Articles Posted in Tax

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Forget it!

Forget about the alimony deduction for all new decrees or instruments post-2019. (See Part I for modification of pre-2019 alimony orders and agreement, as modification has a separate set of rules.) The deduction is gone absent a congressional miracle. That means on December 31, 2018, or before you must have alimony that qualifies under IRC Section 71 before it is repealed. The alimony must meet the terms of Section 71, pre-TCJA and pre-2019, which are as follows:

a. You must have a qualifying decree or instrument;

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Previously, we examined the paragraph and subparagraphs defining “divorce or separation instruments.” Now let’s take a look at which sections of TCJA incorporate these subparagraphs.

Sections incorporating all three subparagraphs of the definition of divorce or separation instrument Post-2018.

The two sections of TCJA that adopt all three subparagraphs of the definition of divorce or separation instrument post-2018 are as follows:

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The repeal of the alimony tax sections for the inclusion of income and deduction has an ancillary impact on other divorce tax issues. The effective date for all ancillary issues discussed in this article is December 31, 2018, the same as the alimony repeal. These December 31, 2018, changes shall be referred to herein as “post-2018” changes.

The law before TCJA will be referred to as “pre-2019.”

In this first section, we’ll look at what a divorce or separation instrument is.

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Divorce was hard enough, and now alimony tax reform. Do you feel good or bad about alimony? No matter your answer, this alimony tax reform revolutionizes the divorce arena, and you need to know how it may affect you and your clients. Judges need to know how it might affect those whose appear before them as litigants. So let’s dig in.

This article is Part I of three parts. Part I deals with the basics of the alimony taxation changes under the Tax Cuts and Jobs Act (“TCJA”), referred to herein as the “new Alimony Statute.” Multiple sections of the Internal Revenue Code related to alimony are changed under the TCJA. The new Alimony Statute is contained in Section 110151 named “Repeal of Deduction for Alimony Payments” in PL 115-97, HR1, December 22, 2017, 131 Stat 2054.  When I refer from now on to the “old Alimony Statute,” I am referring mainly to Internal Revenue Codes Sections 71 and 215 as they existed before the TCJA.

Part II will deal with ancillary federal tax considerations of the new Alimony Statute, of which there are many.  Part III will discuss considerations of the new Alimony Statute under North Carolina domestic relations law and explore creative possibilities for the use of the new Alimony Statute.

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Yancey v. Comm’r, T.C. Memo. 2017-59, 2017 WL 1289451 (2017)

Facts: A husband and wife filed joint returns. The returns were prepared by the wife. The returns understated the amount of tax due, mostly because they wrongly double-counted certain gambling losses incurred by the husband.

The IRS assessed a deficiency. The wife filed a petition for innocent spouse relief, the IRS denied it, and the wife appealed to the Tax Court.

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Dear Carolyn,

I think my husband and I may be getting separated and divorced, and I am concerned about our 2016 tax return, which has not been filed yet. The tax return is under an extension.  My husband has a small business in Greensboro, and I have no idea if he reports all of the income in the business.   I have heard that I can be responsible if I sign the return.  He never gives me a copy.  Do you have any thoughts on this issue?  Do I have to worry?

~ Worried and in the Dark

 

Dear Worried and in the Dark,

This is always a tough decision, and the law that applies to this is called:  “Innocent Spouse Relief.”  There are some things that you need to know in making the critical decision of whether to file a joint income tax return with your spouse.

First, you need to know that you do not have to sign a joint return, but if you elect to do so, you are potentially 100 percent liable for any income taxes, interest or penalties related to the return you sign.  Yes, I said 100 percent, not 50 percent.  You see, the Internal Revenue Code holds each signer of a tax return jointly and severally liable for all taxes, interest and penalties, absent a co-signer being an innocent spouse. So, to me, signing a joint tax return is always a big decision for a person with a small business.  Contrast this with spouses who both have W-2 incomes from employment with third parties;  if the only income on the return is W-2 income, then generally it is safe to sign a joint return properly prepared.  You, however, are in the riskier situation with the small business.

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Stapleton v. Comm’r, T.C. Memo. 2015-171, 2015 WL 5049758

Facts: A father and mother had two children. The parents were never married. No court was ever asked to decide custody, but the parents agreed that the father would have the children every Monday and Wednesday night and every other weekend. In 2011, the father had custody of the children for 176 days.

The father claimed the dependency exemption for both children on his 2011 tax return. The IRS disallowed the exemption, and the father appealed to the Tax Court.

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Belot v. Comm’r, T.C. Memo. 2016-113, 2016 WL 3248031 (2016)

Facts: During their marriage, the parties operated a dance studio. The business consisted of an S corporation which was the actual studio, an LLC which operated a boutique selling dance clothing, and another LLC which owned the real estate on which the studio operated. The parties owned each of these entities in different percentages.

The parties were divorced in New Jersey in 2007. The decree incorporated an agreement signed by the parties, in which they agreed to convey interests in the entities so that each of them owned 50% of all three entities. The decree therefore left the divorcing parties as joint owners of the business.

Later in 2007, the wife filed a complaint against the husband, alleging that he had mismanaged the studio, and seeking to remove him as director and employee. This action was settled in 2008 by an agreement, in which the wife agreed to buy the husband’s interest in the business for $900,000 to be paid at closing, and $680,000 to be paid over 10 years.

The husband filed tax returns which claimed that the sale of the business under the 2008 agreement was a § 1041 exchange. When the IRS assessed a deficiency, the husband then appealed to the Tax Court.

Issue: Was the transfer required by the 2008 agreement a 1041 exchange?

Answer to Issue: Yes

Summary of Rationale: The IRS relied upon Reg. § 1.1041-1T(b), Q&A-7, which provides:

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Anderson v. Comm’r, T.C. Memo. 2016-47, 2016 WL 976816 (2016)

Facts: An Alabama court entered a pretrial order in a divorce case, requiring both parties to “[m]aintain status quo as to payment of house note or rent, utilities, food, necessities, fixed credit obligations, ” 2016 WL 976816, at *1. After the order was entered, the husband transferred at least $1,000 each month to the wife “for her spending money and other things that I had previously paid for.” Id.

The husband took an alimony deduction for the amounts paid. When the IRS did not allow the deduction, the husband then appealed to the Tax Court.

Issue: Were the payments alimony for federal tax purposes?

Answer to Issue: Summary of Rationale: The first requirement in the federal definition of alimony states that it must be received under a “divorce or separation ” I.R.C. § 71(b)(1)(A). A “divorce or separation instrument” includes “a decree of divorce or separate maintenance or a written instrument incident to such a decree.” Id. § 71(b)(2)(A). A pretrial order is not a divorce decree, but it is a written instrument incident to such a decree. Thus, the premarital order was a divorce or separation instrument.

The pretrial order directed the husband to maintain the status quo. The husband testified that the payments were intended to cover things he had previously paid for. He was therefore maintaining the status quo, as required by the order, so that the payments were received under a court order. There is no requirement that the divorce or separation instrument list the specific exact amount of support required.

The pretrial order did not specify whether the payments stopped upon death. But the payments occurred periodically, so they were periodic alimony, and Alabama case law stated clearly that periodic alimony ceases upon the death of the payee. Because the payments stopped upon death, they were alimony for purposes of federal tax law.

Lesson: Temporary support, alimony pendente lite, or postseparation support can all constitute alimony under federal tax law, so long as it is clear from the language of the agreement or the order, or from state law if the order is silent, that the obligation terminates upon death of the payee.

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Wolens v. United States, 125 Fed. Cl. 422 (2016)

Facts: The parties married in New York, but divorced in England. Their English divorce decree provided for a large initial payment to be made by the husband to the wife, followed by annual payments of £441,667 in 2007, 2008, and 2009. (The 2009 payment was one pound less.)The husband’s initial tax return did not claim the 2007 payment as alimony. He later filed an amended return which did claim the 2007 payment as alimony. The IRS disallowed this return and refused to issue a refund.

The husband then filed suit in the Court of Federal Claims to obtain the refund. The IRS then moved to dismiss the action, arguing that the husband could not establish that the 2007 payment terminated upon death of the payee. The husband filed a motion for summary judgment, arguing that the payments clearly did terminate.

Issue: Was the 2007 payment alimony?

Answer to Issue: The answer depends upon material issues of fact; the motion to dismiss and motion for summary judgment are therefore denied.

Summary of Rationale: If the 2007 payment did not terminate upon death of the payee, it clearly could not be alimony for federal tax purposes. The agreement itself was silent on this point. The key question was therefore whether the payment automatically terminated at death under the controlling domestic relations law. “[A]lthough the government has shown that the term ‘lump sum’ is typically associated in the United Kingdom with a division of marital assets, it has not established that this is the only reasonable interpretation” of the agreement. 125 Fed. Cl. at 430. In particular, the annual payments might be construed together as a periodic obligation, instead of being construed separately as individual lump-sum obligations. The IRS’s motion to dismiss was therefore denied.

The husband’s motion for summary judgment was also denied, for essentially the same reason; the decree was ambiguous, and its construction was therefore an issue for trial. Continue reading →