Married File Separate Community Property State Tax Withholding adjustment

[slaidlaw911]

Hello,

I received a notice from the state of CA saying they adjusted my wife's return to 0 due to the fact  EDD couldn't verify the state tax withholding amount on her W2 or 1099 which is correct because the funds are from my state tax withholding from my W2. 

In the tax withholding adjustment section in community property I made a $2258 adjustment to her return and a negative on my return in the same section which I thought was the proper way. After the adjustments because she made next to no income in 2019 we have split my state withholding down the middle.

The representative I spoke to at the tax board said she had never heard on that and withholdings are kept by the person that paid them not split. My wife and I have only community property so I split everything down the middle. 

The turbo tax info section says this

"Your income tax withholding from W-2s, 1099s, etc. is considered community property, which means that half belongs to your partner/spouse.

You must compare your total withholdings to those of your partner/spouse and calculate how much of your withholdings belong to your partner/spouse and how much of their withholdings belong to you."

Am I doing this totally wrong?

[macuser_22 · Accepted solution]

I don't understand why unless they are totally clueless when the CA FTB Pub 1031 says on page 11 for Married Filing Separately.  The CA tax return should have a copy of the Federal Tax return that has the Federal  8958 form for the community property income splitting and CA uses that form.

You need to talk to someone in CA that knows what they are talking about.

Separate Property
Separate property includes the following:
• Property owned separately by each spouse/
RDP before marriage or registering as a domestic
partnership.
• Property received separately as gifts or inheritances.
• Property purchased with separate property funds.
• Money earned while domiciled in a separate property
state.
• All property declared separate property in a valid
agreement.
Maintain separate property separately. If the property
or the income from the property is used for community
purposes, or commingled, it could lose its separate
property character, overriding any agreements

While it does not specifically say to split "CA tax withheld", it only stands to reason that if CA income must be split then tax withheld on that income must also be split otherwise the spouse with no actual CA income would be under withheld and the spouse with the CA income would be over withheld - and that would lead to a illogical result.

[macuser_22]

But why file MFS in the first place.   It is rare that MFS is better then filing jointly.

If you file MFS (Married Filing Separately) keep in mind that there are several limitations to MFS.  Married filing Jointly is usually the better way to file.
 
A few of those limitations are: (see IRS Pub 17 for the full list

https://www.irs.gov/pub/irs-pdf/p17.pdf page 21

1. Your tax rate generally is higher than on a joint return.
2. Your exemption amount for figuring the alternative minimum tax is half that allowed on a joint return.
3. You cannot take the credit for child and dependent care expenses in most cases, and the amount you can exclude from income under an employer's dependent care assistance you are legally separated or living apart from your spouse, you may be able to file a separate return and still take the credit. For more information about these expenses, the credit, and the exclusion, see chapter 32.
4. You cannot take the earned income credit.
5. You cannot take the exclusion or credit for adoption expenses in most cases.
6. You cannot take the education credits (the American opportunity credit and lifetime learning credit) or the deduction for student loan interest.
7. You cannot exclude any interest income from qualified U.S. savings bonds you used for higher education expenses.
8. If you lived with your spouse at any time during the tax year:
a. You cannot claim the credit for the elderly or the disabled, and
b. You must include in income a greater percentage (up to 85%) of any social security or equivalent railroad retirement benefits you received.
9. The following credits and deductions are reduced at income levels half those for a joint return:
a. The child tax credit,
b. The retirement savings contributions credit,
10. Your capital loss deduction limit is $1,500 (instead of $3,000 on a joint return).
11. If your spouse itemizes deductions, you cannot claim the standard deduction. If you can claim the standard deduction, your basic standard deduction is half the amount allowed on a joint return.

- If you live in a community property state you must allocate community income between both spouses..
-
- Community property states.   If you live in Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, or Wisconsin and file separately, your income may be considered separate income or community income for income tax purposes. See Publication 555. http://www.irs.gov/publications/p555/index.html

 
See this TurboTax article for help with this.
https://ttlc.intuit.com/questions/1894449-married-filing-jointly-vs-married-filing-separately

https://ttlc.intuit.com/questions/1901162-married-filing-separately-in-community-property-states

[slaidlaw911]

My reason for filing married separate has to do with income based repayment on my wife's student loans we pay on. In addition I ran both tax married joint and separate and separate turned out a little better.

So to recap I am correct? 

[macuser_22]

That is one of the few reason that MFJ might be an advantage.

Yes, in my opinion, you did it correctly.  CA would seem to be wrong according  to the CA tax laws.

[Buck_Fievre]

Your reasoning is sound regarding a student loan repayment benefit in some situations by filing MFS.  It's ridiculous that the federal IBR/ICR rules drive you to this extreme solution, but my wife and I save hundreds monthly using this same ploy. 

Ironically though, one of the things you lose filing MFS is the ability to deduct student interest payments.  Could it get any more Catch-22 than that?

I also agree with macuser_22 that you need to talk to someone with California Franchise Tax Board who "knows what they are talking about."  But it's probably not a good idea to use that exact terminology when calling them back.   Haha. 

[si29xnm]

FYI, I'm not sure if FTB fixed their system, but for 2021 and 2022, I didn't have this problem. My RDP and I filed California tax return separately. My Form 540 line 71 (California income tax withheld) did NOT match my W-2's box 17 (state income tax) -- in 2021, it was lower (because I made more than RDP) and in 2022, it was higher (because I made less than RDP). Both years, FTB didn't have an issue with that.

On Federal Form 8958, TurboTax did put information on how we were splitting Federal withholding in line 11. But TurboTax didn't put anything about how we were splitting California withholding. So on my CA tax return, I don't see any entry showing how I arrived at the figure on Form 540 line 71, but FTB didn't raise any issues. FTB does know about my RDP's return because box 3 is checked on page 1 of Form 540, along with my RDP's SSN on the top of page 1, so maybe FTB is smart enough to verify that the sum of Form 540 line 71 from both our returns matches the sum of both of our W-2's box 17.

[DMarkM1]

The CA FTB should use information from both returns to reconcile both your tax returns.  However be sure to keep records of your calculations should the question ever come up.