The IRS has updated its online FAQ[1] on the unemployment compensation exclusion for 2020 and its application in community property states.

State law generally determines ownership of property and income, thus defining what is each spouse’s income when filing separate returns. In a community property state, community income (which is the default income in a community property state) is considered to be equally the income of each spouse, even if the income arises from the services of one spouse to the exclusion of the other.

When Congress in the American Rescue Plan Act added IRC §85(c), it excluded up to $10,200 of unemployment compensation from a taxpayer’s income as long as the taxpayer’s modified adjusted gross income is less than $150,000. Unusually, Congress did not provide for a lower modified adjusted gross income limit if married taxpayers file separate returns. Rather, each of the taxpayers gets his/her own $150,000 income limit.

Advisers who have taxpayers in one of the community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin) began speculating that, due to the division that will take place for much of the couple’s income as community income, married couples in such states could have income of up to $300,000 and still get the exclusion if the taxpayers filed separate returns.

As well, even if total unemployment received by one spouse was more than $10,200, filing separate could also serve to increase the amount deductible in total between the spouses if the other spouse did not also have $10,200 of unemployment compensation.

On April 29, 2021, the IRS confirmed this thinking in Q&A 4 in Section A of the FAQ. The FAQ provides:

Q4. I’m married and don’t file a joint return with my spouse. We live in a community property state. Are we eligible for the exclusion? (added April 29, 2021)

A4. Yes. Because you live in a community property state, you report half of your unemployment compensation and half of your spouse’s unemployment compensation on your tax return and your spouse reports the other half of your unemployment compensation and half of his or her unemployment compensation on his or her tax return. You should exclude up to $10,200 on your tax return if your modified AGI is less than $150,000. Your spouse should exclude up to another $10,200 on his or her tax return if your spouse’s modified AGI is less than $150,000. Neither of you should exclude more than the amount of unemployment compensation you report on your Schedule 1, Line 7.[2]

[1] “2020 Unemployment Compensation Exclusion FAQs — Topic A: Eligibility,” IRS webpage, Q&A4, April 29, 2021, https://www.irs.gov/newsroom/2020-unemployment-compensation-exclusion-faqs-topic-a-eligibility#:~:text=Q4,7 (retrieved April 30, 2021)

[2] “2020 Unemployment Compensation Exclusion FAQs — Topic A: Eligibility,” IRS webpage, Q&A4, April 29, 2021