COMPUTATION OF OVERPAYMENT ON JOINT RETURN THAT MAY BE CREDITED TO SPOUSE'S UNPAID SEPARATE TAX LIABILITY IN COMMUNITY PROPERTY STATE IS EXPLAINED

Rev. Rul. 85-70

ISSUE

If spouses who reside in a community property state file a joint return on which an overpayment is reported, in the situations described below that amount may the Internal Revenue Service apply against a separate liability of one of the spouses?

FACTS

SITUATION 1. A and B are married and reside in X, a community property state. They filed a joint Federal income tax return claiming an overpayment. The return showed income solely from wages from which tax has been withheld. B has an unpaid liability to the Service for tax assessed before the marriage.

Under the laws of X, all community property is subject to the pre-marital or other separate debts of either spouse.

SITUATION 2. Same as SITUATION 1, except that A and B reside in Y, a community property state in which all community property is subject to the pre-marital or other separate debts of either spouse but is exempt under state law from tax claims.

SITUATION 3. Same as SITUATION 1, except that A and B reside in Z, a community property state in which community property is not subject to the pre-marital or other separate debts of either spouse.

LAW AND ANALYSIS

Section 6402(a) of the Internal Revenue Code provides that in the case of any overpayment, the Secretary may within the applicable period of limitations credit the amount of the overpayment, including any interest allowed thereon, against any liability in respect of an internal revenue tax on the part of the person who made the overpayment and shall refund the balance to such person.

Rev. Rul. 74-611, 1974-2 C.B. 399, provides that when a husband +and wife file a joint return, each spouse has a separate interest in the jointly reported income and a separate interest in any overpayment.

Rev. Rul. 80-7, 1980-1 C.B. 296, provides that if spouses file a joint return showing an overpayment, then the amount that may be credited to one spouse's separate liability is the amount of that spouse's interest in the overpayment, computed by subtracting that spouse's share of the joint liability, determined in accordance with the separate tax formula, from that spouse's contribution toward the joint liability. The amount credited cannot exceed the amount of the joint overpayment. Under the separate tax formula a spouse's share of the joint liability is computed as follows:

          spouse's separate tax

Determining the amount the Service may apply against the separate liability of one of the spouses in the situations described is a two-step process. In the first step, the Service may offset the liable spouse's allocable share under section 6402 of the Code. Although the spouses may have earned different amounts of wages, each spouse in a community property state is considered to be the recipient of one-half of the aggregated wages. Each spouse is also entitled to a credit for one-half of the taxes that are withheld from such wages. Accordingly, when the above formula is used, each spouse has a one-half interest in the overpayment. The Service may, therefore, offset one-half of the overpayment against the separate liability of one of the spouses.

Under the second party of the two-step process, the Service may, depending on local law, offset an additional amount of the refund against the separate liability of one of the spouses. this right of offset is a common law right of offset and can be exercised by the United States. United States v. Munsey Trust Co., 332 U.S. 234 (1946). The right of set off is available in a community property state where the property itself (as opposed to the person) can be reached under local law for the payment of the separate debts of the liable spouse. Eaves v. United States, 433 F.2d 1296 (19th Cir. 1970). Depending on the law of the particular state, the Service may thus be able to exercise a common law right to set off against the balance of the overpayment otherwise payable to the nonliable spouse.

Thus, the amount the Service may be able to offset in the second step of this process is dependent upon the applicable laws in the community property state. In a state in which all community property is subject to the pre-marital or other separate debts of either spouse, the Service may offset the entire amount otherwise refundable to the nonliable spouse. In a state in which all community property is subject to the pre-marital or other separate debts of either spouse but is exempt under state law from tax claims, the state law exemption is invalid against the United States. United States v. Mitchell, 403 U.S. 190, 204 (1970), 1971-2 C.B. 419. See also United States v. Rodgers, 461 U.S. 677 (1983), 1983-2 C.B. 253. Therefore, the Service may similarly offset the entire amount that is otherwise refundable to the nonliable spouse. However, in a state in which community property is not subject to the pre-marital or other separate debts of either spouse, the Service may not offset the amount due the nonliable spouse.

HOLDINGS

SITUATION 1. The Service may apply the entire amount of the overpayment against B's liability.

SITUATION 2. The Service may apply the entire amount of the overpayment against B's liability.

SITUATION 3. The Service may apply one-half of the overpayment against B's liability.

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 74-611 and Rev. Rul. 80-7 are amplified.