Married Filing separately, non-community-property state

Yes, I do prepare taxes professionally, but I can't find a clear answer to this very basic question:

For a married couple living together in a non-community-property state but filing separately, how are joint income and deductions to be divided up and claimed on the separate returns, assuming there is no dispute between the spouses regarding the method of division?

I can't find a clear answer from a definitive source. Just a smattering of court cases that seem to address only cases where the spouses don't agree on the division, and the court has to resolve the dispute. (But for the record, I'm not particularly good at researching court cases...)

"Joint income": let's say income to a jointly-held investment account, created and funded after the couple was married.

"Joint deduction": let's say real estate taxes paid out of a joint account on a house that's jointly owned.

Is there a rule? 50/50? Or any other division that's consistently applied? Is it different for income vs deductions?

(I have clients who file separately for reasons related to student loan repayments, and I've often been asked to divide things up in a way that's "optimal". I can't figure out how much leeway I actually have!)

I think you're missing the part about them agreeing! Whatever they agree to.

I think you're missing the part about them agreeing! Whatever they agree to.

That's how I've always done it. But recently I came across https://www.irs.gov/faqs/itemized-deductions-standard-deduction/other-deduction-questions/other-deduction-questions, which says (an an example):

"if amounts are paid from a joint checking account for interest on a residence both you and your spouse own, you would each deduct half of the mortgage interest paid on your separate returns"

This "faq" of course has no authority, and I think it's downright wrong (especially because the next example provided there raises more questions than it answers!), but it got me thinking: if someone asked me to support my position that the amounts can be divided up in any way agreed upon, I wouldn't know what to point to!

I think you're missing the part about them agreeing! Whatever they agree to.

That's how I've always done it. But recently I came across https://www.irs.gov/faqs/itemized-deductions-standard-deduction/other-deduction-questions/other-deduction-questions, which says (an an example):

"if amounts are paid from a joint checking account for interest on a residence both you and your spouse own, you would each deduct half of the mortgage interest paid on your separate returns"

This "faq" of course has no authority, and I think it's downright wrong (especially because the next example provided there raises more questions than it answers!), but it got me thinking: if someone asked me to support my position that the amounts can be divided up in any way agreed upon, I wouldn't know what to point to!

Get the agreement as to deductible expenses in writing from the TP's. That is your document of proof.

Get the agreement as to deductible expenses in writing from the TP's. That is your document of proof.

Why would that be necessary? If they each sign their separate return, then they've agreed. How would that not be "proof" to the IRS of agreement?

What I'm more worried about would be a situation like this: TP claims 100% of real estate taxes, spouse claims 0%. IRS audits TP's return, and auditor says "You can only claim 50%". I say, "I don't believe that's correct." Auditor says "Of course it is. And it's perfectly logical, even obvious, that it would have to be 50/50. What evidence do you have to support your position that a different allocation is allowable?"

Now, I'm not saying that the IRS would prevail were this to go to court. It's just that I would never want things to get anywhere close to that stage. But I can't find clear evidence that a non-50/50 allocation is allowed if TP/SP agree to it.

This is all 100% hypothetical. I'm just surprised that I can't point to anything that says a non-50/50 split is allowed.

Is there a rule? 50/50?

Part interest. If you own a part interest in rental property, you can deduct expenses you paid according to your percentage of ownership.
Example. Roger owns a one-half undivided interest in a rental house. Last year he paid $968 for necessary repairs on the property. Roger can deduct $484 (50% × $968) as a rental expense. He is entitled to reimbursement for the remaining half from the co-owner.

What is the source of this from Pub 504? (Format is way better in the Pub.) https://www.irs.gov/pub/irs-pdf/p504.pdf

Table 1. Itemized Deductions on Separate Returns
This table shows itemized deductions you can claim on your married filing separate return whether you paid the expenses separately with your own funds or jointly with your spouse.
Caution: If you live in a community property state, these rules don’t apply. See Community Property.

IF you paid ...
AND you ...
THEN you can deduct on your separate federal return...
medical expenses
paid with funds deposited in a joint checking account in which you and your spouse have an equal interest
half of the total medical expenses, subject to certain limits, unless you can show that you alone paid the expenses.
state income tax
file a separate state income tax return
the state income tax you alone paid during the year.
file a joint state income tax return and you and your spouse are jointly and individually liable for the full amount of the state income tax
the state income tax you alone paid during the year.
file a joint state income tax return and you are liable for only your own share of state income tax
the smaller of:
the state income tax you alone paid during the year, or
the total state income tax you and your spouse paid during the year multiplied by the following fraction. The numerator is your gross income and the denominator
is your combined gross income.

property tax
paid the tax on property held as tenants by the entirety
the property tax you alone paid.
mortgage interest
paid the interest on a qualified home1 held as tenants by the entirety
the mortgage interest you alone paid.
casualty loss
have a casualty loss on a home you own as tenants by the entirety
half of the loss, subject to the deduction limits. Neither spouse may report the total casualty loss.
1 For more information on a qualified home and deductible mortgage interest, see Pub. 936, Home Mortgage Interest Deduction.

I think the rule is actually that whoever paid the interest, takes the deduction. If the mortgage is being paid out of a joint account, we have to know who is funding the account. Using any reasonable method may be appropriate, but I don't see where that's endorsed by law. 50-50, or in proportion to AGI both make sense. I don't think 100-0 is correct unless it can be convincingly argued that only one person paid the interest.

(a) General rule
There shall be allowed as a deduction all interest paid or accrued within the taxable year on indebtedness.

More than one borrower.
If you and at least one other person (other than your spouse if you file a joint return) were liable for and paid interest on a mortgage that was for your home, and the other person received a Form 1098 showing the interest that was paid during the year, attach a statement to your return explaining this. Show how much of the interest each of you paid, and give the name and address of the person who received the form. Deduct your share of the interest on Schedule A (Form 1040), line 11, and print "See attached" next to the line.

Similarly, if you're the payer of record on a mortgage on which there are other borrowers entitled to a deduction for the interest shown on the Form 1098 you received, deduct only your share of the interest on Schedule A (Form 1040), line 10. Let each of the other borrowers know what his or her share is.

Similarly, a joint brokerage statement must be broken down to determine what is actually owned by each spouse. Filing a 1099 as a nominee is normally required for non-spouses, but can be skipped for spouses.

Nominees. If you received ordinary dividends
as a nominee (that is, the dividends are in your
name but actually belong to someone else), include
them on line 5 of Schedule B (Form
1040A or 1040). Several lines above line 6, put
a subtotal of all dividend income listed on line 5.
Below this subtotal, enter “Nominee Distribution”
and show the amount received as a nominee.
Subtract the total of your nominee distributions
from the subtotal. Enter the result on
line 6.

If you received a capital gain distribution or
were allocated an undistributed capital gain as
a nominee, report only the amount that belongs
to you on Form 1040A, line 10; Form 1040,
line 13; or Schedule D (Form 1040), line 13,
whichever is appropriate. Attach a statement to
your return showing the full amount you received
or were allocated and the amount you
received or were allocated as a nominee.

File Form 1099-DIV with the IRS. If you
received dividends as a nominee in 2017, you
must file a Form 1099-DIV (or Form 2439) for
those dividends with the IRS. Send the Form
1099-DIV with a Form 1096 to your Internal
Revenue Service Center by February 28, 2018
(April 2, 2018, if you file Form 1099-DIV electronically).
Give the actual owner of the dividends
Copy B of the Form 1099-DIV by January
31, 2018. On Form 1099-DIV, you should be
listed as the “Payer.” The other owner should
be listed as the “Recipient.” You do not, however,
have to file a Form 1099-DIV to show payments
for your spouse. For more information
about the reporting requirements and the penalties
for failure to file (or furnish) certain information
returns, see the General Instructions for
Certain Information Returns and the Instructions
for Form 2439.

Similar instructions appear for other types of 1099 income.

What is the source of this from Pub 504? (Format is way better in the Pub.) https://www.irs.gov/pub/irs-pdf/p504.pdf

I don't know the source. (I'm hoping that wasn't a rhetorical question on your part!) That Table 1 is so poorly constructed/worded that it's hard not to think the IRS is just making stuff up. But yes, if we could somehow trace it back to a source, that would be helpful.

(You can deduct "the property tax you alone paid"? So, neither spouse gets to deduct property tax paid out of a joint account? Nonsense.)

I don't know who writes Pubs or where they get the info, but there are quite a few TPT posts that (a) rely on them, and/or (b) claim they come from regs. and rulings and laws and stuff.

For residents of community-property states, Pub 555 (Community Property) says: "If you file separate returns, you and your spouse must each report half of your combined community income and deductions in addition to your separate income and deductions." It's of course logically false to conclude that if you don't live in a community-property state, then that rule does not apply. It's equally false to conclude that it does apply.

So what's the rule for residents of non-community-property states, and where is it stated?

Tax Preparer A: "You have to split it 50/50."
Tax Preparer B: "You can split it any way you want as long as the total is 100%."
If you're the judge, is there a statute/regulation/rule that you can rely on?

I can find no authoritative guidance for those in non community property states. That Pub and some PPC commentary were as close as I came. I spent some time looking yesterday in response to a client request.

I can find no authoritative guidance for those in non community property states. That Pub and some PPC commentary were as close as I came. I spent some time looking yesterday in response to a client request.

I prepare more and more MFS returns every year due to clients wanting to take best advantage of the various student loan repayment/forgiveness programs. I guess I'm just going to have to get used to not having anything authoritative/definitive to rely on, in terms of income/deduction allocation. That doesn't sit well with me, but it is what it is!

The quotes I posted above seem authoritative enough to me. Each spouse can only deduct what he or she paid. If the payments came out of a joint account, you have to figure out how much of the joint funds belong to each spouse. This could be 50-50, or in proportion to their income, or something else.

This page says that the deduction should be 50-50, but I don't think that's right.

Chief Counsel Memorandum 201451027 summarizes the Tax Court's position that, "Under normal circumstances, a deduction in respect of payment of a joint obligation is allowable to whichever of the parties liable thereon makes the payment out of his own funds," and the implications of that position. Although not authoritative in itself, it does cite authoritative sources.

From your link to the Chief Counsel Memorandum: "Based on these authorities, we conclude that funds paid from a joint account with two equal owners are presumed to be paid equally by each owner, in the absence of evidence showing that is not the case, as reflected in PLR 5707309730A."

So... what's sufficient evidence? Is it sufficient for the taxpayers to simply say, "We want the deduction to be split in the way that maximizes our overall tax benefit, whether that's 50/50 or 75/25 or 100/0?" Can the payments be separated retroactively, in a proportion that might vary from year to year, with no "evidence" other than a verbal agreement/understanding? Because that's the situation I'm looking at when a married couple tells me they need to file separately but they want me to "maximize" their refunds by allocating deductions to whoever gets the greater tax benefit. Same with claiming dependency exemptions, child tax credit, etc.

In fishing through some of the court cases referenced in the memorandum, I find this in Finney v. Commissioner, T.C. Memo. 1976-329:

Turning to the facts herein, John and Barbara both stipulated with respondent that the funds used to make the payments on the mortgage on the Dent Street property were supplied by John. While there concededly was not such earmarking of the funds as was present in Edward C. Kohlsaat, [35 T.C.M. 1508] supra, we think this stipulation is sufficient to satisfy John's burden of proof as to the tracing of the interest payments. Cf. Alice G.K. Kleberg [Dec. 11,618], 43 B.T.A. 277 295 (1941). Accordingly, we hold that he is entitled to the deduction for the full amount of the interest paid and that Barbara is not entitled to any deduction therefor.

In this case, the funds were paid out of Barbara's account rather than out of a joint account, but what seems relevant is that the Court found it sufficient that both John and Barbara "stipulated" with the respondent that the funds were John's. Is that all it takes, then?

I think "sufficient evidence" would be an indication of where the funds came from. For example, if both spouses are working but H has $1080 per month direct deposited into the joint account while W has $720 per month direct deposited into the joint account, that would likely be enough to show that the deductions should be split 60-40. Another example is if the joint account were completely funded by W's inheritance, then W should get 100% of the deduction. Finally, if the joint account is their main account, and all of their respective paychecks are deposited to that account, then the allocation should be in proportion to their income.

In the context of the Finney case you quoted, "stipulated" simply means that they reached an agreement with the IRS and they are not asking the court to decide that point.

As a practical matter, if I were in your shoes, I would do the returns two ways: One with a 50-50 split, and one with a split in proportion to AGI. It seems to me that any other division would require a potentially time-consuming and invasive inquiry as to the ultimate source and use of the funds in the joint checking account.

In the context of the Finney case you quoted, "stipulated" simply means that they reached an agreement with the IRS and they are not asking the court to decide that point.

Interesting - I hadn't realized what "stipulate" means, in a legal context. I appreciate the explanation! I assumed it just meant "specified" or something like that. I thought I was onto something there, but I guess not! :)

I understand where you're coming from (I think) with the 50/50 or proportionate-to-AGI approach, but it feels a bit too "play it safe" to me if my clients have specifically requested that I allocate the deductions in the most beneficial way (allowable). That's not in any way meant to be a knock against your approach! It's just that I still can't say with confidence that what JR1 said back in post #2 in this thread is incorrect or disallowed:

Whatever they agree to.

If that's never been specifically, explicitly disallowed, then ... my inclination (tilted, but uncertain) here is to assume it's allowed.

(Obviously that's not a general guideline, but for such a common situation, I can't see how this would not have been challenged in the past. Maybe it has, maybe the IRS won, but I can't find it.)

https://www.leagle.com/decision/195115616rtc1401139
And Rev Rul 59-66
And viewtopic.php?f=8&t=12332

Interesting - I hadn't realized what "stipulate" means, in a legal context.

See Tax Court Rule #91. It makes the Tax Court unique, so that trial time is minimized.

https://www.ustaxcourt.gov/rules/rule_91_091809.pdf

I tried to bait someone into answering this question I posed:

Question: What if *both* parties (namely the IRS) don’t agree?

…here:

viewtopic.php?f=8&t=12029&p=109268&hilit=ira+prohibited+transaction#p109268

And here’s the answer in case you’re interested: In that case that Wiles referenced (Marks), if the IRS did not stipulate that a prohibited transaction took place long ago, when there was clear evidence that it did, the judge would have been very pissed (to put it lightly) at the IRS for that lack of stipulation. The taxpayer would have had to file a motion to compel stipulation and the judge would have had to deal with it.

https://www.leagle.com/decision/195115616rtc1401139
And Rev Rul 59-66
And viewtopic.php?f=8&t=12332

RR 59-66 looks for "competent evidence" in order for funds paid out a joint account to be considered as paid separately. The opinion in the Higgins case you linked to says:

Neither petitioner nor his wife testified as to any understanding between them.

So... would a verbal understanding between spouses be sufficient to support the claim that funds paid out of a joint account are to be (retroactively) considered as paid for out of separate funds belonging to whichever spouse receives the greater tax benefit (t.b.d)?

I get the sense that there isn't going to a be an answer that (to me) is clear-cut. That's what I find kind of astonishing about this whole thing. How can I really not know the answer (or have a confident approach) to something that seems so basic??