Articles Posted in Tax

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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 →

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By: Dana M. Horlick, Attorney, Woodruff Family Law Group

 

Hollimon v. Comm’r, T.C. Memo. 2015-157, 2015 WL 4747779 (2015)

(a) Facts: During their marriage, the parties established and worked for a business providing temporary staffing to hospitals. The wife testified that the husband ran the business and she was an employee. The husband testified that the parties ran the business together.

“Unfortunately, Ms. Hollimon and Mr. Al Bakari’s relationship has been rife with abuse. The abuse has not been one sided; it has been perpetrated by both parties, and each of them has requested restraining orders against the other at various times.” 2015 WL 4747779, at *1.

The business was run out of the parties’ home. On their joint tax return for 2009, the parties claimed a credit for business use of their home. The wife testified that the husband prepared the return, and that she was scared to question it because of the risk of abuse. The husband testified that both parties prepared the return.

The IRS disallowed a portion of the credit for the business use of the parties’ home and assessed a deficiency. The wife filed Form 8857, seeking discretionary innocent spouse relief. The IRS denied relief and the wife appealed to the Tax Court. The Ihttps://www.woodrufflawfirm.com/domestic-violence.htmlRS conceded that the wife was entitled to relief, but the husband intervened and opposed relief.

(b) Issue: Was the wife entitled to discretionary innocent spouse relief?

(c) Answer to Issue: Yes.

(d) Summary of Rationale: The wife met all threshold conditions except the last one, whether the tax at issue was attributable to income of the nonrequesting spouse. It was disputed whether the business income was attributable to the wife. But the court held that the dispute did not matter, because abuse is a recognized exception to the last condition, and abuse was present on the facts:

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By: Dana M. Horlick, Attorney, Woodruff Family Law Group

 

Sapp v. Comm’r, T.C. Memo. 2015-143, 2015 WL 4639260 (2015)

(a) Facts: The IRS assessed deficiencies on a husband and wife’s joint income tax returns for 2004, 2006, and 2008. The parties appealed to the Tax Court, and the wife sought both mandatory and discretionary innocent spouse relief. The IRS conceded that relief was appropriate, but the husband argued otherwise.

The tax at issue arose from the husband’s plumbing business, for which the wife served as bookkeeper. There was a history of domestic abuse in the marriage going back to 2002. The parties had been separated multiple times, and the wife spent time living in a domestic violence shelter.

At the time of the Tax Court hearing the parties were separated but not yet divorced. The wife had little income and was receiving food stamps.

(b) Issue: Was the wife entitled to innocent spouse relief?

(c) Answer to Issue: Yes.

(d) Summary of Rationale: Because the wife served as bookkeeper for the business, she knew of the tax matters at issue, and she was not eligible for mandatory innocent spouse relief.

For discretionary innocent spouse relief, there is an exception to the knowledge requirement in cases of abuse. The court summarily held that abuse was present, so the threshold conditions were met.

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By: Dana M. Horlick, Attorney, Woodruff Family Law Group

 

Agudelo v. Comm’r, T.C. Memo. 2015-124, 2015 WL 4086310 (2015)

(a) Facts: A husband and wife filed a joint tax return for tax year 2010. The return did not report as income certain unemployment benefits received by the husband. The IRS discovered this fact and assessed a deficiency.

The husband filed a request for innocent spouse relief. In support of that request, he testified that the wife had taken the benefit checks without his knowledge. The wife intervened and testified that she never opened the husband’s mail for him. By the time of trial, the parties were separated, though not yet divorced.

(b) Issue: Was the husband entitled to innocent spouse relief?

(c) Answer to Issue: No.

(d) Summary of Rationale: One of the threshold conditions for innocent spouse relief is proof that the tax at issue is based upon the nonrequesting spouse’s income. The tax at issue here was based upon the husband’s own income.

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By: Dana M. Horlick, Attorney, Woodruff Family Law Group

 

Palomoares v. Comm’r, T.C. Memo. 2014-243, 2014 WL 6778542 (2014)

(a) Facts: A husband and wife lived in Washington State. The wife was not fluent in English and mostly spoke Spanish.

The parties separated in 2005, and the wife filed sole tax returns for 2006 and 2007, claiming refunds. The IRS rejected the wife’s claims, as it seized the amount of her refunds to satisfy unpaid tax liability from the parties’ joint 1996 tax return.

When the wife did not receive the refunds, a legal clinic helped her to file Form 8379, Injured Spousal Allocation, which is aimed at allocation of liability on a joint tax return by an injured spouse.  The IRS rejected the form, informing the wife by letter that she needed to file Form 8857 to seek innocent spouse relief. The wife did not do this, but she barely spoke English and could not understand the letter.

Throughout this period, the wife was abused physically by the husband, her father in Mexico was seriously ill, and her wages were garnished because of the husband’s business activities. These problems caused the wife to suffer from depression, which was treated with medication.

The parties were divorced in 2010. The wife’s divorce attorney learned that the wife’s 2006 and 2007 refunds had been applied to the 1996 liability. With her attorney’s help, she finally filed Form 8857, seeking innocent spouse relief.

The IRS initially indicated an intent to deny the wife’s claim under its former policy regarding the two-year statute of limitations. After the IRS’s policy changed, it did not do this. Instead, it granted innocent spouse relief, but only with regard to payments made within two years of the filing of Form 8857. The wife appealed to the Tax Court, arguing that she should obtain relief retroactive to her filing of Form 8379.

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By: Dana M. Horlick, Attorney, Woodruff Family Law Group

 

Johnson v. Comm’r, T.C. Memo. 2014-240, 2014 WL 6676824 (2014)

(a) Facts: During her marriage, the wife owned and operated a dental practice. The parties filed a joint tax return in 2007, which correctly reported the tax due, but the parties had financial problems and were not able to pay the tax.

In 2010, the parties were divorced in California. Their settlement agreement provided that they would share tax debts equally.

The wife suffered from bipolar disorder, which she was able to manage successfully with medication.

The wife filed a request for innocent spouse relief from the 2007 tax liability. The IRS denied that request, and the wife appealed to the Tax Court. The husband intervened to oppose relief.

(b) Issue: Was the wife entitled to innocent spouse relief?

(c) Answer to Issue: No.

(d) Summary of Rationale: The last of the seven threshold conditions for granting innocent spouse relief provides that the tax at issue must be based upon the income of the nonrequesting spouse. That condition was not met; the tax was attributable to the income from the wife’s dental practice.

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