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.

Non-Custodial Parents - You Need the Freaking Form 8332

Originally published on Passive Activities and Other Oxymorons on February 4th, 2011.
____________________________________________________________________________
Michael F. Wesner v. Commissioner, TC Summary Opinion 2011-5

Here is some advice for the about to be divorced.  I will preface it with a cautionary note.  It is a minority opinion and the simplest thing is probably to just go with the flow of however your attorney is handing things.  There are two issues that I think they often get wrong, though.  The first is filing a joint return in the final year of the marriage.  It is usually assumed that this is a simple numbers exercise of comparing the total tax of two married filing separate (or head of household) returns and a single joint return.  I have more posts on this subject than just this one, but it will give you the gist of why this is not a good approach.  It ignores the joint and several liability created by a joint return.  That is not the topic of this post though.

The other is the dependency deduction.  The most common solution to this overrated problem is for the couple to divide up the dependency deductions and in the case of a single child take it in alternate years.  Here is my advice on that.  If you are the non-custodial parent and you can get any concession at all in exchange for giving up the dependency deduction entirely, give it up. The case of Michael Wesner is a good illustration of this point, although as you can see here, by no means, the only one.

This was the Court order relative to the child support and dependency deduction :If *** [petitioner] has paid in full all current support and court ordered arrearage payments due for the calendar year by December 31, *** , the Federal tax exemption for the minor child(ren) shall be allocated as follows: *** [petitioner] to claim 2006 & 2007. *** [Ms. Tokar] to claim 2008. Three year pattern to continue. [Ms. Tokar] shall execute the necessary Internal Revenue Service forms to transfer the exemption(s) consistent with the order. Note: The exemptions are not allocated unless the current support obligation is greater than $1,200 per year. Petitioner was also obligated to pay 60 percent of the minor child's unreimbursed medical and dental expenses. In addition to future child support, petitioner was also ordered to pay past care and support of $9,160 for April 1, 2003, through June 30, 2006, at the rate of $76 per month.


Mr. Wesner followed through on his obligations and accordingly thought he was entitled to the dependency deduction.  Things were difficult though.

Petitioner approached Ms. Tokar, the custodial parent, immediately after the entry of the court order and arranged an appointment with her to execute the Internal Revenue Service forms (tax forms) as ordered by the divorce court. Ms. Tokar did not appear at the appointed time and failed to execute the tax forms. After petitioner's attempt to obtain Ms. Tokar's signature failed, he sought enforcement of the court order by service of legal process but he did not know her mailing address. He requested Ms. Tokar's address from the agency to which he made the support payments, and it refused to provide her address. Accordingly, at the time his 2007 income tax return was due, petitioner did not have the required consent form executed by Ms. Tokar; and his income tax return was filed without the form or any other documentation supporting his claim for the dependency exemption deduction.

After more than 6 months of trying to obtain Ms. Tokar's address, petitioner hired a process server during August 2009 to find and serve her. By the time the matter came before the divorce court it was too late for Ms. Tokar to sign the tax forms.


It seems like the IRS or the Tax Court should have cut Mr. Wesner a break.  No such luck.

“The custodial parent signs a written declaration *** that such custodial parent will not claim such child as a dependent *** and *** the noncustodial parent attaches such written declaration to the noncustodial parent's return for the taxable year.”

No such document was executed and/or attached to petitioner's 2007 income tax return and, accordingly, petitioner does not meet the requirements of the statutory exception and is not entitled to claim the minor child as a dependent. This is so even though a State court with jurisdiction over the parties to a divorce proceeding ordered that petitioner was entitled to the dependency exemption deduction for 2007 and even though the custodial parent had been ordered but failed to execute the consent form required by the Federal statute. The consent form requirement is in absolute terms and is unambiguous.

In this case Mr. Wesner did get some relief from the divorce court :

The divorce court, finding that petitioner had made support payments for 2007 and had qualified under the court order for the dependency exemption deduction, credited $2,559 against petitioner's future support payments beginning September 1, 2009. The income tax deficiency respondent determined for 2007 was $2,559.

Presumably, he is still out the interest on the deficiency.

Here is the problem.  The divorce court has a lot of power over you and your ex-spouse, but it takes time, energy and money to get it to use that power to enforce its orders.  The divorce court has no power over the IRS.  The divorce court can order that the dependency deduction be released or, as in many innocent spouse cases, that your ex-spouse is liable for an income tax deficiency, but its determinations are not binding on the IRS.

Here is another way to look at the dependency deduction that might be applicable to those more prosperous than Mr. Wesner, who was working down a child support arrearage of $9,160 at the rate of $76 per month.  If you and your ex-spouse are on the older side and are both prosperous enough that the estate plan of bouncing your last check is improbable (i.e. you are both going to be leaving money to the same kids), does a couple of thousand dollars one way or the other matter at all ?  That is an attitude that probably has limited applicability, but it does have the potential of cutting your stress level.

Chief Counsel Reiterates Dependency Option for Same Sex Couples

CCA 201040012

This was originally published on October 29th, 2010.

I am always on the lookout for anything that might be relevant for my mythical clients Robin and Terry, a couple of indeterminate gender and marital status, whose role in life is to help me avoid awkward pronoun problems.  I introduced them in my post on CCA 201021050, which calls for income splitting for California domestic partners.  They also appear in my post on Gill v OPM, which declared a portion of the Defense of Marriage Act unconstitutional.  Incidentally the Justice Department filed a notice of appeal in Gill.

A CCA, by the way, is a Chief Counsel Advice.  Here is the meat of the latest CCA bearing on Robin and Terry :


The issue raised by the agent was discussed here in the National Office and with Treasury in connection with the development of Notice 2010-38. The conclusion reached at that time is that the FICA and FUTA provisions relating to “dependent” aren't really definitions in the sense of an exclusive meaning. They're instead worded to say “dependents” “include” an employee's family members. They do not preclude the possibility that other individuals could also be dependents for purposes of the FICA and FUTA exclusions.


When the issue was discussed in connection with Notice 2010-38, we viewed the PLRs (e.g., PLR 200339001 and PLR 200108010) as expanding the group of dependents described in the FICA and FUTA regs to include individuals who are dependents under section 152. Therefore, even though the PLRs can't be relied on by taxpayers other than those who got them, it is Counsel's position that a domestic partner who is a dependent of an employee under section 152 is also a dependent for purposes of the FUTA exclusion. Thus, the value of the health coverage for the domestic partner isn't FUTA wages.

In order for someone to be your dependent you must meet three tests - relationship, support and gross income.  One of the possible relationships is "member of your household" (with the quaint caveat that the household composition not violate local law).  So if Robin provides more than 1/2 of Terry's support and Terry's gross income is below the threshold (currently $3,650) Terry can be Robin's dependent.  This will qualify Robin for the more favorable head of household rates and exempt from payroll and withholding the health benefits that Robin's employer provides to Terry.  To be someones dependent for medical purposes, however, does not require that you meet the gross income tax.  So Terry could have substantial income and still be a dependent for purposes of the medical benefit exclusion.

An interesting question is what is going to happen to California domestic partners who have benefited from this technique.  Thanks to CCA 201021050 Terry will now be taxed on 1/2 of Robin's income and presumably will no longer qualify as a dependent.  I can hear somebody howling "That doesn't make any sense."  The answer to that is that making sense is not a requirement.

Need Form for Dependency Deduction

This was originally published on PAOO on September 1st, 2010.

I've told a couple of sad stories of damsels in distress who the Tax Court couldn't help.  Well here's hoping for a little schadenfreude for Caron Riganti  and Laura Brady as they contemplate the fate of Gary Knorad in TCM 2010-179.  I hate the apparent gender stereotyping from having two women going for innocent spouse treatment followed by a guy getting stiffed on a dependency deduction, but I'm stuck with the raw material that I find.  Except by special request, my material is less than a year old and sometimes hot off the press.

The dependency deduction probably absorbs more attention in divorce negotiations than it really deserves.  It it never going to amount to a very large amount of money.  It probably has to do with the emotions involved. What seems to be common nowadays is an every other year deal between the custodial and non-custodial parent.  What is commonly missed though is that in order for the non-custodial parent to take the deduction he or she must have a release signed by the custodial parent. If that detail is neglected, the non-custodial parent is not entitled to the deduction.

By the terms of his divorce decree Mr. Konrad believed he was entitled to a dependency deduction.  He submitted the decree to the tax court.  They noted it was signed by a clerk of the court and the judge, but not the former Mrs. Konrad.  She had refused to sign Form 8332 when it was provided to her.  Accordingly Mr. Konrad did not have a signed copy to attach to his return. 

The stipulation and the judgment petitioner submitted do not conform to the form and substance of Form 8332. Petitioner failed to procure Ms. Konrad's signature on either the stipulation or the judgment. When petitioner later attempted to procure Ms. Konrad's signature on Form 8332, Ms. Konrad refused. The signatures of the judge and the clerk from the divorce proceeding are not adequate substitutes for Ms. Konrad's signature. Thus, without her signature on a form that releases her claim to the dependency exemption deduction, petitioner failed to satisfy section 152(e)(2)(A) and may not claim L.W.K. for the purpose of receiving the exemption.

My response to this is that maybe you shouldn't get all that excited about crafting how the dependency deduction will be shared.  If you are going to be excited about it though remember that the non-custodial parent will need that form.  Custodial parents are unlikely to be willing to sign an unconditional permanent release, which is the only sure solution, but it is unlikely to be worth pursuing them in court if they are uncooperative in the future.  Such are the human dynamics that assure we will read more on this issue in years to come.