The US Tax Trap: International Marriage, Community Property and the Mobile Couple

Readers of my blog know from previous posts (for example here and here) that unless the international couple enjoys dealing with complicated US tax matters and filings, holding title to assets jointly with a non-US citizen spouse is risky business!  The well-advised keep their assets completely separate to avoid nasty US tax complications. However, this alone may not help – community property laws may override any such attempt to keep assets “separate”.

Community Property and the International Marriage

Community property is not defined in the US Internal Revenue Code. The case of Poe v. Seaborn, 282 US 101 (1930) decided by the United States Supreme Court almost 100 years ago, gives us an excellent overview.  In Seaborn, the Court held that in a community property state (as relevant, Washington), due to the operation of state law, a married person’s income is divided with his spouse such that the income earned by one spouse is immediately one half the property of the other spouse.   Under “community property” principles generally,  community property is property (i) that is not otherwise classified as “separate property” (ii) held by a married couple who are domiciled in a community property jurisdiction (iii) under the laws of the relevant jurisdiction each spouse has a “vested” undivided one-half ownership interest in the community property owned by the couple (iv)  at death or divorce, the law entitles each spouse / the surviving spouse the right to partition the community property and receive one-half.

While there is considerable variation in the community property laws in different jurisdictions, the takeaway is that the husband and wife are considered to own equal and undivided half interests in each item of community property. In certain respects this is modified by Internal Revenue Code Section 879 which generally overrides application of Poe v. Seaborn.  Instead of applying community property laws, Section 879 applies special allocation rules to certain kinds of income that another jurisdiction might treat as community property. For example, under Section 879, earned income (e.g., wages, salaries, professional fees) is taxed only to the spouse who performed the services which earned the income; partnership income is taxed only to the spouse who is the partner in the partnership and that individual will be taxed on the distributive share of partnership income or loss.

Mobile Society – Further Problems for the Migrating Couple

In today’s world, it is very common to see not only international marriages, but also what I call “migrating couples” (those who move from one country to another).   Many individuals involved in an international marriage or in “migrations” are unaware of the potential US tax consequences that can result when community property rules come into play as a result of their unique facts. The impact of community property laws can be unexpected and diverse.  The fact of the matter is that community property laws may affect a couple if they have ever lived in a community property jurisdiction at any time.

The laws of countries throughout Latin America and continental Europe have been influenced by the civil law, and in these countries, community property is common.  Nine US states have community property regimes. While there is no single system of community property, as a general matter, in these places marriage will convey joint property rights to each of the spouses.

The laws of different countries will have different rules concerning community property. In some countries, the couple may elect into one of several property regimes, and in the absence of a formal election, a default regime will automatically apply.   Once a given property regime applies it will often (but not always) do so for the duration of the marriage and cannot be changed.  Despite the general principle that the marital regime is fixed at the time of marriage, figuring out which country’s law to apply can often be a complicated task.  For example, some countries will apply the laws of the jurisdiction where the marriage took place (even if the couple did not have a home there), but other countries apply the law of the first matrimonial home.  All of these nuances make it very important that the couple and their tax advisor understand the rules relevant to their particular case so that the US tax ramifications can be fully ascertained and planning done as required.

Next week, I examine a case that illustrates the complexity involved with mobile international couples, the US tax system and international community property regimes. While the case involves a couple who were not even US citizens or residents, the US tax regime got them with a tax bill over USD2 million plus penalties.  Ouch. An expensive error that could have been avoided with proper tax advice.


Posted March 9, 2023

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