Texas is a community property state, which means that all “community property” is owned jointly and equally by both spouses. In Texas, all property accumulated during marriage is community property unless it is received by gift, devise, or inheritance. Tex. Fam. Code Ann. § 5.01. Even income derived from separate property—including interest and dividends from separately owned securities—is considered community property. Commissioner of Internal Revenue v. Chase Manhattan Bank, 259 F.2d 231, 239 (5th Cir. 1958), cert. den., 359 U.S. 913 (1959). Texas’s community property laws can have unusual implications for married couples’ federal income tax liabilities.
What is Each Spouse’s Liability on a Tax Return?
Sometimes, sorting out tax liability for spouses in community property states is simple and straightforward. For instance, when spouses are jointly and severally liable for federal taxes—spouses who file joint tax returns, for instance—the IRS can collect these taxes from any community or separate property. However, most community property collection issues come from more complicated circumstances.
Community property collection issues typically arise where only one spouse owes a tax liability. This can happen in a variety of contexts, but most commonly occurs when:
- Neither spouse files a return;
- Both spouses file separate returns;
- One spouse is given “innocent spouse relief;” or
- One spouse incurs employment taxes or is assessed a trust fund recovery penalty.
The chief issues in these contexts are: (1) identifying which assets are available to satisfy the obligations; and (2) navigating how community property laws affect these obligations.
Section 6321 of the Internal Revenue Code imposes a federal tax lien on “all property and rights to property” of a taxpayer who neglects or refuses to pay assessed taxes after notice and demand. State laws determine the extent to which a taxpayer has an interest in property for federal tax purposes, while federal law determines the consequences of that interest. National Bank of Commerce, 472 U.S. at 722.
Navigating the second issue is slightly more complicated. The Texas Family Code characterizes a spouse’s earnings as the “sole management community property” of that spouse and makes them exempt from the other spouse’s creditors. Tex. Fam. Code Ann. §§ 5.22(a)(1), 5.61(b)(2). However, the Supreme Court has held that state law exemptions are not effective against the United States for federal tax purposes. United States v. Mitchell, 403 U.S. 190, 205 (1971). Applying this ruling, the Fifth Circuit has held that, in community property states, the tax debts of one spouse (but not the other) may be satisfied with 100% of that spouse’s “sole management” community property and 50% of the other spouse’s “sole management” property. See, e.g., Medaris v. United States, 884 F.2d 832 (5th Cir. 1989); Broday v. United States, 455 F.2d 1097, 1100 – 01 (5th Cir. 1972).
Property that is the sole management property of one spouse is subject to that spouse’s control despite the other spouse’s half interest in it. In essence, it is the property the spouse would have if he or she were single.
What Happens to Tax Debt When the Liable Spouse Passes Away?
Things can become a bit complicated when only one spouse is liable for back taxes and then passes away before the non-liable spouse. A decedent’s estate is responsible for paying his or her tax debts. Tex. Fam. Code Ann. § 5.01. This includes any income derived from separate property. Chase Manhattan Bank, 259 F.2d 231, 239 (5th Cir. 1958). Although Texas state law exempts certain property from creditors, the Supreme Court and Fifth Circuit have held that state law exemptions are not effective against the United States for the purpose of tax liens. Mitchell, 403 U.S. at 205; Medaris, 884 F.2d 832; Broday, 455 F.2d at 1100 – 01.
Further, in Medaris and Broday, the Fifth Circuit has held that, in community property states, the federal tax debts of one spouse (but not the other) may be satisfied with 100% of that spouse’s “sole management” community property and 50% of the other spouse’s “sole management” property. Thus, the IRS is allowed to attach 100% of the deceased (liable) spouse’s interest in the community property, as well as half of the surviving spouse’s interest. Moreover, the IRS was not required to provide notice to the surviving spouse when attaching the property.