TAXATION OF UNMARRIED PARTNERS.

• Author: Cain, Patricia A.

TABLE OF CONTENTS I. A SHORT HISTORY OF MARRIAGE AND THE INTERNAL REVENUE CODE II. THE ROLE OF STATE PROPERTY LAW II. WHAT ARE THE PROPERTY RIGHTS OF UNMARRIED COUPLES? 1936 IV. TAX ISSUES FOR UNMARRIED COUPLES 1938 A. Payments from One Partner to the Other During the Relationship B. Transfers of Property at Dissolution of the Relationship 1. Divorce Taxation Prior to the Enactment of Section 1041 in 1984 2. Property Division for Washington Committed Partners, Registered Domestic Partners, and Civil Union Partners 3. Property Division for Cohabiting Couples Who are Making Marvin Claims C. Transfers at Death V. HOW OTHER COUNTRIES TREAT COHABITANTS CONCLUSION INTRODUCTION

Marriage plays an essential role in federal taxation. Marital status determines how you file your taxes and what rate is applied to your income. If you are married, you are entitled to file a joint return that will include the aggregated income of both spouses. Sometimes filing as a married couple can create a benefit. More often joint filing will create a penalty. (1) Many scholars have addressed this problem and suggested solutions. (2) In an ideal tax system, these scholars believe that tax laws should be marriage neutral.

Recognizing marriage as such a bright line in our tax system results in a system that ignores unmarried couples. That doesn't have to be the case as laws from other countries show. The problems for unmarried couples and how they are taxed in the United States are twofold. First, the tax law treats unmarried couples as strangers even though their lives often closely resemble those of spouses. (3) Sometimes this treatment can be beneficial (e.g., two single taxpayers can avoid the marriage penalty created by the joint return). But sometimes failure to recognize the reality of the relationship can be detrimental. For example, two unrelated individuals who share income and expenses may be viewed by the IRS as making taxable transfers. But the second problem, which I believe to be even more serious, is that the IRS has been notoriously silent on what the tax rules are that should be applied to unmarried cohabitating couples. (4) This results in a degree of tax uncertainty. Cohabiting couples simply do not know what the relevant tax rules are.

This Article argues that the uncertainty of the tax consequences of dealings between unmarried partners is particularly problematic and results in uneven tax treatment of similarly situated unmarried couples across the country. That is primarily because their tax advisors, in the absence of clear guidance, advise taking different sorts of positions, some that are protaxpayer and some that are not. (5) This uneven treatment is bad tax policy. Indeed, this lack of guidance is bad tax policy. Taxpayers deserve to know in advance the rules that govern their transactions.

1. A SHORT HISTORY OF MARRIAGE AND THE INTERNAL REVENUE CODE

   In 1948 the United States first embraced the principle that a married couple should be the taxable unit. The primary principle was that every married couple should pay the same amount of income tax on the same amount of income, no matter how the income might be owned or controlled by the individual spouses. That meant if a husband earned $ 100,000 and the wife earned nothing, that couple should pay the same amount in taxes as a couple in which the husband earned $50,000 and the wife also earned $50,000.

   This was not, strictly speaking, a policy decision. It was an eighteen-year delayed congressional reaction to the 1930 Supreme Court decision in Poe v. Seaborn. (6) In that case, the Supreme Court had ruled that spouses living in community property states could split all earned income 50/50. Because of the progressive rate schedule that applied to a taxpayer's income that meant that spouses in community property states paid a lower income tax bill than spouses in non-community property states. Splitting the earned income allowed them to take double advantage of the lower brackets. To prevent that geographic discrimination, Congress elected to enable all spouses to split their income by using a joint return in which the brackets were double what they were for single taxpayers.

   There are three tax policy maxims that come into conflict because of the way we have structured our tax system around marriage. Boris Bittker explained this conflict clearly in his important 1975 article on Taxation of the Family. (7) If you embrace these three tax principles: (1) progressive rates, (2) marriage neutrality, and (3) equal taxation of married couples, you will have to choose which is more important. That is because it is impossible to accomplish all three. The aggregation of income owned by two single taxpayers upon their marriage to each other necessarily violates marriage neutrality in a system that uses progressive rates.

   The Revenue Act of 1948 was passed almost seventy-five years ago and not much has changed since then. Married couples still file jointly. But the rate structure has changed since 1948 in response to political pressure from taxpayers, first from those who were single and raising children. They argued they should be able to split their income with the children they were raising. And so, in 1951, a Head of Household rate was enacted which provided 50% of the benefit of income splitting. (8) Then single taxpayers complained that they were being overtaxed as compared with married couples who often had a stay-at-home spouse providing beneficial untaxed services in the home. Nor did single taxpayers enjoy economies of scale since they were not sharing a home and home expenses with another.9 Congress listened to those arguments and in the Tax Reform Act of 1969 reduced the rates of single taxpayers, thereby adding to the effect of what has become known as the marriage tax penalty. (10) Today many married couples face a marriage tax penalty. (11) And all couples who file jointly are subject to joint and several liability, which can often seem a penalty to a spouse who is held responsible for the unreported income of an absent spouse. (12)

   No other advanced country embraces the joint return concept. (13) Great Britain was perhaps the last to abandon the notion and that was thirty years ago. (14) We, the United States, cling to this notion that it is right and just to treat spouses as a single taxpaying unit, indeed often as a single taxpayer.

   At the other end of the spectrum are the rules governing taxation of unmarried couples. There are, in point of fact, very few rules, and, for the most part, unmarried couples are treated as two individual single taxpayers who are virtually strangers for purposes of tax law. Even if the couple is registered in a marriage-alternative status under state law, such as registered domestic partners or civil union partners, federal tax law treats the couple as unmarried and thus as tax strangers. (15) This treatment produces odd results since under the laws of most states that recognize these marriage-alternatives, the couple is treated as married for purposes of state tax law. (16)

   There is a slight nod by the federal tax authorities to the marriage-alternative status under state law. If the state accords such couples specific state property rights, those rights will be recognized for federal tax purposes. The only clear statement by the IRS that this is the applicable rule is with respect to registered domestic partners in those community properly states in which registration at the state level subjects the couple to the community property regime. (17) The benefit to such couples is often huge. For example, if one partner is earning a high income and the other is earning very little, the two partners can split the overall income relying on Poe v. Seaborn (18) and thereby reduce their overall federal tax burden. Application of this rule creates the same sort of geographical discrimination for unmarried registered couples that Poe v. Seaborn had created for married couples prior to enactment of joint returns in 1948. (19)

   However, in my view, this geographical discrimination is a very small problem compared to the biggest problem facing unmarried couples: uncertainty as to what the tax rules are. The IRS has issued virtually no guidance for unmarried couples generally. And there are very few court decisions addressing the tax issues that typically arise for such couples. The primary purpose of this article is to identify those issues and suggest ways they might be addressed.

2. THE ROLE OF STATE PROPERTY LAW

   "[T]he subject matter of federal taxation is almost always a right, liability, status, or other legal interest created by state law." (20) While there are certain benefits to relying on state property law to determine federal tax outcomes (e.g., certainty and avoiding the need to create an entirely separate federal property regime for tax purposes), there are also built-in inequities such as the one demonstrated by our experience with Poe v. Seaborn. State property laws do differ and therefore can create different tax outcomes between taxpayers living in different states. (21)

   Congress has cured a number of these geographical discrepancies for married taxpayers. Not only did it enact joint returns in 1948 to cure the Poe v. Seaborn income splitting problem, in 1984 it enacted section 1041 to ensure that upon divorce all spouses were treated the same, regardless of the differences in state property rights. (22) Congress has never passed a statute addressing the tax situation of unmarried couples and it is unlikely to do so any time soon. As a result, it is up to the IRS, the agency charged with construing our tax laws, to apply rules to unmarried couples based on existing law, but with as much equity as possible.

3. WHAT ARE THE PROPERTY RIGHTS OF UNMARRIED COUPLES?

   Property rights of unmarried couples is a topic on which states vary considerably. Of course, in every state, true legal joint ownership of property is...