Cross-Border Couples Must Learn to Navigate Tax Planning Traps

While once uncommon, cross-border families now constitute a significant portion of cross-border tax filers. For tax practitioners, this translates into a growing need to reconcile US federal tax rules with foreign marital property systems—particularly where community property law collides with Section 879 of the tax code.

This comes down to one recurring dilemma: Should a US spouse report only half the couple’s earnings, leaving the other half to a non-US spouse?

In community property jurisdictions, the answer is yes. But the IRS’s answer, found in Section 879, is an emphatic no—and that “no” creates planning traps every practitioner must navigate.

Community property rules apply in states such as California and Texas, as well as in foreign jurisdictions such as Spain, France, and much of Latin America. Income earned during marriage is presumed by default to be shared equally between spouses.

For example, consider a US citizen married to a non-US person and living in Mexico. Under Mexican law, absence of express stipulation, income earned during the marriage is split 50/50, regardless of whose name appears on the paycheck.

In the US, those community property allocations are overridden for federal tax purposes. Wages, salaries, professional fees, and other amounts received as compensation for personal services actually performed are taxed to the spouse who earned them. By contrast, only certain passive categories may still be divided equally between spouses.

Say the US citizen who is living in Mexico earns $200,000. Under local law, half of that salary belongs to the non-US spouse. The US spouse could claim to have only $100,000 of income. The other $100,000—allocated to the non-US spouse—would disappear from the US tax base, because the spouse has no US filing obligation.

That was the salary-shifting loophole Congress closed in enacting Section 879. The provision requires wages, salaries, and professional fees to be taxed entirely to the spouse who performs the services. In the example above, the US spouse who earned the $200,000 must report the full amount rather than being able to allocate half to the non-US spouse and reduce the effective US tax rate.

Planning Alternatives

The joint election. Under Section 6013(g) or (h), a couple can elect to treat the non-US spouse as a US resident for income tax purposes. Once the election is in place, Section 879 no longer applies, and community property allocations are respected. The couple files a single joint return, reporting all income together and benefiting from the wider married-joint brackets.

If the US–Mexican couple made a Section 6013(g) election to treat the non-US spouse as a US resident, they could file jointly and use the wider married-joint tax brackets. That doesn’t mean each spouse would report $100,000 separately; instead, the couple would file one return with the full $200,000 of income, but the married brackets would keep all of it in the lower ranges.

This type of election could significantly lower the overall tax bill. The tradeoff is that the non-US spouse would also have to disclose and pay US tax on all worldwide income and assets, with the added burden of FBAR, FATCA, and PFIC rules, when applicable. Making the election could be a prudent strategy if a non-US spouse has little or no outside income or holdings.

Opting out through marital agreements. Section 879 draws a clear line between earned and business income—which is fully taxed to the spouse who performs the services or owns the business—and certain passive income categories—such as dividends, interest, rents, and royalties—that remain subject to a 50/50 community allocation by default.

That default can unintentionally pull foreign-source investment income onto the US spouse’s return, even when the assets are legally owned by the non-US spouse. Many civil law jurisdictions, however, allow couples to opt out of the community property regime through prenuptial or postnuptial agreements.

When properly structured and recognized under local law, these marital agreements can reclassify assets as the non-US spouse’s separate property. In doing so, they shift the associated income entirely to the non-US spouse.

This strategy is particularly relevant where the non-US spouse owns or expects to acquire significant investment holdings abroad. By using a valid marital agreement under local law, couples can reclassify those assets as the non-US spouse’s separate property.

For traditional passive items such as dividends, interest, rents, and royalties, this can keep the income entirely outside the US tax base. It can also prevent the US spouse from being pulled into complex reporting for assets they don’t control. Because PFIC income is subject to its own punitive anti-deferral regime, for example, ensuring the agreement is enforceable under local marital law is essential to avoid unnecessary US tax and compliance exposure.

The Bottom Line

Section 879 ensures that a US spouse can’t shift income onto a non-US spouse simply by relying on community property law. It prevents leakage from the US tax system, but it doesn’t require the US spouse to report the true income earned by the non-US spouse.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Sofía Larrea, an international tax attorney based in Ecuador, specializes in US and cross-border taxation and is admitted in Ecuador, California, and the US Tax Court.

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