If you don’t know what a domestic partnership is, it refers to a gay couple. As you can imagine, there are some tax issues that pertain to a homosexual couple. For example, what’s their marital status? Not all states recognize a gay marriage. In some states (like California), you can’t marry but you can be registered as domestic partners. The Federal government does not view gay couples as married. So would you choose “single”, “married” or “single parent” when filling up your tax return form? The Internal Revenue Service has ruled that the federal Defense of Marriage Act 1996, disallows same-sex couples from filing jointly – or as married filing separately – on federal returns. Thus, domestic partners can either choose a tax authority to defy or file state tax returns that are completely different from their federal returns.
For example, under California law, domestic partners could combine their income and then file jointly or split the combined income and deductions and file two nearly identical "married filing separately" returns. But under federal law, each partner would list his or her own income and deductions. If the partners have children, they must decide who would claim the children as dependents.
Insofar as declaring taxable income is concerned, the task of filling up federal and state tax forms may pose a problem depending on which state you’re in. For example, if you’re in California, your state tax returns (Form 540) must bear the same income as stated in your federal tax return forms. Therefore, if you chose to file jointly under California law, your joint income would not be applicable for federal return forms because you would have to file as separate individuals since the federal government does not recognize same sex couples as married.
Another tax issue arises when one of the partners passes away. Under current federal estate tax laws, if you’re a married couple you are completely exempted from estate taxes when one spouse dies. So when the husband dies, his assets go to his wife and the wife is not subject to estate tax. But after she dies, then estate tax becomes payable. However, with domestic partners there's no such exemption from estate taxes.
Also, in a community-property state (like California), there's a question about ownership of the assets. This is because community-property laws assume that married couples (including domestic partners) are equal owners of most assets like a house. But because the federal government doesn't recognize domestic partnerships, it assumes that the house is owned by only the person whose name is on the title deed.
Hence, if a domestic couple say in California owns a $1 million house and one partner dies, is the entire $1 million subject to estate duty tax or only $500,000?