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Both of the above rulings requiring the separate treatment of the income of husband and wife filing Joint returns as regards the limitations on amount of capital losses and of charitable contributions were held invalid by the Supreme Court on December 9, 1940. /2/

In conformity with the Court's decisions, the Regulations were amended by T. D. 5057, approved July 2, 1941, to provide that under a Joint return limitations upon losses and other deductions are to be computed for husband and wife as if the return were made by one individual. /3/ To a considerable extent, therefore, the procedure followed prior to the B.T.A. decision of August 29, 1932 has been re-established. It should be observed, however, that T.D. 5057 is for the most part restricted to items that are limited under the law by size f net income or by size of correlative item (e.g., in case of net short-term capital loss by size of net short-term capital gain). The decision does not touch upon certain items not involving limitations; such as bad debts between the spouses or wash sales by the spouses separately. /1/

FOOTNOTES

/1/ Thus, Article 117-5 of Regs. 101 under the 1938 Act and Sec. 19.117-5 of Regs. 103 under the IRC stated that: "Under the general rule with respect to taking deductions in a Joint return of husband and wife . . . . a deduction which is not allowable in computing the net income of one spouse making a separate return is not allowable in a joint return made by both spouses. Hence, the limitation. . . . relating to the allowance of short-term capital losses, is, in the case of one spouse, to be computed without regard to the short-term capital gains and losses of the other spouse, regardless of whether a Joint return or separate returns are filed."

/2/ Ct. D. 1478 and 1479, I.R.B. No. 52, December 23, 1940, pages 16-20.

/3/ Specifically, under a joint return:

"The combined losses of the spouses as a result of wagering transactions shall be allowed to the extent of the combined gains of the spouses from such transactions."

"The deduction for contributions or gifts is the aggregate of such contributions or gifts made by the spouses, and is limited to 15 percent of the aggregate net income (computed without regard to such contributions or gifts)."

"The limitation . . . relating to the allowance of short-term capital losses, is to be computed with respect to the combined short-term capital gains and losses of the spouses."

"The long-term capital losses of the spouses are to be deducted from their aggregate gross income in computing the tax imposed by 11 and 12 . . . In computing the alternative taxes under section 117(c) . . . the determination of the 'net long-term capital gain' or the net long-term capital loss' is to be made by combining long-term capital gains and the long-term capital losses of the spouses."

(And similarly with respect to the Joint net operating loss and operating loss carry-over).

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4. TREATMENT OF THE EARNED INCOME CREDIT: Procedure with respect to the earned income credit on joint returns has varied in somewhat the same way as the treatment of deductions. From 1934 until the issuance of T. D. 5057 (approved July 2, 1941) the earned income credit on a joint return was the same as on two separate returns. /2/ In the event of a net loss by one spouse, therefore, the earned income credit on a joint return might exceed 10 percent of the joint net income. /3/ It was also possible for the spouses to have a combined minimum earned income credit of $600 although no income was earned, and a maximum earned income credit of $2,800.

FOOTNOTES

/1/ With respect in particular to wash sales (now allowed on a joint return exactly as on two separate returns) there was in the original draft of T. D. 5057 a provision that such sales should be allowed as on a single return, the husband and wife being considered one taxable unit. This provision was taken out of the final draft, however, because of division of opinion as to whether procedure with respect to wash sales would in fact come under the principles of the Janney-Taft decisions. (Information from Mr. Buxton, Legislation and Regulations Division, Chief Counsel's Office, B.I.R.)

/2/ I.T. 2855 (C.B. XIV-l, 72, 1935); also I.T. 2875 (C.B. XIV-1, 81, 1935). Instructions on Form 1040 were expanded beginning 1936 to incorporate this information. For separate earned income credits to be allowed on joint returns, the earned income, earned income deductions, earned net income, and net income of husband and wife had to be shown separately.

/3/ For example, if the husband had a net income of $12,000, all of which was earned income, and his wife had allowable deductions of $4,000 in excess of her taxable income, the earned income credit on joint return filed by them would be $1,200 notwithstanding the fact that their joint net income was only $8,000. (Bureau of Internal Revenue, Course in Income Tax Law, Individuals, (etc.) Revenue Act (of 1938, p. 10). Or if the wife in such case had allowable deductions of $11,000 (in excess of her taxable income) so that the joint net income was only $1,000, then apparently the earned income credit of the husband would suffice to exempt the pair from normal tax.

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Under T. D. 5057, this procedure was amended so that: "In the case of husband and wife making a joint return, there is but one earned income credit, computed upon the combined income of the spouses, and the maximum and minimum limitations prescribed with respect to such credit shall be based upon the combined income as if the joint return were the return of one individual." /1/ This regulation applies under the 1941 Act also.

5. LIABILITY FOR TAX ON JOINT RETURNS: A ruling by the Bureau in 1923 on a case which arose in 1920 under the Revenue Act of 1918 held that "Where a husband and wife file a joint return, they are individually liable for the full amount of the tax." /2/ After this ruling it became the settled practice of the Bureau to enforce a joint and several liability in all cases of a joint return by husband and wife.

Doubt was cast on the validity of this procedure by a decision of he Ninth Circuit Court of Appeals on December 20, 1935, in the case of Trida Hellman Cole vs. Commissioner. /3/ In this decision the Court held that though a joint return had been filed, there was no joint or several liability in the husband for a deficiency arising out of the income of the wife, but instead that the liability for the tax on the joint return should be apportioned to the husband and wife in accordance with the ratio of their separate incomes to the aggregate income taxed. Board of Tax Appeals subsequently followed the Cole decision. /4/

In order to set at rest any doubt as to the responsibility of each for the tax, Congress has specifically provided beginning with Revenue Act of 1938 that if a joint return is filed, the liability respect to the tax shall be joint and several. /5/

B. PRESENT PROVISIONS /6/

1. FILING REQUIREMENTS: Husbands and wives not living together or any part of the taxable year are treated as single persons and each must file a return if having a gross income of $750 or over.

FOOTNOTES

/1/ It may be noted that under the mandatory joint return provision (rejected by the House) in the Revenue Bill of 1941, H.R. 5417, husband and wife would again have been accorded separate earned income credits.

/2/ I.T. 1575, Cumulative Bulletin II-I, page 144. Regulations 33 under the 1913 Act (Article 10) stated that if the aggregate net income of husband and wife exceeded $4,000, a return of the combined income must be made even though each separate income was less than $3,000, and that husband and wife "are jointly and separately liable for such return and for the payment of the tax." Whether this rule applied generally is not clear.

/3/ Cole vs. Commissioner of Internal Revenue, 81 Fed (2d) 485.

/4/ Cf. 38 BTA 877.

/5/ I.R.C. Sec. 51 (b).

/6/ Under the I.R.C. as amended through the Revenue Act of 1941.

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Husbands and wives living together for part of the taxable year or for the entire taxable year with income equal to or in excess of the minimum filing requirements may file either joint or separate returns according to circumstances. If only one has income, only that one is required to make a return and then only if his gross income is $1,500 or over. /1/ If both have income and the aggregate gross income $1,500 or over, /1/ each must make a return unless a joint return is filed.

A joint return can be filed only if several conditions are met: (1) husband and wife must be living together at the end of the taxable year, (2) their taxable periods must coincide, in order that the return may not cover longer than a 12-month period, /2/ (3) either each must have income, or if only one has income the other must have allowable deductions, (4) neither can be a nonresident alien. /3/

Additional conditions apply to the filing of joint or separate returns under Supplement T, relating to the optional tax on individuals with certain gross income /4/ of $3,000 or less inserted in the Internal Revenue Code by the 1941 Act. A joint return is allowed under Supplement T only if the combined gross income of husband and wife does not exceed $3,000, all from the prescribed sources. Husband and wife with combined gross income up to $6,000, however, can each file a separate return under Supplement T, provided income is from sources specified and neither has gross income in excess of $3,000. Or one spouse meeting the income requirements may file a separate return under Supplement T regardless of size of the other spouse's income. /5/

The election to file a joint return in one year is not binding on other years; the type of return filed may vary from year to year.

2. BASIS FOR DIVISION OF INCOME BETWEEN HUSBAND AND WIFE ON SEPARATE RETURNS: Where the incomes are separately reported, the practice in Federal income tax administration is to recognize the basis for income division between husbands and wives prescribed by State statutes.

FOOTNOTES

/1/ Except that in case of change of marital status during the taxable year, filing may be required where the sole income or the combined income is less than $1,500, since the requirement is adjusted on the basis of the allowable personal exemption (disregarding head of family status).

/2/ I.T. 1514, C.B. I-2, 174 (1922)

/3/ This last limitation was inserted under the Revenue Act of 1938.

/4/ The gross income must consist wholly of one or more of the following: Salaries, wages, compensation for personal services, dividends, interest, rent, annuities, and royalties.

/5/ Separate filing under Supplement T by one or both spouses is likely to be disadvantageous, however, because of the required even split of the personal exemption between the spouses. (See section IIB1, following.)

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a. COMMUNITY PROPERTY STATES: Eight States, Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas and Washington have long held to the system of community property. In substance, the system within these States allocates one-half the community income to the husband and the remaining one-half to the wife. In a majority of these States income from property separately owned /1/ is not considered income of the marital community, but belongs entirely to the owning spouse. In Texas and Idaho, however, even income from separate property (apart from certain capital gains) constitutes as a rule community income; and this holds also in Louisiana under certain circumstances. /2/

In the case of husband and wife domiciled in one of the eight community property States, separate income tax returns may be filed on the community income basis. On such community property returns, each spouse includes on his or her return one-half of all community income plus any non-community income received.

b. OKLAHOMA: Oklahoma also adopted a community property law effective July 28, 1939, but gave husband and wife the option of remaining on a separate income basis or adopting the community income basis, the choice once made being final. This elective feature differentiates the Oklahoma law from the laws of the eight community property States named above, under which without election the wife has a present vested right in the community property equal to that of the husband. On the basis of this difference the Bureau of Internal Revenue is disallowing, for purposes of the Federal income tax, the division of income on a community income basis in Oklahoma. /3/ The issue is involved in litigation pending before the U.S. Board of Tax Appeals.

c. OTHER STATES: Some States retain essentially the common law basis which does not recognize any separation of property interests between husbands and wives. The wife's property at date of marriage, and all property and income that she may acquire after marriage, belong to the husband. Still other States have adopted variations of the common law or of the community property system.

FOOTNOTES

/1/ Such as property owned before marriage or property acquired after marriage by gift, devise, bequest, or inheritance.

/2/ E.g., if a wife having separate property allows the husband to manage it.

/3/ Unpublished G.C.M. to Commissioner of Internal Revenue, RE Oklahoma Community Property Law May 10, 1940; and general instructions from the Commissioner to the Internal Revenue Agent in Charge, Oklahoma City, August 2, 1940 and to the Collector of Internal Revenue, Oklahoma City, August 3, 1940.

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3. DIVISION OF EXEMPTIONS AND CREDITS

PERSONAL EXEMPTION: On joint returns and on the returns of husbands or wives whose spouses have no income, a personal exemption of $1,500 is allowed. /1/ On separate returns, including community property returns, the personal exemption may be taken by either husband or wife or divided between them in any proportion, as they agree, except that if one or both spouses make a return under Supplement T the personal exemption of each spouse is $750.

DEPENDENT CREDIT: This credit is allowed only to the spouse contributing the chief support of the dependent and cannot be divided between husband and wife. Under Supplement T, credit is determined by status with respect to dependents as of the last day of the taxable year but otherwise the annual amount of $400 per dependent is adjusted on the basis of the number of months of dependency.

EARNED INCOME CREDIT: As noted above, under the Regulations as amended July 1941, only one earned income credit is allowed on a joint return, such credit being computed as if the return were that of one individual. In the case of separate returns, each spouse receives an earned income credit. On community property returns, one-half the income derived from personal services rendered by one spouse may be treated as earned income in the return of the other spouse. /2/

The allowance of separate earned income credits does not necessarily mean an advantage to those filing separate returns. The difference in credit, if any occurs, may be in favor of the joint return.

No difference occurs in those cases where the several statutory limitations /3/ do not become applicable, since the 10. percent allowance comes to the same aggregate figure whether applied to the combined or to the separate amounts of earned net income. /4/

FOOTNOTES

/1/ In case of change of marital status during the taxable year, the personal exemption is adjusted according to the number of months under each status except that under Supplement T (relating to the optional tax on individual with certain gross income of $3,000 or less) status is determined as of the last day of the taxpayer's taxable year.

/2/ Regulations 103 under the Internal Revenue Code, Sec. 19.25-2, p. 146. Viz., the statutory limitations on earned net INCOME, to a maximum of $14,000 and, if net income is more than $3,000, to a minimum of $3,000; and the statutory limitation on the earned income CREDIT (10 percent of earned net income) to not more than 10 percent of net income. I.R.C. Sec. 25(a)(4)(c) and Sec. 25(a)(3).

/3/ Assuming that the aggregate earned net income computed under the joint return does not differ from the sum of the separate EARNED net incomes.

/4/ Apparently such differences would occur but rarely in earned net income.

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A difference in fever of those filing separate returns, i.e., a larger combined earned income credit than under a joint return, occurs in cases where the minimum credit of $300 (for returns with net income above $3,000) /1/ or the maximum credit of $1,400 applies to one or both spouses; and also as a rule /2/ in cases where the aggregate net income is smaller than the sum of the separate net incomes. (See Appendix A, Oases 1-4.)

A difference in favor of those filing joint returns, i.e., a credit larger than the combined earned income credit under separate returns, occurs, however, in cases where one spouse has earned net income in excess of net income while the other spouse has earned net income smaller than net income /3/; and also in cases where though both spouses have earned net income in excess of net income, the aggregate net income is larger than the sum of the separate net incomes. (See Appendix A, Cases 5-6.)

CREDIT FOR INTEREST ON GOVERNMENT OBLIGATIONS: The same ruling that provided in 1934 for separate computation of the earned income credit on joint returns /4/ also stated that the credit for interest on United States obligations under Sec. 25(a) of the Revenue Act of 1934 may be computed separately in the case of husband and wife even though a joint return is filed. Thus, interest received on the first $5,000 of United States Savings Bonds and Treasury Bonds held by each spouse is wholly tax-exempt. This ruling is viewed as in accord with the provision of the basic act /5/ under which the obligations were issued exempting interest on a principal amount not exceeding $5,000 OWNED BY ANY INDIVIDUAL, and therefore was not altered Under the amended Regulations of July 1941.

FOOTNOTES

/1/ More generally as respects the lower limit a larger credit is secured under separate returns (provided that the combined net income exceeds $3,000) whenever one spouse has earned net income only by virtue of the provision that if the taxpayer's net income is not more than $3,000 his entire net income shall be considered to be earned net income. (I. R. C. Sec. 25(a)(4)(c).)

/2/ Exceptions may occur in some cases where one spouse has earned net income in excess of net income while the other spouse has earned net income smaller than net income (see following paragraph); and will also occur if the limitation by size of net income does not become applicable.

/3/ Unless the aggregate net income is lower then the sum of the separate EARNED net incomes as limited in effect for one spouse by net income.

/4/ I.T. 2855, C.B. XIV-1, p. 72.

/5/ Generally the Second Liberty Bond Act or that Act as amended.


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