.”

Alice Kessler, director of legislative affairs for Equality California, disagrees with Taggart. EQCA sponsored SB 1827. “Our research shows that being able to file jointly will benefit the taxpayers,” Kessler said.

EQCA has sponsored another bill in this year’s legislative session, SB 105, also authored by Migden, which intends to smooth the rough edges of SB 1827.

But Kessler believes that taxpayer reticence is normal. “Every time there’s a change in the tax code, it causes a bit of anxiety, but that’s not uncommon,” she said. “It generally works out without much problem.”

Meanwhile, McDonnell told SN&R that the FTB still is determining exactly what should change in the tax return to meet the requirements of the law without causing more problems. “It’s a very complex situation that we’re still trying to figure nuts and bolts of ourselves. Our legal department and legislative-review group both are working on solutions.”

No taxpayer wants to attract the attention of the IRS. Could a discrepancy in the returns trigger an audit? According to the FTB’s McDonnell, it’s possible but not likely. Because the state and federal governments share information, discrepancies “might result in contact, but not automatically. And we want to reassure everyone that we are working our best to see that this law does not put anyone in that position.”

Hughes pointed out that information already is being sent out to enrolled agents. The CSEA’s first update session is scheduled for May 2. “We’ll be doing all we can to make sure that California tax practitioners are prepared to assist taxpayers to file their returns for 2007,” she said.

McDonnell is similarly upbeat. “We’re all working our best to see that equal treatment is the result of this law.”