3

Background:

I am married and file joint tax returns. I am the sole income provider and my wife is a stay-at-home mom. Given that we live in a community property state and given the Unlimited Marital Deduction I can share all my earned income with my wife without any tax repercussions (at the state and federal level).

Question:

Can we open a brokerage account in her name and invest all our money in her account, then instead of filing a joint tax return, file separate tax returns - effectively resulting in a 0% tax on Long Term Capital Gains, because she has no reportable income?

Does anyone have any experience or knowledge with a scenario like this? I've been searching the depths of the internet and reading as much tax regulations as I can digest and have been unable to find a definite reason as to why this would not work, but it seems like such a blatantly obvious loophole that there must be something I am overlooking.

Edit regarding income tax increases:

I recognize that filing separately would increase the tax bracket I fall into. In my case, filing joint married returns I'm in the 22% tax bracket and filing separately I would fall into the 24% tax bracket. However, going from a 15% capital gains tax bracket to 0% capital gains tax bracket could result in a considerable amount of money saved, well justifying the 2% increase on earned income. At least that is my thought with this idea.

5
  • 3
    What you're overlooking is that if you file separately then the rates you pay on your earned income (assuming it's over $40k) will go up. – The Photon Dec 10 '20 at 20:19
  • 1
    The IRS figured out that "one simple trick" decades ago. Many decades ago. – RonJohn Dec 10 '20 at 20:26
  • 1
    Speaking as a divorced person in a CP state, is any of your money commingled with our money? – RonJohn Dec 10 '20 at 21:00
  • 4
    It's not a 2% increase. Filing singly, you'll pay 24% instead of 22% on your income between $85k and $171k. But you'll also be paying 22% on your income between 53K and $85k, where before you only paid (just over) 12% on the same income. – chepner Dec 10 '20 at 21:17
  • It just occurred to me... I opened IRAs in my wife's name (so that we could contribute more). That was all considered CP during the divorce. – RonJohn Dec 10 '20 at 21:42
6

The key here is that you state: we live in a community property state.

In a community property state, your salary is by definition community income. As such, if you file separately, she must claim half of that salary herself. See the IRS publication 555 on Community Property for more details:

Community income is income from:

  • Community property;
  • Salaries, wages, or pay for services of you, your spouse (or your registered domestic partner), or both during your marriage (or registered domestic partnership) while domiciled in a community property state; and
  • Real estate that is treated as community property under the laws of the state where the property is located.

Later on:

Wages, earnings, and profits. A spouse's (or your registered domestic partner's) wages, earnings, and net profits from a sole proprietorship are community income and must be evenly split.

So if you earn $100k, and you file separately, and were domiciled in a community property state, you would report $50k yourself and she would report $50k herself.

The capital gains income might or might not be split, depending on where the property came from originally; if it originated from before the marriage, it might be considered separate income. However, it seems to me like the IRS would be very likely to characterize the particular scheme you envision as violating the separation of property. I would also be concerned that if you did successfully have the property declared as separate, you might lose all of it in the event of a divorce. And of course, if you are gifting her money from your salary after marriage, that money is community income and then property bought with it is community property, unless you come to some legal arrangement otherwise and your state permits that.


The idea you suggest in the OP is not totally off the wall, however; some couples do file separately for roughly the same reason. I still don't think the specific example you show would pass muster, though I am not a tax specialist, but for example if my wife had come into the marriage with $1M in securities, and I was the sole wage earner, that would probably qualify in a non-community property state; she would pay income tax on her capital gains each year at a lower rate (up to the cutoff), and I would pay tax on my salary. See this article by USAA for a high level discussion of that concept.


One other note. Since you're married, your nonworking spouse may still be able to make contributions to an IRA, which would allow you some of the tax avoidance you are craving - and in an IRS-approved manner! The Kay Bailey Hutchinson Spousal IRA limit allows a nonworking spouse to deduct up to the individual limit themselves (in addition to the working spouse doing the same), so long as the spouse earns enough (since, normally, you cannot contribute to an IRA if you have no earned income). This limit may be reduced or eliminated depending on your total income, so you may want to consult a tax professional if you're interested in this.

4
  • "your salary is by definition community income". I never knew that. Of course, we did MFJ so the topic never arose... – RonJohn Dec 10 '20 at 21:43
  • 1
    @RonJohn Only in CP states (mostly the west - CA, NM, AZ, NV, WA, ID, plus LA, TX, WI. according to the linked publication); other states the rules vary more. – Joe Dec 10 '20 at 21:45
  • Yes. That was implied by the context of the quote. – RonJohn Dec 10 '20 at 22:01
  • Really great explanation and links - thank you for your answer and time! I was completely unaware that if we filed separately she would have to claim half my income too. If she did that we'd both still fall into the 22% tax bracket and 15% long term gain bracket so it would completely negate any perceived benefit I had hoped for. I like the IRA idea too, I'll certainly spend some time learning about that option. Once again - thank you! – Larm Dec 11 '20 at 1:58
2

No.

Per your cited article: "The unlimited marital deduction is an estate tax provision." (emphasis mine)

Gifts are after-tax money. You still have to pay capital gains. Photon's comment to your question is also spot-on -- your earned income rates would also go up if you file separately.

5
  • Forgive me, I don't fully understand your response. I updated my question to account for the income tax increase. However, I'm not sure what you're trying to convey with the regard to the Unlimited Marital Deduction. – Larm Dec 10 '20 at 20:40
  • 1
    I know the IRS was wise to this, but I am still looking at the numbers. The difference on 100K (taxable) going for MFJ to MFS is about $4500. If his LT gain was $40000, that's $6000 saved ($1500 net). Yes, I'm sure I missed something obvious. – JTP - Apologise to Monica Dec 10 '20 at 21:00
  • @Rocky I think you misunderstand the question. OP is suggesting gifting the capital to OP's wife, and then the wife claims the income from said capital as her own. Obviously there is some complication here if OP already owns the stocks, but OP did not suggest that - simply suggested handling cash money to OP's wife. – Joe Dec 10 '20 at 21:24
  • @Joe -- I see. Yes, I think I misunderstood. In that case, the cost basis of the stocks/securities is still maintained, at least I'm pretty sure. I think my answer will have to be edited, just not sure about the nuances. I might delete. – Rocky Dec 10 '20 at 21:34
  • @Rocky - There are other repercussions to the MFS. All are costly, but I don't know the whole list. My comment (too short for 'answer') is to run it through TurboTax. If everything would be in OP's name, it's not tough to just change to MFS, remove the cap gain stock sale, and add a MFS for the wife. When I wrote blog posts for this topic, I'd run those scenarios just as I suggested. – JTP - Apologise to Monica Dec 10 '20 at 22:20

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.