Part I. Rulings — Internal Revenue Bulletin 2004-30

Section 61.—Gross Income Defined

26 CFR 1.61–8: Rents and royalties.

T.D. 9135

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1

Rents and Royalties

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final regulations relating to the inclusion in gross income of advance rentals. The regulations authorize the Commissioner to provide rules allowing for the inclusion of advance rentals in gross income in a year other than the year of receipt. The regulations will affect taxpayers that receive advance payments for the use of certain items (such as intellectual property and computer software) to be designated by the Commissioner.

DATES: Effective Date : These regulations are effective July 8, 2004.

Applicability Date : The amendments made by these regulations apply after December 18, 2002.

FOR FURTHER INFORMATION CONTACT: Edwin B. Cleverdon, (202) 622–7900 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

On December 18, 2002, the IRS published a notice of proposed rulemaking (REG–151043–02, 2003–1 C.B. 300) in the Federal Register (67 FR 77450), proposing amendments to 26 CFR part 1 under section 61 of the Internal Revenue Code (Code) regarding the inclusion in gross income of advance rentals. The notice of proposed rulemaking invited

comments and requests for a public hearing, but no comments were received and no public hearing was requested or held.

Contemporaneously with the publication of the notice of proposed rulemaking, the IRS published a proposed revenue procedure in Notice 2002–79, 2002–2 C.B. 964, that, when final, implements the amendments made by these final regulations. The proposed revenue procedure was finalized, with modifications, as Rev. Proc. 2004–34, 2004–22 I.R.B. 991. Comments received in connection with the proposed revenue procedure, including comments concerning the proposed treatment of advance rentals, are addressed in Announcement 2004–48, 2004–22 I.R.B. 998, which accompanies Rev. Proc. 2004–34.

Explanation of Provisions

This document contains amendments to 26 CFR part 1 relating to the inclusion in gross income of advance rentals under section 61 of the Code. Prior to amendment, §1.61–8(b) provided that, except as provided in section 467 and the regulations thereunder, advance rentals must be included in gross income in the year of receipt regardless of the period covered or the method of accounting employed by the taxpayer. The amendments authorize the Commissioner to provide, through administrative guidance, rules for deferring income inclusion of advance rentals to a taxable year other than the year of receipt. This amendment ensures that the Commissioner, in modifying Rev. Proc. 71–21, 1971–2 C.B. 549, may provide deferral rules for the use of intellectual property and computer software.

Special Analyses

of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Code, the notice of proposed rulemaking preceding this regulation was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business. The Chief Counsel for Advocacy did not submit any comments on the regulations.

Drafting Information

The principal author of these regulations is Edwin B. Cleverdon of the Office of Associate Chief Counsel (Income Tax and Accounting). However, other personnel from the IRS and Treasury Department participated in their development.

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Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 1 is amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read, in part, as follows:

Authority: 26 U.S.C. 7805 * * *

§1.61–8 [Amended]

Par. 2. The first sentence of §1.61–8(b) is amended by adding the language “and except as otherwise provided by the Commissioner in published guidance (see §601.601(d)(2) of this chapter),” immediately after “thereunder,”.

Mark E. Matthews, Deputy Commissioner for Services and Enforcement .

Approved June 30, 2004.

Gregory Jenner, Acting Assistant Secretary of

the Treasury .

(Filed by the Office of the Federal Register on July 7, 2004, 8:45 a.m., and published in the issue of the Federal Register for July 8, 2004, 69 F.R. 41192)

2004–30 I.R.B. 69 July 26, 2004

Section 404.—Deduction for Contributions of an Employer to an Employees’ Trust or Annuity Plan and Compensation Under a Deferred-Payment Plan

26 CFR 1.404(b)–1T: Method or arrangement of con- tributions, etc., deferring the receipt of compensation or providing for deferred benefits (Temporary). 26 CFR 1.404(d)–1T: Questions and answers relat- ing to deductibility of deferred compensation and de- ferred benefits for independent contractors (Tempo- rary).

Circumstances under which an insurance company that makes incentive payments to health care providers will be permitted to include those payments in discounted unpaid losses without regard to section 404. See Rev. Proc. 2004-41, page 90.

Section 446.—General Rule for Methods of Accounting

26 CFR 1.446–1: General rule for methods of ac- counting.

Procedures under which an insurance company that makes incentive payments to health care providers may obtain automatic consent of the Commissioner to change its method of accounting for such payments. See Rev. Proc. 2004-41, page 90.

Section 832.—Insurance Company Taxable Income

26 CFR 1.832–4: Gross income.

Section 846.—Discounted Unpaid Losses Defined

Section 5891.—Structured Settlement Factoring Transactions

26 CFR 157.5891–1: Imposition of excise tax on structured settlement factoring transactions.

T.D. 9134

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Parts 157and 602

Excise Tax Relating to Structured Settlement Factoring Transactions

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations and removal of temporary regulations.

SUMMARY: This document contains final regulations relating to the manner and method of reporting and paying the nondeductible 40 percent excise tax imposed on any person who acquires structured settlement payment rights in a structured settlement factoring transaction. The regulations provide the guidance necessary to comply with the reporting requirements of the excise tax.

DATES: Effective Date : These regulations are effective July 8, 2004.

Applicability Dates : For dates of applicability, see §157.5891–1(e).

FOR FURTHER INFORMATION CONTACT: Shareen S. Pflanz of the Office of Associate Chief Counsel (Income Tax and Accounting) at 202–622–4920 (not a toll-free call).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information contained in these final regulations have been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)) under control number 1545–1824. The collections of information in these final regulations are in

§§157.6001–1, 157.6011–1, 157.6081–1, and 157.6161–1. This information is required by the IRS to verify that the excise tax imposed under section 5891 is properly reported on Form 8876 and timely paid. This information will be used for that purpose.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a valid control number assigned by the Office of Management and Budget.

The burden is reflected in the burden estimate on Form 8876. Suggestions for reducing the burden of the collection of information in these regulations should be sent to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, SE:W:CAR:MP:T:T:SP, Washington, DC 20224, and to the Office of Manage- ment and Budget, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503.

Books or records relating to a collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. 6103.

Background

This document contains final regulations that replace the temporary regulations in 26 CFR part 157. The regulations provide guidance on the proper manner and method of reporting and paying the 40 percent excise tax imposed under section 5891. The regulations reflect the addition to the Internal Revenue Code (Code) of chapter 55 and section 5891 by section 115 of the Victims of Terrorism Tax Relief Act of 2001, Public Law 107–134, (115 Stat. 2427, 2436–2439). On February 19, 2003, temporary regulations (T.D. 9042, 2003–1 C.B. 564) adding a new part 157, Excise Tax on Structured Settlement Factoring Transactions, to title 26 of the Code of Federal Regulations were published in the Federal Register (68 FR 7922). A notice of proposed rulemaking (REG–139768–02, 2003–1 C.B. 583) cross-referencing the temporary regulations was also published in the Federal Register (68 FR 7956). No public hearing was requested or held. One written

July 26, 2004 70 2004–30 I.R.B.

the factoring discount with respect to such factoring transaction.

(b) Exceptions for certain approved transactions —(1) In general . The excise tax shall not apply to a structured settlement factoring transaction if the transfer of structured settlement payment rights is approved in advance in a qualified order.

(2) Qualified order dispositive . A qualified order shall be treated as dispositive for purposes of this exception.

(i) A statute that is enacted by the state in which the payee of the structured settlement is domiciled and provides for the entry of an order, judgment, or decree described in paragraph (c)(4)(i) of this section; or

(ii) If there is no such statute, a statute that—

(A) Is enacted by the state in which either the party to the structured settlement (including an assignee under a qualified assignment under section 130) or the person issuing the funding asset for the structured settlement is domiciled or has its principal place of business; and

(B) Provides for the entry of such an order, judgment, or decree.

(2) Applicable state court means, with respect to any applicable state statute, a court of the state that enacted such statute. If the payee of the structured settlement is not domiciled in the state that enacted the statute, the term also includes a court of the state in which the payee is domiciled.

(3) Factoring discount means an amount equal to the excess of—

(i) The aggregate undiscounted amount of structured settlement payments being acquired in the structured settlement factoring transaction; over

(ii) The total amount actually paid by the acquirer to the person from whom such structured settlement payments are acquired.

(4) Qualified order means a final order, judgment, or decree that—

(i) Finds that the transfer of structured settlement payment rights does not contravene any Federal or state statute, or the order of any court or responsible administrative authority, and is in the best interest of the payee, taking into account the welfare and support of the payee’s dependents; and

(ii) Is issued under the authority of an applicable state statute by an applicable

comment responding to the notice of proposed rulemaking was received in which the writer commended the issuance of the temporary and proposed regulations and urged that they be finalized without change. The proposed regulations are adopted by this Treasury decision without any substantive changes.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5), does not apply to these regulations. It is hereby certified that the collection of information in these regulations will not have a significant economic impact on a substantial number of small entities. This certification is based upon the expectation that the excise tax imposed by section 5891 will apply to few structured settlement factoring transactions. Therefore, a Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the Code, the proposed regulations preceding these final regulations were submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact.

Drafting Information

The principal author of these final regulations is Shareen S. Pflanz, Office of Associate Chief Counsel (Income Tax and Accounting). However, other personnel from the IRS and Treasury Department participated in their development.

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Adoption of Amendments to the Regulations

Accordingly, title 26 CFR parts 157 and 602 are amended as follows: Paragraph 1. Part 157 is revised to read as follows:

PART 157—EXCISE TAX ON STRUCTURED SETTLEMENT FACTORING TRANSACTIONS

Subpart A — Tax on Structured Settlement Factoring Transactions

Sec. 157.5891–1 Imposition of excise tax on structured settlement factoring transactions.

Subpart B — Procedure and Administration

157.6001–1 Records, statements, and special returns.

157.6011–1 General requirement of return, statement, or list.

157.6061–1 Signing of returns and other documents.

157.6065–1 Verification of returns. 157.6071–1 Time for filing returns. 157.6081–1 Extension of time for filing the return.

157.6091–1 Place for filing returns. 157.6151–1 Time and place for paying of tax shown on returns.

157.6161–1 Extension of time for paying tax.

157.6165–1 Bonds where time to pay tax has been extended.

Authority: 26 U.S.C. 7805. Section 157.6001–1 also issued under 26 U.S.C. 6001. Section 157.6011–1 also issued under 26 U.S.C. 6011. Section 157.6061–1 also issued under 26 U.S.C. 6061. Section 157.6071–1 also issued under 26 U.S.C. 6071. Section 157.6091–1 also issued under 26 U.S.C. 6091. Section 157.6161–1 also issued under 26 U.S.C. 6161.

Subpart A — Tax on Structured Settlement Factoring Transactions

§157.5891–1 Imposition of excise tax on structured settlement factoring transactions.

(a) In general . Section 5891 imposes on any person who acquires, directly or indirectly, structured settlement payment rights in a structured settlement factoring transaction a tax equal to 40 percent of

2004–30 I.R.B. 71 July 26, 2004

contents thereof may become material in the administration of any internal revenue law.

§157.6011–1 General requirement of return, statement, or list.

Every person liable for tax under section 5891 must file a return with respect to the tax in accordance with the forms and instructions provided by the Internal Revenue Service.

§157.6061–1 Signing of returns and other documents.

Any return, statement, or other document required to be made with respect to a tax imposed by chapter 55 (Structured Settlement Factoring Transactions) of the Internal Revenue Code or the regulations under chapter 55 must be signed by the person required to file the return, statement, or other document, or by the persons required or duly authorized to sign in accordance with the regulations, forms, or instructions prescribed with respect to such return, statement, or document. An individual’s signature on such return, statement, or other document shall be prima fa- cie evidence that the individual is authorized to sign the return, statement, or other document.

§157.6065–1 Verification of returns.

If a return, statement, or other document made under the provisions of chapter 55 (Structured Settlement Factoring Transactions) or of subtitle F of the Internal Revenue Code, or the regulations under those provisions with respect to any tax imposed by chapter 55, or the form and instructions issued with respect to such return, statement, or other document, requires that it shall contain or be verified by a written declaration that it is made under the penalties of perjury, it must be so verified by the person or persons required to sign such return, statement, or other document. In addition, any other statement or document submitted under any provision of chapter 55 or subtitle F, or the regulations under those provisions, with respect to any tax imposed by chapter 55 may be required to contain or be verified by written declaration that it is made under the penalties of perjury.

state court, or is issued by the responsible administrative authority (if any) which has exclusive jurisdiction over the underlying action or proceeding which was resolved by means of the structured settlement.

(5) Responsible administrative author- ity means the administrative authority that had jurisdiction over the underlying action or proceeding that was resolved by means of the structured settlement.

(6) State includes the Commonwealth of Puerto Rico and any possession of the United States.

(7) Structured settlement means an arrangement—

(i) that is established by— (A) Suit or agreement for the periodic payment of damages excludable from the gross income of the recipient under section 104(a)(2); or (B) Agreement for the periodic payment of compensation under any workers’ compensation law excludable from the gross income of the recipient under section 104(a)(1); and (ii) Under which the periodic payments are—

(A) Of the character described in section 130(c)(2)(A) and (B); and

(B) Payable by a person who is a party to the suit or agreement or to the workers’ compensation claim or by a person who has assumed the liability for such periodic payments under a qualified assignment in accordance with section 130.

(8) Structured settlement factoring transaction means a transfer of structured settlement payment rights (including portions of structured settlement payments) made for consideration by means of sale, assignment, pledge, or other form of encumbrance or alienation for consideration other than—

(i) The creation or perfection of a security interest in structured settlement payment rights under a blanket security agreement entered into with an insured depository institution in the absence of any action to redirect the structured settlement payments to such institution (or agent or successor thereof) or otherwise to enforce such blanket security interest as against the structured settlement payment rights; or

(ii) A subsequent transfer of structured settlement payment rights acquired in a structured settlement factoring transaction.

(9) Structured settlement payment rights means rights to receive payments under a structured settlement.

(d) Coordination with other provisions of the Internal Revenue Code —(1) In gen- eral . If the applicable requirements of sections 72, 104(a)(1), 104(a)(2), 130, and 461(h) were satisfied at the time the structured settlement involving structured settlement payment rights was entered into, the subsequent occurrence of a structured settlement factoring transaction shall not affect the application of the provisions of such sections to the parties to the structured settlement (including an assignee under a qualified assignment under section 130) in any taxable year. (2) No withholding of tax . The provisions of section 3405 regarding withholding of tax shall not apply to the person making the payments in the event of a structured settlement factoring transaction.

(e) Effective dates . This section applies to structured settlement factoring transactions entered into on or after July 8, 2004. For structured settlement factoring transactions entered into before July 8, 2004, see §157.5891–1T of this chapter (2003–1 C.B. 564. See §601.601(d)(2) of this chapter.), as it appeared in the April 1, 2003, edition of 26 CFR part 157.

Subpart B — Procedure and Administration

§157.6001–1 Records, statements, and special returns.

(a) In general . Any person subject to tax under chapter 55 (Structured Settlement Factoring Transactions) of the Internal Revenue Code must keep such complete and detailed records as are sufficient to enable the Internal Revenue Service (IRS) to determine accurately the amount of liability under chapter 55.

(b) Notice by the IRS requiring returns, statements, or the keeping of records . The IRS may require any person, by notice served upon him, to make such returns, render such statements, or keep such specific records as will enable the IRS to determine whether or not the person is liable for tax under chapter 55.

(c) Retention of records . The records required by this section must be kept at all times available for inspection by the IRS, and shall be retained so long as the

July 26, 2004 72 2004–30 I.R.B.

(b) Certain rules relating to extension of time for paying income tax to apply . The provisions of §1.6161–1(b), (c), and (d) of this chapter (relating to a requirement for undue hardship, to the application for extension, and to payment pursuant to an extension) shall apply to extensions of time for payment of the tax imposed by chapter 55 of the Code.

§157.6165–1 Bonds where time to pay tax has been extended.

If an extension of time for payment is granted under section 6161, the Internal Revenue Service may, if it deems necessary, require a bond for the payment, in accordance with the terms of the extension, of the amount with respect to which the extension is granted. However, the bond shall not exceed double the amount with respect to which the extension is granted. For provisions relating to the form of bonds, see the regulations under section 7101 contained in part 301 (Regulations on Procedure and Administration) of this chapter.

PART 602—OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 2. The authority citation for part 602 continues to read as follows: Authority: 26 U.S.C. 7805. Par. 3. In §602.101, paragraph (b) is amended by removing the entries for “157.6001–1T,” “157.6011–1T,” “157.6081–1T,” and “157.6161–1T” and adding entries in numerical order to the table to read, in part, as follows:

§602.101 OMB Control numbers.

- - - (b) - *

§157.6071–1 Time for filing returns.

(a) In general . Except as provided in paragraph (b) of this section, returns required by §157.6011–1 (relating to returns of tax with respect to structured settlement factoring transactions) must be filed on or before the ninetieth day following the receipt of structured settlement payment rights in a structured settlement factoring transaction.

(b) Returns relating to structured set- tlement payment rights received before February 19, 2003 . Returns required by §157.6011–1 that relate to structured settlement payment rights received on or before February 19, 2003, must be filed on or before May 20, 2003.

§157.6081–1 Extension of time for filing the return.

(a) Application for extension . An application for an extension of time for filing the return required by §157.6011–1 (relating to returns of tax with respect to structured settlement factoring transactions) must be completed in accordance with the forms and instructions provided by the Internal Revenue Service. It should be made before the expiration of the time within which the return otherwise must be filed, and failure to do so may indicate negligence and constitute sufficient cause for denial. It should, where possible, be made sufficiently early to permit consideration of the matter and reply before what otherwise would be the due date of the return. An extension of time for filing a return shall not extend the time for the payment of the tax or any part thereof unless specified to the contrary in the grant of the extension.

(b) Filing of return . If an extension of time for filing the return is granted, a return must be filed before the period of extension expires.

§157.6091–1 Place for filing returns.

The return required by §157.6011–1 (relating to returns of tax with respect to structured settlement factoring transactions) must be filed at the place specified in the forms and instructions provided by the Internal Revenue Service.

§157.6151–1 Time and place for paying of tax shown on returns.

The tax under chapter 55 (Structured Settlement Factoring Transactions) of the Internal Revenue Code shown on any return must, without assessment or notice and demand, be paid at the time and place specified in the forms and instructions provided by the Internal Revenue Service. For provisions relating to the time and place for filing such return, see §157.6071–1 and §157.6091–1. For provisions relating to the extension of time for paying the tax, see §157.6161–1.

§157.6161–1 Extension of time for paying tax.

(a) In general —(1) Tax shown or re- quired to be shown on return . The Internal Revenue Service may, at the request of the taxpayer, grant a reasonable extension of time for payment of the amount of any tax imposed by chapter 55 (Structured Settlement Factoring Transactions) of the Internal Revenue Code and shown or required to be shown on any return. The period of such extension shall not exceed 6 months from the date fixed for payment of such tax, except that in the case of a taxpayer that is abroad, such extension may exceed 6 months. (2) Extension of time for filing distin- guished . The granting of an extension of time for filing a return does not extend the time for the payment of the tax or any part thereof unless so specified in the extension.

2004–30 I.R.B. 73 July 26, 2004

CFR part or section where identified and described

Current OMB control No.

157.6001–1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1545–1824 157.6011–1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1545–1824 157.6081–1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1545–1824 157.6161–1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1545–1824

(Ariz. 1987) (en banc). Arizona law defines separate property as property owned by a spouse before marriage and property acquired during marriage by a spouse by gift, devise, or descent. See Ariz. Rev. Stat. section 25–213 (2003). In addition, separate property includes any profits or income derived from separate property during marriage. See Ariz. Rev. Stat. section 25–213 (2003).

Arizona law provides that a creditor may reach all of the liable spouse’s separate property and all of the community property to satisfy a community debt. See Ariz. Rev. Stat. section 25–215(D) (2003). In addition, a creditor may reach all community property that would have been the liable spouse’s separate property but for marriage and all of the liable spouse’s separate property to satisfy a separate debt. See Ariz. Rev. Stat. section 25–215(B) (2003). Further, the Service may reach the liable spouse’s interest in any community property that would have been the non-liable spouse’s separate property but for marriage to satisfy a separate debt of the liable spouse. In re Ackerman, 424 F.2d 1148 (9 ^th Cir. 1970). However, a creditor may not reach any of the non-liable spouse’s separate property to satisfy the liable spouse’s separate debt. See Ariz. Rev. Stat. section 25–215(A) (2003).

Under Arizona law, community debts are debts incurred during marriage for the benefit of the community. See Ariz. Rev. Stat. section 25–215(D) (2003); Johnson v. Johnson, 638 P.2d 705, 711–712 (Ariz. 1981). Arizona law presumes that a debt incurred by a spouse during marriage is a community debt. See In re Marriage of Hrudka, 919 P.2d 179, 186–187 (Ariz. Ct. App. 1995). If a debt is not a community debt, then it is a separate debt. See id . at 187. Situation 2, Wisconsin . In Year 1, Liable Spouse, who is single, incurs a tax

Mark E. Matthews, Deputy Commissioner for Services and Enforcement .

Approved June 23, 2004.

Gregory Jenner, Acting Assistant Secretary of the Treasury .

(Filed by the Office of the Federal Register on July 7, 2004, 8:45 a. m., and published in the issue of the Federal Register for July 8, 2004, 69 F.R. 41192)

Section 6402.—Authority to Make Credits or Refunds

26 CFR 301.6402–1: Authority to make credits or refunds.

Offsets under section 6402; Arizona and Wisconsin law. This ruling provides guidance regarding the amount of an overpayment from a joint tax return that the IRS may offset against a spouse’s separate tax liability for taxpayers domiciled in Arizona or Wisconsin. Arizona and Wisconsin are community property states and, under the respective state laws, each spouse has an undivided 50–percent interest in all community property. Rev. Ruls. 80–7 and 85–70 amplified and clarified.

Rev. Rul. 2004–71

ISSUE

What amount of an overpayment reported on a joint return may the Internal Revenue Service apply against one spouse’s separate tax liability if the spouses are domiciled in Arizona or Wisconsin?

This ruling addresses how offsets apply for taxpayers filing joint returns and domiciled in Arizona or Wisconsin. Because these states have similar community property laws, Arizona and Wisconsin are addressed in one ruling. This ruling

makes assumptions about the operation of state community property laws which are highly dependent on facts and circumstances. Therefore, taxpayers are cautioned to check current state law and apply it to their particular facts. Taxpayers domiciled in California, Idaho, or Louisiana should refer to Rev. Rul. 2004–72; taxpayers domiciled in Nevada, New Mexico or Washington should refer to Rev. Rul. 2004–73; and taxpayers domiciled in Texas should refer to Rev. Rul. 2004–74.

FACTS

Situation 1, Arizona . In Year 1, Liable Spouse, who is single, incurs a tax liability of $20,000. Liable Spouse does not pay this tax liability. In Year 2, Liable Spouse and Non-Liable Spouse marry. In Year 4, Liable Spouse and Non-Liable Spouse file a joint return for Year 3, reporting an overpayment of $1,000. The overpayment results from income taxes withheld from Liable Spouse’s and Non-Liable Spouse’s wages during Year 3. Liable Spouse and Non-Liable Spouse are domiciled in Arizona at all relevant times. The tax liability incurred by Liable Spouse for Year 1 is a separate debt under Arizona law. Applying Rev. Rul. 80–7, 1980–1 C.B. 296, the Service determines that $750 of the overpayment is attributable to income taxes withheld from Liable Spouse’s wages, and $250 of the overpayment is attributable to income taxes withheld from Non-Liable Spouse’s wages.

Arizona law provides that community property is all property acquired during marriage, except for property acquired by a spouse by gift, devise, or descent. See Ariz. Rev. Stat. section 25–211 (2003). There is a rebuttable presumption under Arizona law that all property acquired during marriage is community property. See Mitchell v. Mitchell, 732 P.2d 208, 212

July 26, 2004 74 2004–30 I.R.B.

during marriage but is not for the benefit of marriage or family. Non-Liable Spouse is not liable for this tax liability under Wisconsin law.

In Year 4, Liable Spouse and Non-Liable Spouse file a joint return for Year 3, reporting an overpayment of $1,000. The overpayment resulted from income taxes withheld from Liable Spouse’s and Non-Liable Spouse’s wages during Year 3. Applying Rev. Rul. 80–7, the Service determines that $750 of the overpayment is attributable to income taxes withheld from Liable Spouse’s wages, and $250 of the overpayment is attributable to income taxes withheld from Non-Liable Spouse’s wages. Wisconsin community property laws are the same as in Situation 2 .

Situation 4, Wisconsin . Same as Situ- ation 3, except that under Wisconsin law, Liable Spouse’s Year 2 tax liability is a liability for the benefit of marriage or family.

LAW

Section 6402(a) of the Internal Revenue Code provides that, in the case of any overpayment, the Service may credit the amount of the overpayment, including interest, against any internal revenue tax liability on the part of the person who made the overpayment and shall refund the balance to the person.

Revenue Ruling 74–611, 1974–2 C.B. 399, holds that if 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. However, filing a joint return does not create a new property interest for the husband or the wife. Id .

Revenue Ruling 80–7, 1980–1 C.B. 296, holds that if a husband and wife file a joint return showing an overpayment, the Service may credit one spouse’s interest in the overpayment against that spouse’s separate tax liability. The amount of the spouse’s interest in the overpayment is calculated by subtracting the spouse’s share of the joint tax liability, determined under a separate tax formula, from the spouse’s contribution towards the joint tax liability. Under the separate tax formula, a spouse’s share of the joint tax liability is calculated as follows:

liability of $20,000. Liable Spouse does not pay this tax liability. In Year 2, Liable Spouse and Non-Liable Spouse marry. In Year 4, Liable Spouse and Non-Liable Spouse file a joint return for Year 3, reporting an overpayment of $1,000. The overpayment results from income taxes withheld from Liable Spouse’s and Non-Liable Spouse’s wages during Year 3. Liable Spouse and Non-Liable Spouse are domiciled in Wisconsin at all relevant times. The tax liability incurred by Liable Spouse for Year 1 is a liability incurred before marriage that is attributable to action or inaction before marriage under Wisconsin law. Applying Rev. Rul. 80–7, 1980–1 C.B. 296, the Service determines that $750 of the overpayment is attributable to income taxes withheld from Liable Spouse’s wages, and $250 of the overpayment is attributable to income taxes withheld from Non-Liable Spouse’s wages.

Wisconsin law classifies property owned by a spouse as either marital property or individual property. See Wis. Stat. section 766.31 (2002). Marital property is a form of community property, and each spouse has a 50 percent interest in the marital property. See Wis. Stat. section 766.31(3) (2002); Rev. Rul. 87–13, 1987–1 C.B. 20. Marital property includes all property that is not individual property and that was acquired after the determination date. See Wis. Stat. section 766.31 (2002). The determination date is the latest of either: (1) the date of marriage; (2) the date both spouses are domiciled in Wisconsin; or (3) January 1, 1986. See Wis. Stat. section 766.01(5) (2002). Wisconsin law presumes that all property owned by a spouse is marital property. See Wis. Stat. section 766.31(2) (2002). This presumption may be rebutted. See Lloyd v. Lloyd, 487 N.W.2d 647, 652 (Wis. Ct. App. 1992).

Wisconsin law defines individual property as property owned by a spouse before the determination date. See Wis. Stat. section 766.31(9) (2002). In addition, individual property includes property acquired during marriage and after the determination date if the property is: (1) received by gift, bequest, or devise to one spouse; (2) income paid to one spouse from a trust, unless the trust provides otherwise; (3) received in exchange for or obtained with the proceeds of other individual property;

(4) designated as individual property by decree, marital property agreement, or reclassification pursuant to Wis. Stat. section 766.31(10); or (5) recovered for personal injury. See Wis. Stat. section 766.31(7) (2002). Wisconsin law classifies debts incurred by a spouse into three separate categories: (1) debts incurred before or during marriage that are attributable to action or inaction before marriage; (2) debts incurred during marriage for the benefit of the marriage or family; and (3) debts incurred during marriage that are not for the benefit of marriage or family. See Wis. Stat. section 766.55 (2002). Wisconsin law presumes that a debt incurred during marriage is for the benefit of the marriage or the family. See Wis. Stat. section 766.55(1) (2002). If a spouse before marriage or during marriage incurs a debt that is attributable to action or inaction before marriage, Wisconsin law allows that spouse’s creditor to reach all marital property that would have been that spouse’s individual property but for the marriage and all individual property of that spouse. See Wis. Stat. section 766.55(2)(c)(1) (2002). Further, Wisconsin law allows the Service to reach the liable spouse’s interest in any marital property that would have been the non-liable spouse’s individual property but for marriage. Vorhies v. Z. Manage- ment, Civil No. 86-C695-S (W.D. Wis. 1987). If a spouse incurs a debt for the benefit of the marriage or the family, Wisconsin law allows a creditor to reach all marital property and all individual property of that spouse. See Wis. Stat. section 766.55(2)(b) (2002); Sokaogon Gam- ing Ent. v. Curda-Derickson, 668 N.W.2d 736 (Wis. Ct. App. 2003). If a debt incurred by a spouse was not for the benefit of the marriage or the family, Wisconsin law allows a creditor to reach that spouse’s individual property and interest in marital property. See Wis. Stat. section 766.55(2)(d) (2002).

Situation 3, Wisconsin. Liable Spouse and Non-Liable Spouse are domiciled in Wisconsin at all relevant times. In Year 1, Liable Spouse and Non-Liable spouse are single and have no outstanding tax liabilities. In Year 2, Liable Spouse and Non-Liable Spouse marry. For Year 2, Liable Spouse incurs a tax liability, that, under Wisconsin law, is a liability incurred

2004–30 I.R.B. 75 July 26, 2004

Spouse’s Separate Tax

Total of Both Spouses’ Separate Tax

x Joint Tax Liability Reported on Return

Revenue Ruling 85–70, 1985–1 C.B. 361, provides a two-step process to determine the amount of a joint overpayment that the Service may offset against one spouse’s separate tax liability if the spouses are domiciled in a community property state. First, if the joint overpayment is from wages that are community property income, then each spouse is considered to be the recipient of one-half of the aggregated wages regardless of whether the spouses may have earned different amounts of wages (the one-half rule). Accordingly, each spouse has a one-half interest in the overpayment, and the Service may offset the liable spouse’s one-half interest in the overpayment against the liable spouse’s separate federal tax liability regardless of whether state law provides that creditors may reach community property to satisfy the separate debts of a spouse. Id . Rev. Rul. 85–70 does not specifically address what portion of each spouse’s actual wages is treated as having been offset as a result of applying the one-half rule. Under the facts of Rev. Rul. 85–70, and specifically the assumed state laws, that analysis was not necessary. However, applying the second step of Rev. Rul. 85–70 in other cases may require a determination of the amount of each spouse’s actual wages that were offset after applying the one-half rule. For that purpose, each spouse under the first step

of Rev. Rul. 85–70 is treated as receiving one half of the wages from each community property source (or, collectively, one-half of the aggregated wages) and as such being entitled to receive one-half of the income tax withheld from each community property source.

Second, Rev. Rul. 85–70 provides that state law may enable the Service to offset an additional portion of the joint overpayment from community property sources to satisfy a spouse’s separate federal tax liability. This additional right of offset is available if state law provides that creditors may reach community property to satisfy the separate debts of a spouse. (The amount potentially available to be offset under the second step of Rev. Rul. 85–70 is the amount remaining after application of the first step of that revenue ruling.) However, if state law provides that community property may not be reached to satisfy the premarital or other separate debts of either spouse, then the Service may not offset any portion of the non-liable spouse’s share of the overpayment from community property sources against the liable spouse’s separate tax liability. Id .

Five-step process to determine amount of joint overpayment that the Service may offset against separate federal tax liability of one spouse .

Tax Payment From a Separate Property Source

Total Tax Payments

A five-step process is required to determine the amount of a joint overpayment that the Service may, pursuant to section 6402(a), offset against the separate federal tax liability of one spouse.

The first step is to identify the underlying source of the overpayment. The Service looks to the tax payments made by the spouses, including income tax withholding and estimated tax payments and other credits, such as the earned income tax credit, that gave rise to the overpayment. If the earned income tax credit is a source of the overpayment, see Rev. Rul. 87–52, 1987–1 C.B. 347, for guidance. The second step is to characterize the underlying source of the overpayment as either separate or community property. Because an overpayment will be characterized in the same manner as the source of the overpayment, an overpayment will be characterized as community property, separate property, or as part community property and part separate property, depending on the character of the source of the overpayment. If the overpayment is part community property and part separate property, the portion of the overpayment attributable to a separate property source must be subtracted from the remainder of the overpayment. The portion of the overpayment attributable to a separate property source is calculated as follows:

x Overpayment

able Spouse’s and Non-Liable Spouse’s wages.

(2) Step 2 . Arizona and Wisconsin law presume that all property acquired during marriage by either spouse or both spouses, including wages, is community property. In Situation 1, Situation 2, Situation 3, and Situation 4, the overpayment results from income tax withholding from Liable Spouse’s and Non-Liable Spouse’s wages. Because state law presumes that wages are community property, the entire overpayment in Situation 1, Situation 2, Situation

The third step is to offset the liable spouse’s share of the overpayment from a community property source against the liable spouse’s separate tax liability. Under Rev. Rul. 85–70, the Service may offset the liable spouse’s 50-percent interest in the overpayment from a community property source to satisfy the liable spouse’s separate tax liability.

The fourth step is to determine whether, under state law, the Service may reach the non-liable spouse’s share of the overpayment from a community property source. See Rev. Rul. 85–70.

The fifth step is to determine whether the Service may, under state law, reach a portion of the overpayment from a separate property source of the liable spouse or the non-liable spouse.

ANALYSIS

Apply the five-step process to each situ- ation .

(1) Step 1 . In Situation 1, Situation 2, Situation 3, and Situation 4, the overpayment is from income taxes withheld in Year 3 from Li

July 26, 2004 76 2004–30 I.R.B.

Situation 2 . The Service may offset $875 of the overpayment against Liable Spouse’s separate Year 1 tax liability.

Situation 3 . The Service may offset $500 of the overpayment against Liable Spouse’s separate Year 2 tax liability.

Situation 4 . The Service may offset $1,000 of the overpayment against Liable Spouse’s separate Year 2 tax liability.

EFFECT ON OTHER REVENUE RULINGS

Revenue Ruling 80–7 and Rev. Rul. 85–70 are amplified and clarified.

DRAFTING INFORMATION

The principal author of this revenue ruling is Michael A. Skeen of the Office of the Associate Chief Counsel (Procedure and Administration), Administrative Provisions and Judicial Practice Division. For further information regarding this revenue ruling, contact Michael A. Skeen at (202) 622–4910 (not a toll-free call).

26 CFR 301.6402–1: Authority to make credits or refunds.

Offsets under section 6402; Califor- nia, Idaho, and Louisiana law. This ruling provides guidance regarding the amount of an overpayment from a joint tax return that the IRS may offset against a spouse’s separate tax liability for taxpayers domiciled in California, Idaho, or Louisiana. California, Idaho, and Louisiana are community property states and, under the respective state laws, each spouse has an undivided 50–percent interest in all community property. Rev. Ruls. 80–7 and 85–70 amplified and clarified.

Rev. Rul. 2004–72

ISSUE

What amount of an overpayment reported on a joint return may the Internal Revenue Service apply against one spouse’s separate tax liability if the spouses are domiciled in California, Idaho, or Louisiana?

This ruling addresses how offsets apply for taxpayers filing joint returns and domiciled in California, Idaho, or Louisiana. Because these states have similar community property laws, California, Idaho,

3, and Situation 4 is assumed to be from a community property source.

(3) Step 3 . Under Arizona and Wisconsin law, each spouse has a present and equal interest in all community property. In Sit- uation 1, Situation 2, Situation 3, and Situation 4, $750 of the overpayment is from income tax withholding from Liable Spouse’s wages, and $250 of the overpayment is from income tax withholding from Non-Liable Spouse’s Year 3 wages. Applying Rev. Rul. 85–70, the Service may offset $375 of the income tax withholding attributable to Liable Spouse’s wages and $125 of the income tax withholding attributable to Non-Liable Spouse’s wages. Therefore, in Situation 1, Situation 2, Sit- uation 3, and Situation 4, the Service may offset $500 of the overpayment against Liable Spouse’s separate tax liability.

(4) Step 4 . Under Arizona and Wisconsin law, the amount of community property that a creditor may reach depends on the character of the debt.

In Situation 1, Liable Spouse’s Year 1 tax liability is a separate debt under Arizona law. To satisfy a separate debt, Arizona law provides that a creditor may reach all community property that would have been Liable Spouse’s separate property but for marriage. Under Arizona law, Liable Spouse’s wages and income tax withholdings would have been Liable Spouse’s separate property had Liable Spouse and Non-Liable Spouse not married. Therefore, a creditor may reach all of Liable Spouse’s wages and income tax withholdings to satisfy Liable Spouse’s separate debt. Applying Arizona law in Step 4, and in addition to the amount offset in Step 3, the Service may offset the remaining $375 of the overpayment that is attributable to Liable Spouse’s wages and income tax withholdings.

In Situation 2, Liable Spouse’s Year 1 federal tax liability is a liability incurred before marriage that is attributable to action or inaction before marriage under Wisconsin law. In this situation, Wisconsin law provides that a creditor may reach all marital property that would have been Liable Spouse’s individual property but for marriage. Under Wisconsin law, Liable Spouse’s wages and income tax withholding would have been Liable Spouse’s separate property had Liable

Spouse and Non-Liable Spouse not married. Therefore, a creditor may reach all of Liable Spouse’s wages and income tax withholding to satisfy Liable Spouse’s Year 1 tax liability. Applying Wisconsin law in Step 4, and in addition to the amount offset in Step 3, the Service may offset the remaining $375 of the overpayment that is attributable to Liable Spouse’s wages and income tax withholdings.

In Situation 3, Liable Spouse’s Year 2 tax liability is a liability that was incurred during marriage but was not for the benefit of the marriage or the family under Wisconsin law. In this situation, Wisconsin law provides that a creditor may reach Liable Spouse’s interest in marital property. However, because the debt was not for the benefit of the marriage or family, applying Wisconsin law in this Step 4, the Service may reach only Liable Spouse’s individual property and interest in marital property, and therefore may not offset any amount of the overpayment in addition to the amount offset in Step 3, from a community property source. Accordingly, the additional amount the Service may offset under Step 4 is zero. In Situation 4, Liable Spouse’s Year 2 tax liability is a liability that was incurred during marriage and was for the benefit of the marriage or the family under Wisconsin law. In this situation, Wisconsin law provides that a creditor may reach all marital property. Accordingly, the Service may offset the remaining $500 of the overpayment against Liable Spouse’s Year 2 tax liability.

(5) Step 5 . Under both Arizona and Wisconsin law, a creditor may reach 100 percent of Liable Spouse’s separate property to satisfy Liable Spouse’s separate tax liability. A creditor may not, however, reach any of Non-Liable Spouse’s separate property to satisfy Liable Spouse’s separate tax liability. In Situation 1, Situation 2, Situation 3, and Situation 4, no part of the overpayment is from a separate property source. Accordingly, there is no separate property that the Service may offset against the Liable Spouse’s separate tax liability.

HOLDING

Situation 1 . The Service may offset $875 of the overpayment against Liable Spouse’s separate Year 1 tax liability.

2004–30 I.R.B. 77 July 26, 2004

the husband’s separate property to satisfy this debt. See Idaho Code section 32–910 (2003).

Situation 3, Louisiana . In Year 1, Liable Spouse, who is single, incurs a tax liability of $20,000. Liable Spouse does not pay this tax liability. In Year 2, Liable Spouse and Non-Liable Spouse marry. In Year 4, Liable Spouse and Non-Liable Spouse file a joint return for Year 3, reporting an overpayment of $1,000. The overpayment results from income taxes withheld from Liable Spouse’s and Non-Liable Spouse’s wages during Year 3. Liable Spouse and Non-Liable Spouse are domiciled in Louisiana at all relevant times, and Liable Spouse’s tax liability is a separate obligation as defined by Louisiana law.

Louisiana law defines separate property as including property acquired by a spouse prior to marriage, property acquired with that spouse’s separate property, property acquired by a spouse through inheritance or donation to that spouse individually, damages awarded to a spouse in connection with the management of that spouse’s separate property, and property acquired by a spouse from a voluntary partition of the community during marriage. See La. Civ. Code Ann. art. 2341 (2003). Louisiana law defines community property as property acquired by a spouse during marriage that is not separate property. See La. Civ. Code Ann. art. 2338 (2003). Louisiana law provides a rebuttable presumption that all property in the possession of either spouse is community property. See La. Civ. Code Ann. art. 2340 (2003). Each spouse has a 50 percent interest in community property. See La. Civ. Code Ann. art. 2336 (2003).

Louisiana law provides that a creditor may reach all of the community property to satisfy separate and community obligations. See La. Civ. Code Ann. art. 2345 (2003). In addition, a creditor may reach all of the liable spouse’s separate property to satisfy separate and community obligations. See Id .

Under Louisiana law, obligations incurred by a spouse are either community obligations or separate obligations. See La. Civ. Code Ann. art. 2359 (2003). A community obligation is defined as an obligation incurred during marriage for either the common interest of both spouses or for the interest of the other spouse. See

and Louisiana are addressed in one ruling. This ruling makes assumptions about the operation of state community property laws which are highly dependent on facts and circumstances. Therefore, taxpayers are cautioned to check current state law and apply it to their particular facts. Taxpayers domiciled in Arizona or Wisconsin should refer to Rev. Rul. 2004–71; taxpayers domiciled in Nevada, New Mexico or Washington should refer to Rev. Rul. 2004–73; and taxpayers domiciled in Texas should refer to Rev. Rul. 2004–74.

FACTS

Situation 1, California . In Year 1, Liable Spouse, who is single, incurs a tax liability of $20,000. Liable Spouse does not pay this tax liability. In Year 2, Liable Spouse and Non-Liable Spouse marry. In Year 4, Liable Spouse and Non-Liable Spouse file a joint return for Year 3, reporting an overpayment of $1,000. The overpayment results from income taxes withheld from Liable Spouse’s and Non-Liable Spouse’s wages during Year 3. Liable Spouse and Non-Liable Spouse are domiciled in California at all relevant times.

Except as otherwise provided by statute, California law provides that all property, either real or personal, that is acquired during marriage is community property, and each spouse has a 50 percent interest in the community property. See Cal. Fam. Code sections 760, 751 (2003). There is a rebuttable presumption under California law that all property acquired by a spouse during marriage is community property. See In re Marriage of Haines, 39 Cal. Rptr. 2d 673, 681 (1995). California law defines separate property as all property owned by a spouse prior to marriage, and all property acquired by a spouse by gift, bequest, devise, or descent. See Cal. Fam. Code section 770(a)(1), (a)(2) (2003). In addition, California law provides that all rents, issues, and profits from separate property are separate property. See Cal. Fam. Code section 770(a)(3) (2003).

California law provides that a creditor may reach all of the community property to satisfy a debt incurred by a spouse before or during marriage. See Cal. Fam. Code section 910(a) (2003). A creditor may also reach all of the liable spouse’s separate

property to satisfy a debt incurred by the liable spouse; however, a creditor may not reach any of the non-liable spouse’s separate property. See Cal. Fam. Code section 913 (2003). Situation 2, Idaho . In Year 1, Liable Spouse, who is single, incurs a tax liability of $20,000. Liable Spouse does not pay this tax liability. In Year 2, Liable Spouse and Non-Liable Spouse marry. In Year 4, Liable Spouse and Non-Liable Spouse file a joint return for Year 3, reporting an overpayment of $1,000. The overpayment results from income taxes withheld from Liable Spouse’s and Non-Liable Spouse’s wages during Year 3. Liable Spouse and Non-Liable Spouse are domiciled in Idaho at all relevant times.

Idaho law defines separate property as all property owned by a spouse before marriage, and all property acquired by a spouse during marriage by gift, bequest, devise or descent, or property acquired with the proceeds of his or her separate property. See Idaho Code section 32–903 (2003). Idaho law defines community property as all other property acquired by either spouse during marriage. See Idaho Code section 32–906(1) (2003). Idaho law provides a rebuttable presumption that property acquired during marriage is community property, and the burden of proof is on the party asserting that the property is separate property. See Worzala v. Worzala, 913 P.2d 1178, 1182 (Idaho 1996). Idaho law provides that income generated during marriage from any property, regardless of whether the property is separate or community property, is generally community property, unless: (1) the conveyance by which the property is acquired specifically identifies this property as the separate property of one spouse; or (2) both spouses agree in writing that the property, and any income related to this property, is the separate property of one spouse. See Idaho Code section 32–906(1) (2003).

Idaho law provides that a creditor may reach all of the community property; both real and personal, to satisfy a spouse’s separate debt. Bliss v. Bliss, 898 P.2d 1081, 1084 (Idaho 1995). If the husband incurs a debt, a creditor may not reach the wife’s separate property to satisfy this debt. See Idaho Code section 32–911 (2003). Further, if the wife incurs a debt before marriage, a creditor may not reach

July 26, 2004 78 2004–30 I.R.B.

joint return showing an overpayment, the Service may credit one spouse’s interest in the overpayment against that spouse’s separate tax liability. The amount of the spouse’s interest in the overpayment is calculated by subtracting the spouse’s share of the joint tax liability, determined under a separate tax formula, from the spouse’s contribution towards the joint tax liability. Under the separate tax formula, a spouse’s share of the joint tax liability is calculated as follows:

La. Civ. Code Ann. art. 2360 (2003). A separate obligation is defined as an obligation that was incurred before marriage, after marriage has terminated, or during marriage, though not for the benefit of the community. See La. Civ. Code Ann. art. 2363 (2003). Louisiana law provides a rebuttable presumption that all obligations incurred during marriage are community obligations. See La. Civ. Code Ann. art. 2361 (2003).

LAW

Section 6402(a) of the Internal Revenue Code provides that, in the case of any

overpayment, the Service may credit the amount of the overpayment, including interest, against any internal revenue tax liability on the part of the person who made the overpayment and shall refund the balance to the person.

Revenue Ruling 80–7, 1980–1 C.B. 296, holds that if a husband and wife file a

Spouse’s Separate Tax

Total of Both Spouses’ Separate Tax

x Joint Tax Liability Reported on Return

A five-step process is required to determine the amount of a joint overpayment that the Service may, pursuant to section 6402(a), offset against the separate federal tax liability of one spouse.

Five-step process to determine amount of joint overpayment that the Service may offset against separate federal tax liability of one spouse .

2004–30 I.R.B. 79 July 26, 2004

Tax Payment From a Separate Property Source

Total Tax Payments

x Overpayment

ruling, contact Michael A. Skeen at (202) 622–4910 (not a toll-free call).

26 CFR 301.6402–1: Authority to make credits or refunds.

Offsets under section 6402; Nevada, New Mexico, and Washington law. This ruling provides guidance regarding the amount of an overpayment from a joint tax return that the IRS may offset against a spouse’s separate tax liability for taxpayers domiciled in Nevada, New Mexico, and Washington. Nevada, New Mexico, and Washington are community property states and, under the respective state laws, each spouse has an undivided 50–percent interest in all community property. Rev. Ruls. 80–7 and 85–70 amplified and clarified.

Rev. Rul. 2004–73

ISSUE

What amount of an overpayment reported on a joint return may the Internal Revenue Service apply against one spouse’s separate tax liability if the spouses are domiciled in Nevada, New Mexico, or Washington?

This ruling addresses how offsets apply for taxpayers filing joint returns and domiciled in Nevada, New Mexico, or Washington. Because these states have similar community property laws, Nevada, New Mexico, and Washington are addressed in one ruling. This ruling makes assumptions about the operation of state community property laws which are highly dependent on facts and circumstances. Therefore, taxpayers are cautioned to check current state law and apply it to their particular facts. Taxpayers domiciled in Arizona or Wisconsin should refer to Rev. Rul. 2004–71; taxpayers domiciled in California, Idaho, or Louisiana should refer to Rev. Rul. 2004–72; and taxpayers domiciled in Texas should refer to Rev. Rul. 2004–74.

The third step is to offset the liable spouse’s share of the joint overpayment from a community property source against the liable spouse’s separate tax liability. Under Rev. Rul. 85–70, the Service may offset the liable spouse’s 50-percent interest in the overpayment from a community property source to satisfy the liable spouse’s separate tax liability.

The fourth step is to determine whether, under state law, the Service may reach the non-liable spouse’s share of the overpayment from a community property source. See Rev. Rul. 85–70.

The fifth step is to determine whether the Service may, under state law, reach a portion of the overpayment from a separate property source of the liable spouse or the non-liable spouse.

ANALYSIS

Apply the five-step process to each situ- ation .

(1) Step 1 . In Situation 1, Situation 2, and Situation 3, the overpayment is from income taxes withheld in Year 3 from Liable Spouse’s and Non-Liable Spouse’s wages.

(2) Step 2 . California, Idaho, and Louisiana law presume that all property acquired during marriage by either spouse or both spouses, including wages, is community property. In Situation 1, Situation 2, and Situation 3, the overpayment results from income tax withholding from Liable Spouse’s and Non-Liable Spouse’s wages. Because state law presumes that wages are community property, the entire overpayment in Situation 1, Situation 2, and Situation 3 is assumed to be from a community property source.

(3) Step 3 . Under California, Idaho, and Louisiana law, each spouse has a present and equal interest in all community property. In Sit- uation 1, Situation 2, and Situation 3, the Service may offset Liable Spouse’s $500 share of the overpayment, which is from a community property source against Liable Spouse’s separate tax liability.

(4) Step 4 .

In Situation 1 and Situation 2, under California and Idaho law respectively, a creditor may reach all of the community property to satisfy a debt incurred by Liable Spouse, regardless of whether the debt was incurred before or after marriage. In Situation 3, under Louisiana law, a creditor may reach all of the community property to satisfy a debt, regardless of whether the debt is a separate or community debt. Accordingly, in Situation 1, Situation 2, and Situation 3, the Service may offset the remaining $500 of the overpayment.

(5) Step 5 . Under California, Idaho, and Louisiana law, a creditor may reach all of Liable Spouse’s separate property to satisfy Liable Spouse’s separate tax liability. A creditor may not, however, reach any of Non-Liable Spouse’s separate property to satisfy Liable Spouse’s separate tax liability. In Situation 1, Situation 2, and Situa- tion 3, no part of the overpayment is from a separate property source. Accordingly, there is no separate property that the Service may offset against the Liable Spouse’s separate tax liability.

HOLDING

Situation 1 . The Service may offset $1,000 of the overpayment against Liable Spouse’s separate tax liability.

Situation 2 . The Service may offset $1,000 of the overpayment against Liable Spouse’s separate tax liability.

Situation 3 . The Service may offset $1,000 of the overpayment against Liable Spouse’s separate tax liability.

EFFECT ON OTHER REVENUE RULINGS

Revenue Ruling 80–7 and Rev. Rul. 85–70 are amplified and clarified.

DRAFTING INFORMATION

July 26, 2004 80 2004–30 I.R.B.

to N.M. Stat. Ann. section 40–4–3 (proceeding for division of property, disposition of children or alimony without dissolution of marriage); (3) a debt designated by a court as a separate debt; (4) a debt contracted by a spouse during marriage which, at the time of creation, is identified to the creditor in writing as the separate debt of the contracting spouse; (5) a debt that arises from a tort committed either before marriage or after entry of a decree of dissolution of marriage; or (6) a debt declared unreasonable pursuant to N.M. Stat. Ann. section 40–3–10.1 (certain debts that did not contribute to the benefit of both spouses or their dependents). See N.M. Stat. Ann. section 40–3–9(A)(1) through (6) (2002). Community debt is defined as a debt, which is not a separate debt, contracted or incurred by one or both spouses during the marriage. See N.M. Stat. Ann. section 40–3–9(B) (2002). New Mexico law presumes that a debt incurred during marriage is community debt. See In re Fingado, 113 B.R. 37, 42 (Bankr. D.N.M. 1990), aff’d, 995 F.2d 175 (10 ^th Cir. 1993). Situation 3, Washington . In Year 1, Liable Spouse, who is single, incurs a tax liability of $20,000. Liable Spouse does not pay this tax liability. In Year 2, Liable Spouse and Non-Liable Spouse marry. In Year 4, Liable Spouse and Non-Liable Spouse file a joint return for Year 3, reporting an overpayment of $1,000. The overpayment results from income taxes withheld from Liable Spouse’s and Non-Liable Spouse’s wages during Year 3. Liable Spouse and Non-Liable Spouse are domiciled in Washington state at all relevant times, and Liable Spouse’s tax liability is a separate debt as defined by Washington state law.

Washington state law defines community property as any property acquired during marriage, by one or both spouses, that is not separate property. See Wash. Rev. Code section 26.16.030 (2003). There is a rebuttable presumption under Washington state law that all property acquired during marriage is community property. See Dean v. Lehman, 18 P.3d 523, 528 (Wash. 2001)(en banc). Each spouse has an undivided 50-percent interest in all community property. See In re Towey’s Estate, 155 P.2d 273, 275 (Wash. 1945). Washington state law defines separate property as property owned by a spouse before marriage and property acquired during mar

FACTS

Situation 1, Nevada . In Year 1, Liable Spouse, who is single, incurs a tax liability of $20,000. Liable Spouse does not pay this tax liability. In Year 2, Liable Spouse and Non-Liable Spouse marry. In Year 4, Liable Spouse and Non-Liable Spouse file a joint return for Year 3, reporting an overpayment of $1,000. The overpayment results from income taxes withheld from Liable Spouse’s and Non-Liable Spouse’s wages during Year 3. Liable Spouse and Non-Liable Spouse are domiciled in Nevada at all relevant times.

Nevada law presumes that property acquired during marriage by either husband, wife, or both, is community property, subject to limited exceptions. See Nev. Rev. Stat. section 123.220 (2003). This presumption may be rebutted. Forrest v. Forrest, 668 P.2d 275, 277 (Nev. 1983). Further, during marriage, each spouse has a 50 percent interest in the community property. See Nev. Rev. Stat. section 123.225 (2003). Generally, property owned by one spouse before marriage, or acquired during marriage by gift, bequest, devise, descent, or an award for personal damages, is separate property, and each spouse has a 100 percent interest in his or her separate property. See Nev. Rev. Stat. section 123.130 (2003).

Nevada law provides that a creditor may reach all of a liable spouse’s separate property and all of the community property to satisfy the liable spouse’s debts that arose during the marriage. See Hardy v. United States, Civil No. CV–N–94–0824 (D. Nev. 1997); Nelson v. United States, Civil No. CV–N–89–659 (D. Nev. 1993), aff’d, 53 F.3d 339 (9 ^th Cir. 1995); United States v. ITT Consumer Financial Corp, 816 F.2d 487, n. 12 (9 ^th Cir. 1987). However, a creditor may not reach any of the non-liable spouse’s separate property to satisfy the liable spouse’s debt that arose during the marriage. See Hardy v. United States, Civil No. CV-N–94–0824 (D. Nev. 1997). In addition, Nevada law provides that a creditor may not reach the non-liable spouse’s separate property or the non-liable spouse’s share of the community property to satisfy the liable spouse’s separate debts incurred or contracted prior to marriage. See Nev. Rev. Stat. section 123.050 (2003).

Situation 2, New Mexico . In Year 1, Liable Spouse, who is single, incurs a tax liability of $20,000. Liable Spouse does not pay this tax liability. In Year 2, Liable Spouse and Non-Liable Spouse marry. In Year 4, Liable Spouse and Non-Liable Spouse file a joint return for Year 3, reporting an overpayment of $1,000. The overpayment results from income taxes withheld from Liable Spouse’s and Non-Liable Spouse’s wages during Year 3. Liable Spouse and Non-Liable Spouse are domiciled in New Mexico at all relevant times, and Liable Spouse’s tax liability is a separate debt as defined by New Mexico law.

New Mexico law provides that property acquired during marriage by the husband, wife, or both is presumed to be community property, and each spouse has a 50 percent interest in community property. See N.M. Stat. Ann. section 40–3–12(A)(2002); Central Adjustment Bureau, Inc. v. Thevenet, 686 P.2d 954, 957–958 (N.M. 1984). This presumption may be rebutted. C & L Lumber and Sup- ply, Inc. v. Texas American Bank/Galeria, 795 P.2d 502, 505 (N.M. 1990). Generally, property owned by a spouse before marriage is separate property, and each spouse has a 100 percent interest in all of his or her separate property. See N.M. Stat. Ann. section 40–3–8 (2002).

New Mexico law provides that a creditor may reach all of the separate property of the spouse or spouses who contracted or incurred the debt, and all of the community property to satisfy a community debt. See N.M. Stat. Ann. section 40–3–11(A) (2002). However, a creditor may not reach any of one spouse’s separate property to satisfy a community debt incurred by the other spouse. See Id . New Mexico law provides that a creditor may reach all of the liable spouse’s separate property and all of the liable spouse’s share of community property to satisfy a separate debt. See N.M. Stat. Ann. section 40–3–10(A) (2002). However, a creditor may not reach any of the non-liable spouse’s separate property to satisfy the liable spouse’s separate debt. See Id .

Under New Mexico law, a separate debt is defined as: (1) a debt contracted or incurred either before marriage or after entry of a decree of dissolution of marriage; (2) a debt contracted or incurred after a court has entered a decree pursuant

2004–30 I.R.B. 81 July 26, 2004

riage by a spouse by gift, bequest, devise, or descent. See Wash. Rev. Code sections 26.16.010, 26.16.020 (2003). In addition, Washington state law defines as separate property any profits or income derived from separate property during marriage. See Wash. Rev. Code sections 26.16.010, 26.16.020 (2003). Under Washington state law, a creditor may reach all of the community property, including the earnings of both spouses, to satisfy a community debt. See Pacific Gamble Robinson Co. v. Lapp, 622 P.2d 850, 854 (Wash. 1980). A creditor may reach all of a spouse’s separate property to satisfy a community debt incurred by that spouse; however, a creditor of a community debt may not reach the other spouse’s separate property. See Wash. Rev. Code sections 6.15.040, 26.16.010, 26.16.020 (2003). In general, under Washington state law, a creditor may not reach any of the community property to satisfy a separate debt. See Wash. Rev. Code section 26.16.200 (2003); Pacific Gamble Robinson Co., 622 P.2d at 854. However,

under United States v. Overman, 424 F.2d 1142 (9 ^th Cir. 1970), the Service may reach the liable spouse’s 50-percent interest in the community property to satisfy a separate tax liability of the liable spouse. See also Draper v. United States, 243 F. Supp. 563 (W.D. Wash. 1965).

Under Washington state law, a debt incurred during marriage, for the benefit of the community, is a community debt. See In re Marriage of Hurd, 848 P.2d 185, 195–196 (Wash. App. 1993). Washington state law presumes that a debt is a community debt. See Pacific Gamble Robinson Co., 622 P.2d at 854. If a debt is not a community debt, then it is a separate debt. See Id .

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the overpayment and shall refund the balance to the person.

Spouse’s Separate Tax

Total of Both Spouses’ Separate Tax

x Joint Tax Liability Reported on Return

85–70 is the amount remaining after application of the first step of that revenue ruling.) However, if state law provides that community property may not be reached to satisfy the premarital or other separate debts of either spouse, then the Service may not offset any portion of the non-liable spouse’s share of the overpayment from community property sources against the liable spouse’s separate tax liability. Id .

Five-step process to determine amount of joint overpayment that the Service may offset against separate federal tax liability of one spouse .

A five-step process is required to determine the amount of a joint overpayment that the Service may, pursuant to section 6402(a), offset against the separate federal tax liability of one spouse.

Rul. 85–70, and specifically the assumed state laws, that analysis was not necessary. However, applying the second step of Rev. Rul. 85–70 in other cases may require a determination of the amount of each spouse’s actual wages that were offset after applying the one-half rule. For that purpose, each spouse under the first step of Rev. Rul. 85–70 is treated as receiving one half of the wages from each community property source (or, collectively, one-half of the aggregated wages) and as such being entitled to receive one-half of the income tax withheld from each community property source.

July 26, 2004 82 2004–30 I.R.B.

credit, that gave rise to the overpayment. If the earned income tax credit is a source of the overpayment, see Rev. Rul. 87–52, 1987–1 C.B. 347, for guidance. The second step is to characterize the underlying source of the overpayment as either separate or community property. Because an overpayment will be charac

terized in the same manner as the source of the overpayment, an overpayment will be characterized as community property, separate property, or as part community property and part separate property, depending on the character of the source of the overpayment. If the overpayment is part community property and part separate

Tax Payment From a Separate Property Source

Total Tax Payments

property, the portion of the overpayment attributable to a separate property source must be subtracted from the remainder of the overpayment. The portion of the overpayment attributable to a separate property source is calculated as follows:

x Overpayment

is a separate debt in Situation 2 and Situa- tion 3, the Service may not offset any portion of Non-Liable Spouse’s share of the overpayment against Liable Spouse’s separate tax liability.

(5) Step 5 . Under Nevada, New Mexico, and Washington state law, a creditor may reach all of Liable Spouse’s separate property to satisfy Liable Spouse’s separate tax liability. A creditor may not, however, reach any of Non-Liable Spouse’s separate property to satisfy Liable Spouse’s separate tax liability. In Situation 1, Situation 2, and Situation 3, no part of the overpayment is from a separate property source. Accordingly, there is no separate property that the Service may offset against the Liable Spouse’s separate tax liability.

HOLDING

Situation 1 . The Service may offset $500 of the overpayment against Liable Spouse’s separate tax liability.

Situation 2 . The Service may offset $500 of the overpayment against Liable Spouse’s separate tax liability.

Situation 3 . The Service may offset $500 of the overpayment against Liable Spouse’s separate tax liability.

EFFECT ON OTHER REVENUE RULINGS

Revenue Ruling 80–7 and Rev. Rul. 85–70 are amplified and clarified.

DRAFTING INFORMATION

The fourth step is to determine whether, under state law, the Service may reach the non-liable spouse’s share of the overpayment from a community property source. See Rev. Rul. 85–70.

The fifth step is to determine whether the Service may, under state law, reach a portion of the overpayment from a separate property source of the liable spouse or the non-liable spouse.

ANALYSIS

Apply the five-step process to each situ- ation .

(1) Step 1 . In Situation 1, Situation 2, and Situation 3, the overpayment is from income taxes withheld in Year 3 from Liable Spouse’s and Non-Liable Spouse’s wages.

(2) Step 2 . Nevada, New Mexico, and Washington state law presume that all property acquired during marriage by either spouse or both spouses, including wages, is community property. In Situation 1, Situation 2, and Situation 3, the overpayment results from income tax withholding from Liable Spouse’s and Non-Liable Spouse’s wages. Because state law presumes that wages are community property, the entire overpayment in Situation 1, Situation 2, and Situa- tion 3 is assumed to be from a community property source.

(3) Step 3 .

Under Nevada, New Mexico, and Washington state law, each spouse has a present and equal interest in all community property. In Situation 1, Situation 2, and Situation 3, the Service may offset Liable Spouse’s $500 share of the overpayment against Liable Spouse’s separate tax liability.

(4) Step 4 . Under Nevada, New Mexico, and Washington state law, the amount of community property that a creditor may reach depends on the character of the debt. In Situation 1, Liable Spouse’s tax liability arose before marriage. Nevada law distinguishes between debts that arose before or during the marriage. For debts that arose before marriage, a creditor may not reach either Non-Liable Spouse’s portion of community property or Non-Liable Spouse’s separate property. Accordingly, the Service may not offset any portion of Non-Liable Spouse’s share of the overpayment against Liable Spouse’s tax liability.

In Situation 2, Liable Spouse’s tax liability is a separate debt under New Mexico law. In Situation 3, Liable Spouse’s tax liability is a separate debt under Washington state law. New Mexico and Washington state law distinguish between community debts and separate debts. For a community debt ( e.g., a tax liability of one spouse that arose during the marriage by filing separate returns), a creditor may reach Liable Spouse’s and Non-Liable Spouse’s share of community property to satisfy the Liable Spouse’s separate tax liability. However, if the debt is a separate debt ( e.g., a tax liability of one spouse that arose before marriage), a creditor may reach Liable Spouse’s share of community property, but a creditor may not reach Non-Liable Spouse’s share of community property. Because Liable Spouse’s tax liability

2004–30 I.R.B. 83 July 26, 2004

Although each spouse has a 50 percent interest in the community property, Texas law limits the types of community property that a creditor may reach to satisfy a spouse’s separate liability. See Tex. Fam. Code Ann. section 3.202 (2002). Texas law allows a creditor to reach all of the community property subject to the liable spouse’s sole management, control, and disposition to satisfy the spouse’s separate liability. See Tex. Fam. Code Ann. section 3.202(c) (2002). In addition, a creditor may reach all community property subject to the spouses’ joint management, control, and disposition, and all of the liable spouse’s separate property, whether the debt was incurred before or during marriage. See Tex. Fam. Code Ann. section 3.202(c) (2002). A creditor may not reach any portion of the community property subject to the non-liable spouse’s sole management, control, and disposition, or the non-liable spouse’s separate property. See Tex. Fam. Code Ann. section 3.202(c) (2002). However, under Medaris v. United States, 884 F.2d 832 (5 ^th Cir. 1989), the Service may reach the liable spouse’s 50-percent interest in the non-liable spouse’s sole management community property to satisfy a separate federal tax liability of the liable spouse.

Situation 2 . Same facts as Situation 1, except that $250 of the overpayment is attributable to community property subject to Liable Spouse’s sole management, control, and disposition, and $750 of the overpayment is attributable to community property subject to Non-Liable Spouse’s sole management, control, and disposition.

Situation 3 . Same facts as Situation 1, except that the entire overpayment resulted solely from income tax withholding from Non-Liable Spouse’s wages, and the entire overpayment is attributable to community property subject to Non-Liable Spouse’s sole management, control, and disposition.

LAW

further information regarding this revenue ruling, contact Michael A. Skeen at (202) 622–4910 (not a toll-free call).

26 CFR 301.6402–1: Authority to make credits or refunds.

Offsets under section 6402; Texas law. This ruling provides guidance regarding the amount of an overpayment from a joint tax return that the IRS may offset against a spouse’s separate tax liability for taxpayers domiciled in Texas. Texas is a community property state and, under the state law, each spouse has an undivided 50–percent interest in all community property. Rev. Ruls. 80–7 and 85–70 amplified and clarified.

Rev. Rul. 2004–74

ISSUE

What amount of an overpayment reported on a joint return may the Internal Revenue Service apply against one spouse’s separate tax liability if the spouses are domiciled in Texas?

This ruling addresses how offsets apply for taxpayers filing joint returns and domiciled in Texas. This ruling makes assumptions about the operation of Texas community property laws which are highly dependent on facts and circumstances. Therefore, taxpayers are cautioned to check current state law and apply it to their particular facts. Taxpayers domiciled in Arizona or Wisconsin should refer to Rev. Rul. 2004–71; taxpayers domiciled in California, Idaho, or Louisiana should refer to Rev. Rul. 2004–72; and taxpayers domiciled in Nevada, New Mexico or Washington should refer to Rev. Rul. 2004–73.

FACTS

Situation 1 . In Year 1, Liable Spouse, who is single, incurs a federal tax liability of $20,000. Liable Spouse does not pay this tax liability. In Year 2, Liable Spouse and Non-Liable Spouse marry. In Year 4, Liable Spouse and Non-Liable Spouse file a joint return for Year 3, claiming an overpayment of $1,000. This overpayment results from income taxes withheld from Liable Spouse’s and Non-Liable Spouse’s wages during Year 3. Liable Spouse and

Non-Liable Spouse are domiciled in Texas at all relevant times.

Applying Rev. Rul. 80–7, 1980–1 C.B. 296, the Service determines that $750 of the overpayment is attributable to community property subject to Liable Spouse’s sole management, control, and disposition, and $250 of the overpayment is attributable to community property subject to Non-Liable Spouse’s sole management, control, and disposition.

Texas law defines separate property as property owned by a spouse before marriage; property acquired by spouse during marriage by gift, devise or descent; and any damages recovered by a spouse for personal injuries that do not represent loss of earning capacity during marriage. See Tex. Fam. Code Ann. section 3.001 (2002). Texas law defines community property as property, other than separate property, acquired by either spouse during marriage. See Tex. Fam. Code Ann. section 3.002 (2002). Each spouse has a 50-percent interest in community property. See Broday v. United States, 455 F.2d 1097 (5 ^th Cir. 1972). There is a rebuttable presumption under Texas law that all property acquired during marriage is community property. See Tex. Fam. Code Ann. section 3.003 (2002).

Texas law distinguishes between community property subject to the joint management, control, and disposition of both spouses, and community property subject to one spouse’s sole management, control, and disposition. See Tex. Fam. Code Ann. section 3.102 (2002). A spouse has sole management, control, and disposition over community property that spouse would have owned if that spouse were single. See Tex. Fam. Code Ann. section 3.102(a) (2002). This community property includes personal earnings; revenue from separate property; damages recovered from personal injuries; and the increase in value, mutations and revenue of all property subject to a spouse’s sole management, control, and disposition. See Tex. Fam. Code Ann. section 3.102(a)(1) through (4) (2002). Texas law defines community property subject to joint management, control, and disposition as all community property that is not subject to a spouse’s sole management, control, and disposition, and is not otherwise subject to an agreement of the spouses. See Tex. Fam. Code Ann. section 3.102(c) (2002).

July 26, 2004 84 2004–30 I.R.B.

of the joint tax liability, determined under a separate tax formula, from the spouse’s contribution towards the joint tax liability. Under the separate tax formula, a spouse’s share of the joint tax liability is calculated as follows:

Spouse’s Separate Tax

Total of Both Spouses’ Separate Tax

x Joint Tax Liability Reported on Return

purpose, each spouse under the first step of Rev. Rul. 85–70 is treated as receiving one half of the wages from each community property source (or, collectively, one-half of the aggregated wages) and as such being entitled to receive one-half of the income tax withheld from each community property source.

Five-step process to determine amount of joint overpayment that the Service may

Tax Payment From a Separate Property Source

Total Tax Payments

offset against separate federal tax liability of one spouse .

A five-step process is required to determine the amount of a joint overpayment that the Service may, pursuant to section 6402(a), offset against the separate federal tax liability of one spouse.

The first step is to identify the underlying source of the overpayment. The Service looks to the tax payments made by the spouses, including income tax withholding and estimated tax payments and other credits. If the earned income tax credit is a source of the overpayment, see Rev. Rul. 87–52, 1987–1 C.B. 347, for guidance. The second step is to characterize the underlying source of the overpayment as either separate or community property. Because an overpayment will be characterized in the same manner as the source of the overpayment, an overpayment will be characterized as community property, separate property, or as part community property and part separate property, depending on the character of the source of the overpayment. If the overpayment is part community property and part separate property, the portion of the overpayment attributable to a separate property source must be subtracted from the remainder of the overpayment. The portion of the overpayment attributable to a separate property source is calculated as follows:

x Overpayment

community property source. See Rev. Rul. 85–70. The fifth step is to determine whether the Service may, under state law, reach any portion of the overpayment from a separate

the overpayment from a community property source to satisfy the liable spouse’s separate tax liability.

The fourth step is to determine whether, under state law, the Service may reach any other portion of the overpayment from a

2004–30 I.R.B. 85 July 26, 2004

control, and disposition. Applying Texas law in Step 4, and in addition to the amount offset in Step 3, the Service may offset the remaining $125 of the $250 overpayment that is attributable to community property subject to Liable Spouse’s sole management, control, and disposition.

Further, $750 of the overpayment is attributable to community property subject to Non-Liable Spouse’s sole management, control, and disposition. Applying Texas law in Step 4, in addition to the amount offset in Step 3, the Service may not offset the remaining portion of the overpayment from community property sources subject to Non-Liable Spouse’s sole management, control, and disposition.

In Situation 3, none of the overpayment is attributable to community property subject to Liable Spouse’s sole management, control, and disposition. Applying Texas law in Step 4, in addition to the amount offset in Step 3, the Service may not offset the remaining portion of the overpayment from community property sources.

(5) Step 5 . Under Texas state law, a creditor may reach 100 percent of Liable Spouse’s separate property to satisfy Liable Spouse’s separate tax liability. A creditor may not, however, reach any of Non-Liable Spouse’s separate property to satisfy Liable Spouse’s separate tax liability. In Situation 1, Situation 2, and Situation 3, no part of the overpayment is from a separate property source. Accordingly, there is no separate property that the Service may offset against the Liable Spouse’s separate tax liability.

HOLDING

Situation 1 . The Service may offset $875 of the overpayment against Liable Spouse’s separate tax liability.

Situation 2 . The Service may offset $625 of the overpayment against Liable Spouse’s separate tax liability.

Situation 3 . The Service may offset $500 of the overpayment against Liable Spouse’s separate tax liability.

EFFECT ON OTHER REVENUE RULINGS

Revenue Ruling 80–7 and Rev. Rul. 85–70 are amplified and clarified.

property source of the liable spouse or the non-liable spouse.

ANALYSIS

Apply the five-step process to each situ- ation .

(1) Step 1 . In Situation 1, Situation 2, and Situation 3, the Year 3 joint overpayment is from income taxes withheld in Year 3 from Liable Spouse’s and Non-Liable Spouse’s wages.

(2) Step 2 . Texas law presumes that all property acquired during marriage by either spouse or both spouses, including wages, is community property. In Situation 1, Situation 2, and Situation 3, the overpayment results from income tax withholding from Liable Spouse’s and Non-Liable Spouse’s wages. Because Texas law presumes that wages are community property, the entire overpayment in Situation 1, Situation 2, and Situation 3 is assumed to be from a community property source.

(3) Step 3 . Under Texas law, each spouse has a present and equal interest in all community property. In Situation 1, the Service applies Rev. Rul. 80–7 and determines that $750 of the overpayment is attributable to community property subject to Liable Spouse’s sole management, control, and disposition, and $250 of the overpayment is attributable to community property subject to Non-Liable Spouse’s sole management, control, and disposition. Applying Rev. Rul. 85–70 and Medaris v. United States, 884 F.2d 832 (5 ^th Cir. 1989), the Service may offset $375 of the income tax withholding attributable to Liable Spouse’s wages and $125 of the income tax withholding attributable to NonLiable Spouse’s wages. Accordingly, in Situation 1, the Service may offset $500 of the overpayment against Liable Spouse’s Year 1 tax liability.

In Situation 2, the Service applies Rev. Rul. 80–7 and determines that $250 of the overpayment is attributable to community property subject to Liable Spouse’s sole management, control, and disposition, and $750 of the overpayment is attributable to community property subject to NonLiable Spouse’s sole management, control, and disposition. Applying Rev. Rul. 85–70 and Medaris, the Service may offset

$125 of the income tax withholding attributable to Liable Spouse’s wages and $375 of the income tax withholding attributable to Non-Liable Spouse’s wages. Accordingly, in Situation 2, the Service may offset $500 of the overpayment against Liable Spouse’s Year 1 tax liability.

In Situation 3, the Service applies Rev. Rul. 80–7 and determines that none of the overpayment is attributable to community property subject to Liable Spouse’s sole management, control, and disposition, and $1,000 of the overpayment is attributable to community property subject to NonLiable Spouse’s sole management, control, and disposition. Applying Rev. Rul. 85–70 and Medaris, the Service may offset $500 of the income tax withholding attributable to Non-Liable Spouse’s wages. Accordingly, in Situation 3, the Service may offset $500 of the overpayment against Liable Spouse’s Year 1 tax liability.

(4) Step 4 . Under Texas law, the amount of community property that a creditor may reach depends on the nature of the property. In Situation 1, Situation 2, and Situation 3, under Texas law, the Service may reach all community property subject to Liable Spouse’s sole management, control, and disposition, and all community property subject to Liable Spouse’s and Non-Liable Spouse’s joint management, control, and disposition.

In Situation 1, $750 of the overpayment is attributable to community property subject to Liable Spouse’s sole management, control, and disposition. Applying Texas law in Step 4, and in addition to the amount offset in Step 3, the Service may offset the remaining $375 of the $750 overpayment that is attributable to community property subject to Liable Spouse’s sole management, control, and disposition.

Further, $250 of the overpayment is attributable to community property subject to Non-Liable Spouse’s sole management, control, and disposition. Applying Texas law in Step 4, in addition to the amount offset in Step 3, the Service may not offset the remaining portion of the overpayment from community property sources subject to Non-Liable Spouse’s sole management, control, and disposition.

In Situation 2, $250 of the overpayment is attributable to community property subject to Liable Spouse’s sole management,

July 26, 2004 86 2004–30 I.R.B.

ruling, contact Michael A. Skeen at (202) 622–4910 (not a toll-free call).

DRAFTING INFORMATION

The principal author of this revenue ruling is Michael A. Skeen of the Office of

the Associate Chief Counsel (Procedure and Administration), Administrative Provisions and Judicial Practice Division. For further information regarding this revenue

2004–30 I.R.B. 87 July 26, 2004