Some Tax And Financial Tips For The Divorced From Julian Block

Originally published on forbes.com.

I recently reviewed Julian Block's Tax Tips For Marriage And Divorce. He has provided me with another guest post, this one with some advice oriented to divorced individuals, although, frankly, most of the advice is more broadly applicable.

 Divorced individuals should educate themselves for financial planning.

In these increasingly rough economic times, it’s more vital than ever that you assume greater responsibility for your financial future. You ought not to rely exclusively on paid advisers. At the very least, you should be knowledgeable enough to raise good questions and evaluate answers when you deal with divorce attorneys and other professionals. The informed client gets the best advice.

A quick, low-cost way to become savvy is to sign up for adult education courses on taxes, investing and other aspects of personal finance. Choose from an array of classes tailored to your interest that are available at places like high schools and community colleges. Courses cost a fraction of what it would otherwise cost to meet on a one-to-one basis with instructors, who usually are attorneys, CPAs, financial planners and enrolled agents—i.e., persons licensed to practice before the IRS who are neither attorneys nor CPAs, but who are former IRS employees or have passed rigorous tax examinations administered by the IRS. Instructors use their hands-on experience to provide helpful, unbiased advice on topics that run the gamut from timing the receipt of income and the payment of deductions to your best advantage, to opening, operating and closing business ventures, to getting married or divorced, to when and how much money to take out of tax-deferred retirement accounts like IRAs, 401(k)s and 403(b)s, to whether to make lifetime gifts of money and other kinds of property to family members or to leave the assets to them. 

The courses alert you to money-saving techniques that you can apply yourself or, should you decide to seek professional help, test out on your advisers. And, conceivably, those advisers might turn out to be your instructors, whom you’ve had an excellent chance to evaluate. 

But be wary of retirement planning services and estate planners who send invitations to free lunch seminars geared to seniors. A 2009 survey by AARP of more than 1,000 people 55 and over found that many who attended seminars on retirement and estate planning were "pitched investments that were unsuitable for them or were asked for information that could expose them to financial fraud." 

The invitations consistently offer the same enticements: "a free gourmet meal, tips on how to earn excellent returns on your investments, eliminate market risk, grow your retirement funds, and spouses are urged to attend. These words should be red flags for investors," cautions the North American Securities Administrators Association (NASAA) . NASAA is an international organization devoted to investor protection. 

Review your will and keep it up to date.

Redo your will if you’ve divorced, legally separated or married since you wrote it. Your property intentions normally change when your marriage ends. And a remarriage also increases the complications, particularly when each spouse has children from marriages.

Update beneficiary designations

for insurance policies and retirement plans.Otherwise, proceeds might wind up with a former spouse or someone you now consider unworthy.

Letter of final instructions

Written your will and checked beneficiary designations? Good for you. Next step: Assemble the information for a non-binding document known in legal lingo as a final letter of instructions. The letter is an informal inventory of your financial records. This includes key names and numbers, and where you store insurance policies, bank accounts, tax info, and other papers. The list helps heirs locate assets and save on administrative expenses. Keep the letter up-to-date and accessible.

Watch withholding and estimated payments

Submit new W-4 forms to employers or W-4P forms to pension administrators. Revise the amounts subtracted from salaries, bonuses or pensions up or down to make sure that taxes withheld will be in rough balance with taxes owed when filing time next rolls around. For help on fine-tuning withholding, use the worksheets in How Do I Adjust My Tax Withholding?, Publication 919. Another resource is the IRS’s calculator at irs.gov.

Do you receive income from sources usually not covered by withholding—for instance, alimony, self-employment, Social Security benefits, dividends, interest, and withdrawals from IRAs and other retirement arrangements? Act now to adjust estimated quarterly payments. Tax Withholding and Estimated Tax, Publication 505, lays out the complete rules. 

Copies of income tax returns filed with your spouse.

Need to get hold of copies? You can do so without paying for help from an attorney or anyone else. If you and your spouse paid someone to complete those returns, the easiest way to get them is to contact the preparer. The law, in most cases, requires a paid preparer to keep copies of returns for at least three years after the filing due date—for instance, at least until April, 2013, for a return for tax year 2009, with a filing due date, for most persons, of mid-April, 2010. The preparer is supposed to provide copies to any of the signers.

What if there was no preparer or the returns can’t be obtained from that person? Contact the IRS for copies. You’re entitled to them even if all the jointly reported income was your spouse’s. The IRS charges $57 for each return requested. Simply sign and submit IRS Form 4506, Request for Copy of Tax Form. To ease your burden, it needn’t be signed by your spouse. 

IRS forms and publications are available by downloading from the IRS’s website.
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Julian Block is an attorney and author based in Larchmont, N.Y. He has been cited　as: "a leading tax professional" (New York Times);　"an accomplished writer on taxes" (Wall Street Journal); and "an authority on tax planning" (Financial Planning Magazine). Information about his books is at julianblocktaxexpert.com.

Every encounter I have with Julian, I learn something new.  We were talking yesterday and I asked him why he wasn't blogging.  He said he writes for other people's blogs to promote his books, but doesn't want to start one himself.  I could understand that.  Myself, I like other people's dogs.  Then he told me that when it comes to blogging I could be his Shabbos goy.  That is one Yiddish expression my years at Joseph B Cohan and Associates never taught me.  A Shabbos goy is a non-Jewish individual who regularly provides services that Jews cannot perform on the Sabbath.  At one time lighting stoves was a common service performed by a Shabbos goy.  Among noted individuals who performed this role are Colin Powell and Elvis Presley.

You can follow me on twitter @peterreillycpa.

Kim Kardashian And Kris Humphries - Is There A Tax Angle ?

ulian Block, author of Tax Tips For Marriage and Divorce has provided me with a few brief tips, which I will be posting over the next week.  I reviewed his book last week.  It turns out the first one he sent me might be of interest to Kim Kardashian.  She was married to New Jersey Nets player Kris Humphries for 72 days in 2011 before seeking divorce.  He countered by seeking an annulment.

Divorce Versus Annulment: the Big Tax Difference

Picture a cozy household of three: just Brad Pitt, Angelina Jolie, and the friendly tax man. Fact is, whether Brad, Angelina, Jennifer, Bristol, Levi, Snooki, Kim or anyone else is hooking up, breaking up, or something in between, the odds and ends of their relationships are grist for the IRS mill.

For instance, there’s a difference between a divorce and an annulment. The courts grant a divorce to mark the end of a marriage that was valid when entered into, whereas an annulment is for a marriage that at no time was valid (as when one of the parties was under the age of consent at the time of the marriage).  

To a couple interested only in the fastest way to untie the knot, the question may seem to be an unimportant technicality. Those watchful souls at the Internal Revenue Service, however, think that there’s an important difference when Form 1040 time rolls around. According to an IRS ruling, if an annulment is retroactive, the couple was never married. Result: they had no right to file joint returns (Revenue Ruling 76-255).

 An example: John and Mary married in 2011, filed jointly for that year, and had their marriage annulled after the filing deadline. Because their marriage was declared null and void from its very inception by the annulment decree, they’re considered to be unmarried at the end of 2011. Consequently, as an unmarried couple, they were ineligible to file jointly. The IRS requires John and Mary to "undo" their joint return by the filing of amended returns as unmarried filers. That can mean they get dunned for additional taxes. 

Normally, the IRS doesn’t allow people who file joint returns to change their filing status and switch to separate returns once the filing deadline of April 15 (for most individuals) has passed. Revenue Ruling 76-255 deals with the rare circumstance in which joint filers can switch to separate returns. This ruling involved only a one-year marriage. Nevertheless, the theory would presumably apply regardless of the marriage's length. On the plus side, refunds may be available to couples whose marriages were annulled and who would have paid reduced taxes as single persons. 

ulian Block is an attorney and author based in Larchmont, N.Y. He has been cited　as: "a leading tax professional" (New York Times);　"an accomplished writer on taxes" (Wall Street Journal); and "an authority on tax planning" (Financial Planning Magazine). 

I'm wondering in the Kardashian case, if community property law might be a factor.   If you were ever going to do a reality TV show about tax preparation, Kim and her hoopster might make a good pilot.

You can follow me on twitter @peterreillycpa.

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.

Divorce Attornies Need to Watch Their Language

Originally published on Passive Activities and Other Oxymorons on June 17th, 2011.
____________________________________________________________________________
Betty L Klebanoff v. Commissioner, TC Summary Opinion 2011-46

I've been going back and forth whether to make much of this one or not.  Taxpayer entered into a business venture, whether as a partner or not is a little unclear.  They received a $51,000 "draw" against profits that never materialized.  When her return was due it wasn't clear what she was supposed to report so she didn't report anything.  Then they gave her a K-1 which said she had received a guaranteed payment.  The venture had by then fizzled.  Soon after the IRS audited her.  Her position was that the $51,000 was not reportable.  IRS said it was ordinary income subject to SE tax.

The Tax Court ended up with short term capital gain - distribution from a partnership in excess of basis.  Not only was there no SE tax, there was also no penalty, which I think was on the generous side :

Petitioner was aware that she received $51,000 in payments from Mirus during 2007. She did not understand the legal or technical ramifications of those payments. She made attempts to contact Mirus and Messrs. Buck and Colson, but she did not receive any response regarding the $51,000 in payments. Petitioner did not receive any notification from Mirus before her 2007 income tax return was due and was filed. At the time her 2007 income tax return was due and being filed in 2008, petitioner's lawyer was engaged in negotiations in an attempt to work out some settlement of her interest in Mirus. There was uncertainty about whether petitioner would receive additional amounts from Mirus and/or Messrs. Buck and Colson and as to the nature of the payments already received. Petitioner decided to wait and file an amended return for 2007 after she was able to better address the taxability of the $51,000 in payments.


The events that culminated in the filing of the first Mirus partnership return and petitioner's income tax return were followed in relatively short order by respondent's audit of petitioner's return and the issuance of a notice of deficiency. Petitioner consulted tax professionals who advised her and caused her to file an amended partnership return for Mirus reflecting that the $51,000 in payment was a draw and that Hospice and Rock were the partners of Mirus.

It was therefore reasonable for petitioner to take the position that the $51,000 was not taxable in her 2007 tax year. Under those circumstances, petitioner's actions were reasonable and she is not liable for an accuracy-related penalty.

I really don't see a defensible argument for not reporting the $51,000 somehow or other, but it was a confusing mess, so I'm glad she got a break on the penalty.

Tuwana J. Anthony v. Commissioner, TC Summary Opinion 2011-50

If you have a business that involves selling various items, inventory is likely to enter into your tax computations.  You can't just deduct what you spent on the stuff from what you got paid for stuff in each year.  You have to consider stuff that is bought in one year and sold in a different year.  If you are talking about big items you might specifically identify them, but if its a lot of small stuff you need to take a short cut.  The short cut is this.  To figure your cost of goods sold you take the amount that you spent on stuff during the year ("purchases") and add the cost of stuff you had on hand at the beginning of the year "opening inventory".  That is your cost of goods available for sale.  To get your "cost of goods sold" (which is the number that you get to reduce your income by) you need to subtract the cost of stuff you didn't sell, "ending inventory".  Getting that number can be a bit of production.  It's one thing if you have an auto dealership with paper work on each vehicle from the factory.  If you have a retail store with all sorts of little tchotchkes it can be more of a production.  One way to approach it is to list out all the items with their selling prices and then reduce the total by your mark-up.

Ms. Anthony apparently forgot that last step.  She was audited for 2004 and was able to convince the Tax Court that her ending inventory was overvalued because it was at retail selling price.

During settlement negotiations in docket No. 5791-07S, petitioner affirmatively raised, inter alia, the issue of whether the $41,097 reported ending inventory on petitioner's 2004 Federal income tax return should have been reported as $20,548. Specifically, petitioner took the position that she erroneously reported her 2004 ending inventory using her retail selling price—rather than her cost—for the inventory.

The 2004 case was settled in 2009.  There was a little problem though.  The incorrect 2004 closing inventory was used as the 2005 opening inventory.  This could have been a gotcha on the IRS, since the statute was closed on 2005, but that is not the way it worked out:

In Tuwana J. Anthony v. Commissioner, Docket No. 5791- "07S”, based on representations made by you, the Tax Court made a determination that your ending inventory for 2004 was $20,548, instead of $41,097 as reported by you. Under section 1311, the same adjustment is required to be made to your beginning inventory for 2005. *** This results in an increase to your [2005] income of [$20,549]. On the basis of the above inventory adjustment and other adjustments that petitioner and respondent agreed to, respondent determined a $5,516 deficiency in petitioner's 2005 Federal income tax. Although the section 6501 3-year period of limitations for 2005 had expired at the time respondent issued the notice of deficiency on January 7, 2010, respondent relied on the mitigation provisions of sections 1311 through 1314 to issue the notice of deficiency to petitioner.

On the basis of the foregoing, we find that all requirements of the applicable mitigation provisions have been met and that respondent properly relied thereon in issuing petitioner the notice of deficiency for 2005. Petitioner's opening inventory for 2005 is reduced from $41,097 to $20,548 consistent with the adjustment made to her 2004 ending inventory.

Jose B. Magno, et al. v. Commissioner, TC Summary Opinion 2011-43

This was another case about the real estate trade or business exception to the passive activity loss rules.  The taxpayer hadn't made the aggregation election and his testimony about time spent was not persuasive:

During the audit stage of this proceeding, Mr. Magno told respondent's revenue agent that he worked approximately 25 to 30 hours per week on his financial planning and services business. That conversation was documented in the revenue agent's notes, and the revenue agent testified credibly to its contents at trial. At trial, however, Mr. Magno testified that he worked principally as a financial consultant from January through August 2005. He also testified that he became a full-time manager of the first and second residences in 2006 and 2007 and that he reduced the number of hours which he devoted to his financial consulting services business to “about” 500 hours per year.


We credit the testimony of respondent's revenue agent and therefore conclude that Mr. Magno must have worked more than 1,250 hours during each subject year in real property trades or businesses to qualify as a real estate professional under section 469(c)(7)(B)(i). 6 Mr. Magno was not able to corroborate with written documentation his assertions that more than one-half of the personal services he performed in trades or businesses during the subject years were performed in real property trades or businesses. Accordingly, we find that Mr. Magno has not proven that he meets the requirements of section 469(c)(7)(B)(i).

I'm starting to find these cases a little tedious, but I'm going to continue to report on them.

Timothy O. Micek v. Commissioner, TC Summary Opinion 2011-45

In 1999 petitioner and Ms. Micek orally agreed that petitioner would help support Ms. Micek by paying her $1,250 every 2 weeks. To memorialize this agreement, on November 10, 1999, petitioner signed a spousal support affidavit, stating that he promised to pay Ms. Micek $1,250 biweekly via direct deposit. A notary public of the State of New Jersey notarized the spousal support affidavit. Throughout the years at issue, petitioner made payments to Ms. Micek pursuant to the spousal support affidavit.

While petitioner was making payments, he was diagnosed with multiple sclerosis and was forced to stop working. As a result, in 2003 petitioner stopped making the required payments. On April 21, 2003, petitioner's attorney received a letter from Ms. Micek's attorney inquiring why petitioner had terminated the “alimony/expense payments”.

The issue before us is whether the spousal support affidavit qualifies as a written separation instrument as defined by section 71(b)(2). The spousal support affidavit is a written instrument, signed by petitioner, promising to pay Ms. Micek $1,250 every 2 weeks. As discussed above, a separation instrument does not require a specific medium or form and does not have to be signed by both husband and wife. Further, even though Ms. Micek did not sign the spousal support affidavit, petitioner testified that he reached an oral agreement with Ms. Micek with respect to support payments during their separation. This meeting of the minds not only is memorialized by the spousal support affidavit, but also is supported by the letter from Ms. Micek's attorney received by petitioner's attorney on April 21, 2003, describing the payments she had been receiving from petitioner as alimony payments. Accordingly, the spousal support affidavit qualifies as a written separation instrument as defined by section 71(b)(2), and petitioner is entitled to his claimed alimony deductions for the years at issue.

It looks like the IRS may have been whipsawed by this decision.  If not I would not like to be in the shoes of Ms. Micek's attorney since his use of the word "alimony" was an important element in the decision.  He should have been aware of whether his client was reporting the payments as taxable income.

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.

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.

Owe It to You or Cheat You out of It

Carolee F. Argyle v. Commissioner, TC Summary Opinion 2010-129

This was originally published on October 6th, 2010.

Time for another lesson on not reflexively filing joint returns.  Carollee Argyle was turned down for innocent spouse relief on her tax debt from the 2002 joint return she filed with her then husband, James Newkirk.

Early in 2002 both Ms. Argyle and Mr. Newkirk were laid off from their jobs with AT&T.  Mr. Newkirk withdrew $144,205 from his pension during 2002.  They ended up selling their home in Florida and buying a new home in Utah.  Between this and that and the other thing, the pension money pretty much went.  When it came time to file their 2002 tax return, there was a balance due of $27,539.  Neither of them paid it.

The couple divorced in 2006.  (This being a Tax Court Summary decision we are left to fill in the intervening drama in our imagination).  The divorce agreement indicated that any debts incurred during the marriage should be the responsibility of the one who incurred the debt.  The agreement did not address the unpaid tax.

It may well be that the storm clouds of marital dissolution were not on the horizon in 2003, so my previous post on this issue would not seem relevant.  Nonetheless filing separately should have been considered. Presumably the liability on two separate returns was greater than the joint liability.  Does that really matter though ?  I have a theory that all amounts greater than you can conceivably pay will end up being equal to what somebody else thinks you can afford to pay.  Maybe another couple would have seen a way to pay the $27,539, the Newkirks did not.  By filing a joint return they were telling the IRS to get as much as it could up to $27,539 from both of them.  Had they filed separate returns they would have been telling the IRS to get as much as it could up to say $40,000 from Mr. Newkirk.

Here is the interesting wrinkle.  If it turned out that between both of them they could actually come up with $27,539, they could amend to a joint return at that point.

Filing a timely return even though you don't have the money to pay the tax is definitely the right thing to do.  When you are filing such a return, think before you make it a joint return.  If you are the part of the couple who doesn't have the income think three times.

Joint Extension Payments

This was originally published on September 24th, 2010.

CCA 201035023 highlights one of the problems that arises from routinely filing joint returns and then shifting to a separate return.  The IRS received Form 4868 (Extension request) from a couple along with a payment.  The couple did not, however, file a joint return.  Therefore the payments were allocated in accordance with regulation 1.6654-2(e)(5). Please be patient here.  Readers of this blog number in the scores and not all of them have memorized the regulations - yet.  The payment was therefore apportioned based on the taxpayers gross tax liability.  When husband got wind of this he requested that the portion applied to wife be allocated to him since he was the source of the funds for the payment.  He cited the MacPhail case (96 AFTR 2d 2005-6066). 

The IRS noted that the MacPhail case concerned a refund not the application of an estimated payment.  (In MacPhail all payments on a return were made by wife's family partnership.  The business that the husband and wife ran together produced only losses.)  So they are sticking with the application of the extension payment. 

It's not unusual for the need to  make estimated or extension payments to be generated more by one member of the couple than the other.  I have a mythical couple called Robin and Terry who's function is to help me with awkward pronoun problems.  For purposes of this discussion Robin is a partner in a law firm and Terry is an employee of a high tech company.  Robin gets a monthly draw of 6% of total guaranteed pay and quarterly draw payments of 7%.  The latter are used to make estimated tax payments.  Terry of course has withholding.  If things ever get rocky for this couple Robin could be in a tricky position.  Terry's withholding is Terry's, but absent an agreement Terry would be entitled to a share of Robin's estimated tax payments. 

It's not unusual for family businesses or trusts to make estimated tax payments for beneficiaries or family owners.  Controllers or trustees charged with that responsibility would be prudent to make those payments as individual, not joint, estimated tax payments.  Whoever was making the payments on behalf of Sarah Crane (Angus MacPhail's ex-spouse) probably wishes they had followed that course.

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.

Divorcing Spouses Should be Careful About Joint Returns

This was originally published on PAOO on August 18th, 2010.

Laura Brady (TC Summary Opinion 2010-107)
Sometimes when I advise taxpayers, I have to preface my advice with a warning that it is a minority opinion.  One of those minority opinions is on the subject of filing joint returns in the final year of a marriage.  Generally it is viewed as a simple numbers exercise.  Figure out what the individual returns would be.  Figure out what the joint return would be. If the joint return produces a saving spend about half of it having the attorneys argue about how to split the saving.  That makes four winners, maybe five if the returns are really complicated and the accountant can get paid too.  If you have read enough "innocent spouse" cases in which the purportedly innocent spouse loses, you have to ask a preliminary question - " Do you have any reason to think that your soon to be ex might be less than thorough in reporting gross income ?"

When you file a joint return you are signing it under "pains and penalties of perjury" and asserting that "to the best of your knowledge" the information is true and complete.  There are two other things about a joint return.  One is that it is an irrevocable election.  In other words, you can't decide that it would have been a better idea to file separately and amend.  (You can, however, amend from a separate return to a joint return).  The other is that you are jointly and severally liable for the entire tax.  So they can collect the whole thing from either one of you.  My experience advising in this area, however, is that most advisers don't even consider this issue.  I know of one instance where someone was ordered by a probate judge to sign a joint return that he had reason to believe was less than accurate.  Hopefully, he would qualify as a truly innocent spouse, but I'm not certain.

Th sad case of Laura Brady (TC Summary Opinion 2010-107) has inspired me to add a little addendum to my advice about being cautious in signing a joint return.  Ms. Brady's marriage to Gregory Harris was her third.  The tax court noted that in this case, the third time did not prove to be a charm.  They met in early 2002, were married in March of 2003, separated in early 2004 and were divorced in July of 2004.  All told they lived together for less than a year. 

At some point before October of 2004 Ms Brady gave Mr. Harris her social security number and that of her child from one of her previous marriages.  On October 18, 2004 the IRS received a tax return signed, apparently, by Mr. Harris and Ms. Brady.  The tax was not fully paid.  Ms. Brady first learned about this return when the IRS withheld her $28 refund from her 2004 return to apply to her 2003 liability.  "What 2003 liability ?" she may have exclaimed.  She did not work and had no other income during 2003 and was not required to file a return.

Here is where things start getting complicated.  The Court noted :

According to petitioner, the 2003 return Mr. Harris prepared should not be treated as her return because she neither signed it nor consented to its being signed on her behalf. Respondent now agrees that petitioner did not sign the return. Nevertheless, according to respondent, Mr. Harris prepared the 2003 return with the implicit consent of petitioner, and it would not be inequitable to hold her liable for the income tax liability arising from that return. See secs. 6013(a), 6015(f).


We recognize that if both spouses intend and consent to file a joint Federal income tax return for any given year, then the failure of one spouse to sign the return for that year will not necessarily preclude its treatment as a joint return.

In order to treat the return as a joint return, there must evidence that the non-signing spouse consented.  The consent can be inferred from behavior.  There are eight factors to consider:

(1) Whether the returns were prepared pursuant to an established practice of preparing and filing joint returns;
(2) whether the nonsigning spouse failed to object to the filing of a joint return;
(3) whether an affirmative act was taken indicating an intention to file other than jointly;
(4) whether one spouse entirely relied on the other spouse to file returns;
(5) whether the spouse examined returns presented for a signature;
(6) whether separate returns were filed;
(7) whether the returns included the income and deductions of the nonsigning spouse; 
(8) whether the nonsigning spouse was aware of the contents of the purported joint returns.

IRS argued that providing the social security numbers was evidence that she had consented to a joint return.  The court noted that her former husband would have needed the numbers if he were claiming her and her child as dependents.

So the tax court determined that she had not consented to the joint return.  Therefore she doesn't owe anything on 2003 and the IRS should cough up her $28 right ?  Not so fast.  She had asked the tax court for innocent spouse relief and :

We find that the 2003 return Mr. Harris prepared that gave rise to the 2003 income tax liability from which petitioner seeks relief is neither a joint return as contemplated by section 6013(a) nor petitioner's return. Accordingly, because petitioner did not file a joint return with Mr. Harris for 2003, relief from her outstanding 2003 Federal income tax liability, if otherwise available, is not available in this proceeding.


Hopefully, the mess will be straightened out administratively.

The lesson that I take away from this is that a divorcing spouse who does not intend to sign a joint return, should file a separate return even if he or she is not otherwise required to file.  That should send a pretty clear message to the IRS as to their intent.

One further note.  Another reason not to file a joint return is that you or your soon to be ex, though he or she might be honest as the day as long, may have a high audit potential.  One of you might, for example, be involved in a lot of flow through entities or family businesses.  If you are the one being audited, you probably don't want your ex-spouse involved in the audit and you probably wouldn't want to get sucked into an audit triggered by your ex-spouse's activities.  Granted this is an amorphous concern which would be weighed against real dollar savings from filing a joint return.  Remember, though, filing jointly is irrevocable, while filing separately is not.  You could consider amending to a  joint return when the statute is close to having run out on separate returns.  Like a few of my clever ideas, I have not seen this one played out in practice, so I offer it with caution.

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.