Collecting Separate Tax Debts from Community Property

Originally published by Tom Rhodus.

Texas is a “community property” state; but all property in Texas is not “community property”.

In Texas, each spouse can have his or her own “separate” property, which generally consists of property that was acquired by gift or inheritance, and that which was owned by the spouse prior to marriage.  All other property is generally presumed to be community property.

Partition Agreements

Spouses can “partition” property that would otherwise be community property and cause it to be separate property by executing a “partition agreement”. A partition agreement can be executed either before or after marriage; but in any case it must be carefully drafted and signed by both spouses.

In the absence of a partition agreement, all income earned by either spouse during marriage (other than capital gains from the sale of separate property) is community property, which means that half of such income literally belongs to the other spouse, regardless of which spouse earned the income.  Surprisingly, this concept even applies to income of one spouse that was concealed from the other spouse, even to income from illegal sources such as embezzlement income, e.g. Dawson v. Comm’r, TC Memo. 1996-96. It even applies to “phantom” income from the cancellation of indebtedness, e.g. Wienke c. Comm’r., T.C Memo 2020-143. What this means is that one spouse may be taxed on the other spouse’s receipt of income that he or she did not even know about, let alone benefit from, regardless of whether or not such income was reported on income tax returns.  (A spouse may be able to escape personal liability as an “innocent spouse” under the provisions of §§ 66 or 6015 of the Internal Revenue Code.)

Two Types of Community Property

The community property is divided into two sub-classes: “sole management community property” (for both husband and wife); and “joint management community property”. “Sole management community property” is defined by Texas law as consisting of wages earned by a spouse, revenue from separate property, recoveries from personal injuries, and revenue or property derived from separate community property.  Tex. Family Code, §3.102. All other kinds of community property are “joint management community property”.   Based on the foregoing, it is important to note that the way property is titled (i.e., whether in the name of one spouse or both) is seldom going to be determinative of the true character of the property as “separate”, “joint management” or “separate management.” Although, regardless of how it is titled, property that has been acquired with community property is likely to be considered joint management community property. For example, a residence acquired during marriage is most likely going to be considered to be “joint management community property”.

Separate Tax Debt

A question that frequently arises is, “To what extent can the separate tax debt of one spouse be collected from property belonging to the either spouse”?  (A “separate tax debt” could be a debt for income taxes assessed  prior to marriage, or  for certain types of penalties assessed during marriage such a the “trust fund recovery penalty” that is assessed under § 6672 of the Internal Revenue Code to collect unpaid employment taxes.)

A separate tax debt can never be collected from separate property belonging to the non-debtor spouse. However, it is important to keep in mind that Texas law presumes that all property is community, and that is the responsibility of the spouses to preserve, document and prove that disputed property is truly “separate.”  There are numerous situations where property  has lost its “separate” nature due to commingling  with community property (for example, where interest income, which in Texas is community property even if it is derived from separate funds, is allowed to accumulate in a bank account along with the separate principal).

Community property is a different matter altogether; and a decision of the Fifth Circuit Court of Appeals in Gray v. United States, 553 F.3d 410  (5^th Cir. 2008)  illustrates how the separate tax debt of one spouse can be collected from community property.  According to Texas law, any debtor (not just the IRS) can satisfy a separate debt from any property subject to the debtor spouse’s sole or joint management and control. Tex. Family Code, §3.202 (c).  For one thing, that means that a residence that is considered joint management community property can be seized and sold to satisfy the separate tax debt of the other spouse.  (Federal agencies such as the IRS are not subject to Texas’ homestead rights, although a non-debtor spouse may still derive some benefit from his or her homestead rights upon the IRS’ sale of the home.)  In Harris v. United States, 764 F.2d 1126, the Fifth Circuit confirmed that Texas’ homestead law does not prevent the IRS from seizing a residence to satisfy the separate debt of one spouse  (although the court went on to hold that the proceeds from the seizure and sale of the house had to be divided to compensate the non-debtor spouse for the value of her homestead interest, a property right not subject to the IRS’ claim.)

That leaves the non-debtor’s “sole management community property”, such as the non-debtor spouse’s earnings: Are such earnings liable for the other spouse’s separate tax debts?  They are, in part.  According to Gray and other Fifth Circuit authority, the IRS may reach one-half of the non-debtor spouse’s sole management community property – including one-half of such spouse’s current earnings – to satisfy the liable spouse’s tax debt.

Curated by Texas Bar Today. Follow us on Twitter @texasbartoday.

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