You can get bad tax advice or no tax advice in just about any area of life, but from my reading of tax cases and some personal observations, I think that if you want to get really bad tax advice, you should get divorced. Three issues that seem to get blown consistently are the requirements for dependency exemptions for non-custodial parents, the definition of alimony and the often unwise signing of joint returns for years of the marriage after it is known that the marriage will dissolve. You don't have to go back much more than a month to find an instance of each of these in Tax Court decisions.
Get That Form 8332 - Gary L. Scalone, et ux. v. Commissioner, TC Summary Opinion 2012-40
My advice to non-custodial parents in a divorce negotiation is that if you can get some other concession, give up the dependency exemption. Going a little further if you and your soon to be ex are both in reasonably good financial shape and will more than likely end up leaving money to the same kids, do not even bother with it. Nobody will listen to that, though. I think a lot of people feel that getting a dependency exemption somehow means the IRS is validating them as a true parent. In order for a non-custodial parent to take a dependency exemption, he or she must get the custodial parent to release the exemption. The custodial parent does this with Form 8332. The non-custodial parent attaches Form 8332 or a document that "conforms to the substance of Form 8332" to his or her return. If the custodial parent promises to sign Form 8332 but does not follow through, the non custodial parent is often out of luck.
Gary Scalone proved to be an exception to the out of luck rule, but just barely.
The form that's most "acceptable to the Internal Revenue Service" is Form 8332, Release of Claim to Exemption for Child of Divorced or Separated Parents. A taxpayer who uses this form is unlikely to be hassled by the IRS, and Gary did try to get his ex to fill it out. She refused, even though Gary was current on his support payments. The Scalones, understandably feeling entitled to do so, claimed N.S. as a dependent on their 2006 income tax return. Instead of a Form 8332, however, they attached a signed copy of the separation agreement to their tax return. The Commissioner disallowed the dependency exemption and the child tax credit for N.S. and sent the Scalones a notice of deficiency.
Whether something conforms to the substance of Form 8332 is not always an easy question. When the Scalones filed their taxes, a Form 8332 required the name of the noncustodial parent; the noncustodial parent's Social Security number; the name of the child (or children); the tax year (or years) the exemption was being released for; the custodial parent's Social Security number; the signature of the custodial parent; and the date of the custodial parent's signature. What makes this part of tax law complicated is that some of the information that's listed on the Form 8332 is absolutely required, and some is just helpful to the IRS in processing the return.
The Court ended up ruling that missing social security numbers on the signed separation agreement did not prevent it from being an equivalent for Form 8332. Still, an audit and a trip to Tax Court is a lot to go through for something that should be a piece of cake. I would recommend that it is pointless to bargain for the dependency exemption, if a signed Form 8332 is not part of the "closing package" for the divorce.
If You Say It Is Not Alimony It Is Not Alimony - If You Say It Is Alimony Maybe It Is - Daniel W. Rood, et ux. v. Commissioner, TC Memo 2012-122
Payments that qualify as alimony for income tax purposes are deductible against the adjusted gross income of the payer and includible in the adjusted gross income of the payee. If the agreement indicates that the payments are not to be treated as alimony for tax purposes then they are not. At least that is simple. Payments that are designated as alimony have other hurdles to leap through. Their purpose is to distinguish real alimony from disguised child support or property settlements. Actually who cares what the purpose is ? It is what it is. Deal with it.
One of the requirements is that payments cease in the event of the death of the payee. As I put it in my post on Dave LaPoint, who pitched for the New York Yankees and several lesser major league baseball teams, - alimony is not for the dead. It is really not hard. Just make sure that language to that effect is in the agreement. If it is not, are the payments definitely not alimony ? No. The Tax Court will do an analysis:
In prior cases considering the same question, the courts have applied the following sequential approach: (1) the court first looks for an unambiguous termination provision in the divorce decree; (2) if there is no unambiguous termination provision, then the court looks to whether the payments would terminate at the payee's death by operation of State law; and (3) if State law is unclear, the court will look solely to the divorce decree to determine whether the payments would terminate at the payee's death.
In prior cases considering the same question, the courts have applied the following sequential approach: (1) the court first looks for an unambiguous termination provision in the divorce decree; (2) if there is no unambiguous termination provision, then the court looks to whether the payments would terminate at the payee's death by operation of State law; and (3) if State law is unclear, the court will look solely to the divorce decree to determine whether the payments would terminate at the payee's death.
Mr. Rood was required to pay his ex-wife $5,000 per month for sixty months. The agreement did not say what happened if she died. The Tax Court did not think Florida law was all that clear. End of story. It is not deductible alimony. This happens often enough to have me wondering whether attorneys are doing this deliberately to whipsaw the IRS. The payer has a reasonable argument that it is alimony. The payee has a reasonable argument that it is not. Let's run for luck. I think it more likely that it comes from drafting agreements without looking at the Internal Revenue Code definition. Maybe putting in the death contingency makes people nervous. Regardless, it should be in the agreement if you want to be sure of alimony treatment.
It Is Not Easy To Get Innocent Spouse Treatment - Benjamin C. Sotuyo, et ux. v. Commissioner, TC Summary Opinion 2012-27
Filing a joint return will usually produce a lower tax than filing two married filing separate returns. If married people were allowed to file as single or head of household, separate returns would often produce a lower total tax, but that is not an option. Since married filing separately is so unusual, many tax practitioners act as if filing a joint return is, in practice, required. In fact, filing jointly is an election - an irrevocable election. Filing jointly has a downside. It is called joint and several liability. If there is a deficiency or a balance due, the IRS can collect the whole amount from either party regardless of how the tax liability was generated and what the agreements are between the parties. The deal that you make that is blessed by a probate court judge does not bind the decision of a Tax Court judge.
There is relief from joint and several liability. The relief is referred to as innocent spouse status. The IRS does not hand it out very easily and when you go to Tax Court over it, there is a really fun factor that comes up sometimes. Usually a Tax Court case has two parties - the petitioner and the respondent. The taxpayer is petitioning and the IRS is responding. In an innocent spouse case there is a sometimes an intervenor - the taxpayer's ex. When that happens you get to have a do-over of your divorce litigation, complete with abuse allegations, in Tax Court. In the Sotuyo case, the husband had prepared the return but his wife had several jobs and did not give him all her W-2's. The Tax Court had to determine that he not only did not know about her other job, but that there was not some reason why he should have known. The latter denied him relief under one section, although it was allowed under another. (Thanks to Bob Baty for correcting my initial misreading.) Then there were abuse allegations going both ways. He ended up getting out from the deficiency, but I doubt whatever they saved by filing jointly was worth it.
I really think in a divorce situation the default assumption should be separate returns. The savings from a joint return should be weighed against adequate safeguards in the event of a deficiency. Just having it say in the agreement who is responsible might not be enough. A corollary to this is a tip I have for trustees, family offices and closely held companies that prepare individual estimates for beneficiaries. Those estimates should always be made out as separate estimated payments, so that in the event of a split, there is no question that they belong to your beneficiary.
Is That All There Is ?
Exemptions for non-custodial parents, alimony and innocent spouse cases seem to be the things that end up in Tax Court the most, but there are other income tax aspects of divorce that can trip people up. People can sometimes be surprised by the income tax effects of property divisions, but that will have to be the subject of a future post.
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