Divorce Lawyers - Frequently Not The Best Tax Advisors

Originally published on forbes.com.

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.

 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.

You can follow me on twitter @peterreillycpa.

Wandering Tax Pro On The Tax Aspects Of Divorce

Originally published on forbes.com.

We had about the softest winter I have ever experienced in New England this year, but it is till nice to look around and see the signs of Spring. If you follow tax blogs, one of those signs is the return of The Wandering Tax Pro.  He spends tax season, less the final day, working 168 hours a week, preparing returns by hand, scorning the expensive and unreliable software most of the rest of us use.  I was really pleased at how welcoming he was when I joined the ranks of tax bloggers, despite my being a CPA.  Bob picked up on my recent post about divorce and indicated that he was interested in expanding on the topic, so I invited him back to do another guest post.

         Ain't It The Truth

          by Robert D Flach

Peter J Reilly tells it like it is, and, as my British friends would say, calls a spade a shovel in his post “Divorce Lawyers – Frequently Not the Best Tax Advisors”.

As I have said in the past, while you would certainly want Arnie Becker as your divorce attorney, you should have the divorce agreement reviewed and approved by Stuart Markowitz  before signing it. [The Pro's pop culture reference had me stumped, until I did some research.  Here's a clue.]

Let me begin by addressing the three items discussed by Peter in his post.

Get That Form 8332

If the divorce agreement states that the non-custodial parent is entitled to the dependency exemption for one or more of the dependent children, either annually or every other year, I would not rely on the agreement itself as a substitute for the Form 8332 if the custodial parent refuses to sign it, regardless of how well written it may be.

There should be some kind of “incentive” or “punishment” built into the agreement. While I am not a lawyer, nor am I conversant in divorce law, I would think that it could be written into the agreement that the non-custodial spouse has the right to withhold alimony and/or child support payments until the Form 8332 is signed. Or if the custodial parent refuses to sign the Form 8332 the “injured” parent has the right to deduct the lost tax benefit from future alimony or child support payments.

If You Say It Is Not Alimony It Is Not Alimony – If You Say It Is Alimony Maybe It Is

I had a problem with claiming an alimony deduction for a client based on erroneous wording in a divorce agreement. It dragged on for a long time, and was finally resolved in my client’s favor only after bringing in the Taxpayer Advocate Office.

The problem arose from the wording in the “Dual Judgment of Divorce with Property Settlement Agreement”. It first stated that –

“The parties expressly waive past, present and future alimony against one another.”

But this was followed by –

“The Husband shall pay to the Wife the sum of $650.00 per month which should be applied to pay the monthly rent for {the ex-wife’s apartment}. The balance should be used to defray the cost of insurance or other expenses related to this property.”

My argument was that this $650.00 per month payment qualified under all these conditions –

• The payments were made periodically by the taxpayer in the form of a check.

• The payments were required by the divorce decree.

• The taxpayer and his ex-spouse did not live in the same residence at any time during the year.

• The payments were not for the support of a dependent child.

• The taxpayer and his ex-spouse did not file a joint return for the year.

I further pointed out that the payments were not –

• Child support.

• Noncash property settlements.

• The spouse’s part of community property income.

• Payments made to the ex-spouse for the use of the ex-spouse’s property.

• Payments for the upkeep of property owned by the taxpayer.

The problem probably would not have arisen if the agreement had been worded –

“The parties expressly waive past, present and future support payments against one another.”

And the agreement did not specifically state that payments would cease upon the death of the ex-wife, although it did say –

“The Husband’s obligation to pay this support shall terminate upon either the expiration of ten (10) years from the date of the Judgment of Divorce or upon Wife’s remarriage of upon the Wife being the fee simple owner of this property or other property as a primary residence.”

Another “or” – “or upon the death of Wife” – should have been included.

It Is Not Easy To Get Innocent Spouse Treatment

I do not agree with Peter when he says – “I really think in a divorce situation the default assumption should be separate returns”

I look at each and every return of a currently married couple, whether or not in the middle of a divorce, and determine whether to file joint or separate based on the specific facts and circumstances of the situation. My goal is to file in such a way that the couple pays the least amount of net combined federal, state and local taxes.

I do agree that there are times when a divorcing couple should consider filing separately regardless of the tax consequences – e.g. there is a large balance due that is the result of the income, deductions and withholding of one spouse, one spouse is self-employed, one spouse simply does not trust the other.

Other Issues

In his post Peter only skims the surface on tax-related divorce issues. Tax consequences, both current and future, must be considered and factored into many aspects of the divorce agreement and property settlement.

Let us say a couple has $200,000 in assets to split - $100,000 in CDs (basically cash) and $100,000 in stocks and mutual fund shares. The wife wants to take the cash and give the husband the investments.

It seems equal at first glance – but is it? You must look at the “after-tax” value of the individual assets.

The “after-tax” value of $100,000 in cash is $100,000. But if the husband were to sell the investments for $100,000 on the day of receipt he would very likely have to pay federal and state tax on the gain from the sale.

As there is no basis adjustment for the distribution of assets in a divorce, the original cost of the stocks and mutual fund shares at purchase follow these investments to the husband. If the original cost was $70,000 there would be a $30,000 capital gain. If we assume that the gain would be long term, and the husband is in at least the 25% federal tax bracket the $100,000 would end up as only $95,500 after deducting the federal tax liability. And even less when any state and local income tax is factored in. This is not an equal distribution of the assets.

If there were a $30,000 net capital loss instead then the husband would eventually save anywhere from $4,500 to $7,500 in federal taxes as a result of the sale – so he would be in pocket” perhaps $105,000. Again not an equal distribution of assets.

One must also consider tax consequences when it comes to paying the expenses of, and claiming the dependency exemption for, any children. The availability of education tax benefits, currently phased out based on level of income, and other factors should be reviewed when drawing up the divorce agreement.

A divorce agreement states that the non-custodial parent must pay 100% of the college expenses of his child. That parent’s income is such that he/she would not be able to take advantage of any of the various tax benefits for tuition and fees. Even if the income was not a factor, the non-custodial parent could not claim the benefits if he/she is not claiming the child as a dependent. However, the custodial spouse, who claims the child as a dependent, can claim the full $2,500 American Opportunity Credit.

If the tuition and fees for the child total $50,000, and the non-custodial parent pays the full $50,000 directly to the college, the custodial parent ends up $2,500 “in pocket”.

In such a case the divorce agreement could state that the non-custodial parent must pay 100% of the college costs of the child less any related tax benefits received by the custodial parent. Or that subsequent alimony and/or child support payments are reduced by any related tax benefits received by the custodial parent.

The bottom line – have your divorce agreement run by your tax professional before signing it.

TTFN

The basis issue is one that I am really sensitive about.  An old tax shelter joke was that the only two sure ways to bail out of a burned out tax shelter are to die or give it to your spouse and get a divorce.  The most dramatic example is probably a house versus a retirement account.  I have not noticed the basis issue generating as much Tax Court litigation as dependency and alimony, though.

Why the Pro ends tax season a day early is a rather touching story.  Bob's office is in Jersey City.  He had a client who always came in on the last day. The tradition was so strong that when he came in a couple of days early one year, Bob sent him out and told him to come in on the last day.  Bob's client Officer Maurice Barry of the Port Authority Police was last seen in the North Tower of the World Trade Center on September 11, 2001 - going up the stairs.  Since then the Pro ends tax season a day early in his honor.

You can follow me on twitter @peterreillycpa.

Grandma's Wedding - Grandpa Celebrates

This was published on Passive Activities and Other Oxymorons on December 27, 2010.  Given the recent TIGTA report about the IRS's inability to match alimony deductions to payments with the difference running into the billions, you have to wonder why they prioritized going after this poor schnook.  I was very pleased that the taxpayer won.
___________________________________________________________________________
Michael Walter Bragg v. Commissioner, TC Summary Opinion 2010-172

In some recent posts, I've taken to rooting for one side or the other.  As I was reading the facts in this one, I was definitely with the taxpayer.  He was in tax court representing himself over a $937 deficiency.  At issue was an alimony deduction of $6,340 (which locates Mr. Bragg right in the 15% bracket I guess).

Here is the story.  Michael Bragg was divorced from Rosalie Bragg in 2002.  Although the decree called for him to pay $9,600 per year she had informally agreed to accept a lesser amount.  After the informal agreement they probably didn't communicate all that much.  At some point in 2006, she remarried.  She did not mention that to her ex-husband.  Finally, in December 2007, her grandson ratted her out (The court didn't put it that way, but I think it adds to the drama).  Mr. Bragg ceased making payments.
Under the law in the state of Washington, the obligation to make spousal support payments automatically ceases when the spouse being supported remarries (I think that that may be true in all states).

The IRS disallowed Mr. Bragg's alimony deduction for the year 2007, because he was not under any legal obligation to make the payments.  There isn't any mention of whether they issued the former Mrs. Bragg a refund (Of course maybe she wouldn't be entitled to one.  Much as we accountants like everything to balance, the tax law does admit of asymmetrical results.) So how would you rule ?  I want you to share the suspense for a moment.  This one had me on the edge of my seat.

The IRS argument was :

Despite the fact that petitioner falls within the provisions of the applicable Federal statute, respondent argues that because Ms. Bragg remarried in 2006, petitioner's legal obligation to pay spousal maintenance terminated as a matter of Washington State law; thus, respondent contends that the payments were not received under a divorce instrument as required by section 71(b)(1)(A).

The Tax Court found for Mr. Bragg :


Respondent's (IRS) legal argument has as its foundation old law and does not reflect amendments to the statute. Although there certainly have been cases holding that voluntary payments made outside a written instrument incident to divorce are not alimony, those cases have generally dealt with situations where there was no proper divorce decree or separation agreement, where a payment was made before the operative document went into effect, or where the older version of section 71 applied to the particular case.

The more recent regulation requires only that alimony payments meet the following requirements: (a) That payments be made in cash; (b) that payments not be designated as excludable from the gross income of the payee and nondeductible by the payor; (c) that payments be made between spouses who are not members of the same household;

The court's finale is beautiful:

More than 25 years after the enactment of the amended statute, there is no reason to assume that Congress meant anything other than what it said in enacting the present version  Equip. Corp. v. Commissioner, 98 T.C. 141, 149 (1992). of section 71. It is not the Court's place to support respondent's attempt to include language Congress itself did not.

We have no way of knowing whether the former Mrs. Bragg is still speaking to her grandson. For the life of me, I can't figure out why the IRS bothered with this case.

Another Round of Miscellany

This was originally published on PAOO on November 29th, 2010.

Original source documents appear in RIA and beg to be shared with my vast readership, Repeatedly they are pulled up and labored on. Time passes and more interesting matters easily transform themselves into full length posts as the promising material slowly begins to wither. Finally it comes to the time to fish or get off the pot. (Pardon my love of deliberately mangling common expressions.) Here are some brief summaries of the posts that go to oblivion unless one of my readers demand that they get the full treatment :

FOUNDATION FOR HUMAN UNDERSTANDING v. U.S., Cite as 106 AFTR 2d 2010-5862, 08/16/2010



This was shaping into a maudlin reminiscence of my father who used to go though this sequence with his hands that started with "This is the church" and ended with "Look inside and see all the people" as he turned his hands over and wiggled his fingers. The point being that the Foundation For Human Understanding failed to qualify as a church, because it didn't have a regular group getting together to worship as a body. It gets into the 14 factors that make a church a church for income tax purposes. It's a little troubling that Jesus and the Apostles would probably have had a hard time passing the test.

UNITED ENERGY CORPORATION v. COMM., Cite as 106 AFTR 2d 2010-6056, 08/27/2010

I was going to title this "The Trouble with S Corps". Probably the biggest deficiency to the S corp form compared to that of partnerships (which includes most LLC's) is that the liabilities of the S corp are not allocated to the shareholders even if they have guaranteed them.

S corps.—income and losses—basis— loans—guarantees—economic outlay—S corp. indebtedness to shareholders. Tax Court decision that shareholders in S corp. and other entities weren't entitled for passthrough loss deduction purposes to increase their bases in S corp. by amount of any of its debt, other than by amount of shareholder ledger debts, was affirmed, based on Court's reasoning that other debt, comprising bank loans or loans with related entities, wasn't “indebtedness of S corp. to shareholders” within meaning of Code Sec. 1366(d)(1)(B) because shareholders made no actual economic outlay in respect to same.


Consolidated returns—interco. transactions and obligations—deemed satisfaction—transfers to controlled corps.—basis—gain—discharge of indebtedness—S corp. indebtedness. Tax Court supplemental decision that new corp. realized taxable gain as result of deemed satisfaction of affiliated S corp.'s shareholder ledger debts, when those debts were contributed to corp. in Code Sec. 351 transaction, was affirmed, based on Court's reasoning regarding operative reg regime/former Reg. §1.1502-13(g)(4) and finding that corp. acquired ledger debts with built-in gain.

MAES v. U.S., Cite as 106 AFTR 2d 2010-6752, 10/13/2010


In this case taxpayer tried to argue that amounts she had reported as alimony were actually disguised child support or alternatively a property settlement. The first argument was based on the fact that amount ran until the year that children turned 20. The agreement did not explicitly reference the children and other evidence argued for alimony. The second argument was based on the fact that agreement did not explicitly state that payments terminated in the event of her death. The requirement was, however, fulfilled because of state law provision which terminates support obligations on death. This case reinforces the point that it is important to have good tax advice in the structuring of alimony.


These two are tax nerd tests. If they seem at all interesting, you are a tax nerd. I sometimes get the impression that in the Chief Counsel's office they spend half their time being confused about TEFRA.


CCA 201034021
A partnership cannot have an affected item in itself. Each partnership year is a separate cause of action whose partnership items are not computationally affected by adjustments to other partnership years. Thus, an amortization for one year will not keep the statute open for other partnership years as “affected items“.
CCA 201033037
That's up to Exam. But its probably unnecessary since we would have to conduct a TEFRA partnership proceeding for any year in which they took excessive deductions to determine the amount, character and allocation of partnership debt, and whether it was guaranteed by each respective partner in that year. These determinations would then be binding for purposes of generating any affected item notices of deficiency limiting loss to basis or at risk for that particular year.

Well that leaves me with enough material to finish out the year. I should be confident that more good stuff will be coming, but you never know.

And Another Purge

This was originally published on PAOO on November 17th, 2010.

I was starting to worry about running out of material, but my last ramble through the hottest stuff on RIA indicated that I am well supplied for a while, so I will continue purging those items that I just couldn't seem to turn into a full length post. I thought they were worth sharing when I first saw them though and have looked at them each a dozen or so times since then, so I hate to let them go without a little salute.


Henry A. Williams v. Commissioner, TC Summary Opinion 2010-125

had a fairly messy set of facts. The bottom line is that when it comes to deducting alimony, oral agreements are not worth the paper they are printed on.

Anthony Cicciarella, et ux. v. Commissioner, TC Memo 2010-195 was about medical expenses, but the issue was really just substantiation. The taxpayers had a not unusual amount of lameness, telling the court that they had "researched" the wrong year, but best of all that some of their records were destroyed in a flood. Unfortunately the flood occurred before the records would have been produced. I was going to title the post "Antediluvian".

THE HENRY E. & NANCY HORTON BARTELS TRUST v. U.S., Cite as 106 AFTR 2d 2010-6004

was a good example of an "is what it is" decision. The exempt trust was taxable on UBIT from securities transactions that it had entered into on margin. Trust's attempt to sidestep statute's clear language with claim that UBIT was really meant only to apply in case of unfair competition was off base since statute was clear and didn't limit UBIT in manner suggested.


More Fun For Landlords

was a title of a post I was working on about the extension of 1099 requirements to landlords. The cautionary note that I wanted to make is the language in several IRS audit manuals :

The examiner must be aware of the potential of the information return test work because it can often lead to significant tax dollars which the primary return (corporate, partnership, or individual) may not produce. Large adjustments can be produced through back-up withholding, return penalties, and even on the returns of the payees who were required to report the compensation but did not receive information returns.


If you were supposed to send somebody a 1099, you were supposed to ask them for their social security number of EIN. Since you didn't ask they didn't give it to you. Therefore you should have subjected their payments to back up withholding. It's a nightmare. You can get out of the back-up withholding by getting them to sign a form swearing they reported the income. Good luck.
Rev. Proc. 2010-36, 2010-42 IRB, 09/30/2010

gives taxpayers a special procedure for claiming a casualty loss from corrosive drywall :

An individual who pays to repair damage to that individual's personal residence or household appliances that results from corrosive drywall may treat the amount paid as a casualty loss in the year of payment.

Taxpayers who have a pending claim for reimbursement may deduct 75% of the amount they spend for repairs in the year they spend it. The loss is claimed on Form 4864 and taxpayers should mark "Revenue Procedure 2010-36" on the top of the form.

Joel P. Arnold v. Commissioner, TC Memo 2010-223

I found the IRS and the Tax Court a little mean spirited in this one. The taxpayer worked as a field auditor for the State of Georgia. He was allowed to check out a state vehicle for his work, but if he travelled more than a certain distance he was required to stay over. This would prevent him from going home to his chronically ill son. So he used his own car and claimed mileage which was disallowed. On the other hand they did allow his job hunting expenses, which were based on the same motivation.


ARGYLE v. COMM., Cite as 106 AFTR 2d 2010-6759 10/14/2010



The taxpayer is a CPA, appealing a Tax Court decision, pro se (That means fool for a client). He tried to file as single even though his divorce had not gone through. He was also trying to deduct legal expenses for criminal proceedings for simple assault, the assault being a kiss. Seemed like an interesting story, but ultimately I couldn't make anything much out of it.

Willard R. Randall v. Commissioner, TC Summary Opinion 2010-163

Mr. Randall was entitled to $69,000 in property equalization from his ex-spouse. He offset the amount against alimony that he was required to pay. The IRS wanted to deny the deduction, but the taxpayer won. I was going to title the post "Still Better to Swap Checks", but as I read it more closely I saw that it was possible that check swapping might not have been a viable alternative (e,g, if the property being equalized was illiquid). It does illustrate the principle that your life will be simpler in the long run if you don't skip transaction steps.

Breaking Up is Hard to Do

This was originally published on PAOO June 27, 2010.

There are quite a few developments in the last few months I am hoping to spout about, but I am going to skip straight to PLR 201024005. The situation is not a common one , but it is a good starting point for a discussion of the tax aspects of divorce. The taxpayer held securities that were qualified replacement property from the sale of stock to an ESOP. The requested ruling , which is favorable, holds that the transfer of the securities to the taxpayer’s spouse will not be a gain recognition event.



All well and good. The question that intrigues me is whether taxpayer’s spouse knows the implications of the settlement. In my fantasy spouse will turn the securities over to a money manager who will sell them all and end up being shocked with the resulting tax bill. There used to be a joke that there are three ways to get out of a burned out tax shelter. The first was to put the interest into a defective grantor trust and then cure the defect . It was a really neat idea. It doesn’t actually work, but it was clever. Then there was dying. Pretty drastic, but it worked (until this year anyway). Finally there is giving it to your spouse and getting a divorce. Still works.




The important thing to remember is that property received in a divorce has the same basis that it had to the couple. So if one spouse gets a pile of money and the other spouse gets a pile of low basis assets of equal gross value, there really hasn’t been an even split. If the couple has significant assets, this could be a much more important issue than who gets the dependency deduction. The dependency deduction seems to garner much more attention than it is worth. Ironically, despite all the attention it is not unusual to neglect to follow through on the requirement that non-custodial parents obtain a release form.






Filing joint returns, in my experience, seems to usually be taken as a given. In situations where you have reason to believe that your spouse has unreported income or even when they have a high exposure return, the smart thing could be to forgo some savings in the interest of peace of mind.






Finally, if alimony is involved you need to be aware that there are fairly complex rules to prevent alimony treatment for payments that are more in the nature of property settlement or child support.