On a quarterly basis, Aronson’s Financial Advisory Services Group experts will provide synopses’ on recent court decisions on tax, financial, and valuation issues. This case studies series aims to showcase current trends for family relations attorneys in the Washington D.C. Metro Area.
U.S. Supreme Court
May 15, 2017 – Federal law preempts state as to veteran’s waiver of retirement pay. In Howell v. Howell, SCOTUS held that federal law prevents a state court from ordering a veteran to “indemnify” a divorced spouse for the loss of a portion of the veteran’s retirement pay caused by the veteran’s waiver of retirement pay to receive service-related disability benefits.
U.S. Tax Court
June 1, 2017 – Alimony: Requirement that payments be “under a divorce or separation agreement.” Evidenced in Paul S. Mudrich, TC Memo 2017-101, Paul earned a bonus in 2006 while he was still married to Lauri. In 2007, Paul divorced Lauri and married Kyera. Paul and Lauri had executed an agreement stating that the bonus was community property. Paul would pay Lauri half of the bonus net of taxes and report the bonus on his return. Paul filed a 2007 return claiming an alimony deduction equal to half of the gross amount of the bonus. The IRS disagreed on the basis that the payment was not paid pursuant to a written divorce or separation agreement. The Tax Court sided with the IRS.
May 15, 2017 – Divorce agreements are not binding on the IRS. In T.C. Memo. 2017-80, the Tax Court reminded couples that the IRS is not a party to their divorce. The terms agreed to in a settlement agreement are not binding on the IRS. In this particular agreement, the separating couple agreed to a 50/50 split of any tax liabilities arising from joint returns filed during their marriage. The IRS disagreed, stating that the taxpayers were jointly and severally liable. The Tax Court ruled in favor of the IRS. For more details on this particular case, please read our blog The IRS is Not a Party to Your Divorce, Your Agreement Does Not Bind Them.
District of Columbia
April 20, 2017 – Equitable, not equal distribution of marital property; preexisting retirement funds are separate property unless transformed to marital. In Fleet v. Fleet, the D.C. Court of Appeals found that the trial court’s record of factual findings was inadequate to support its distribution of the marital home and the retirement account between the parties. In this particular situation, two questions went before the Court. First, Mr. Fleet contended that in dividing the marital home, the trial court applied an improper presumption of equal rather than equitable distribution. Second, Mr. Fleet claimed the trial court made a mistake in awarding a portion of his pre-marital retirement account to Mrs. Fleet. The Court of Appeals reversed and remanded the case for further consideration.
May 30, 2017 – Presumptive income must first be based on current year income; gross income from self-employment is subject to reasonable business expenses. The Court of Appeals of Virginia ruled in Tidwell v. Late that the trial court erred when it used the average gross income over four years for a self-employed father whose annual income fluctuated in order to calculate his income for child support purposes. Further, the Court pointed out that the gross income should be subject to reasonable business expenses. The Court clarified that the trial court must first calculate a presumptive support amount based on current year income, and then they could explicitly analyze whether higher income in prior years manifested a greater capacity that rendered the presumptive award inappropriate or unjust. If the trial court then determined that it should deviate from the child support guidelines, it could be within its discretion to average a party’s income over a reasonable period of time.
April 18, 2017 – Court could not grant to wife GI Bill benefits which husband was unable to transfer; non-modifiable support prohibited by statute; distribution of more than 50% of marital share of military pension prohibited. In an unpublished Memorandum Opinion, the Court of Appeals of Virginia found in Garrett v. Garrett that the trial court incorrectly granted 18 months of GI Bill educational benefits after Mr. Garrett was discharged from service and unable to transfer his benefits under the bill; provided for non-modifiable spousal support because the court’s award of non-modifiable support was prohibited by statute; and, it awarded the wife 100% of the marital share of her husband’s military pension, when Virginia law prohibits the distribution of more than 50% of the marital share of the cash benefits actually received. The Court ruled that the trial court was not in error when it imputed income to the husband for the purposes of calculating spousal support.
February 28, 2017 – Coverture fraction applied to company stock sold pre-separation. In an unpublished Memorandum Opinion, the Court of Appeals of Virginia found no error and affirmed the trial court’s ruling in Allen v. Allen on the distribution of marital property and spousal support. Notably, the Court agreed with the trial court’s use of a coverture fraction applied to the stock of a company created by the husband during the marriage and sold pre-separation where the husband was required to provide post-separation services in order to receive payment.
For more information regarding Aronson’s Financial Advisory Services practice and the forensic accounting and litigation support services, contact Sal Ambrosino at 301.231.6272 and firstname.lastname@example.org.
Pat and Jordan were married and lived in the same jointly owned home for 9 years. After their divorce, Jordan lived in the home with their three children. Now, seven years after the divorce, Jordan is selling the house and both parties are asking their respective CPAs how much of the gain may be excluded from their returns. As the professor in my corporate tax class used to say – there is an answer to every tax question: it depends.
In this sad case, these good people still cared about each other and their kids, and had what might be described as a very amicable divorce. They agreed on how the property would be divided and that Jordan would continue to live with the kids in the family home. They decided there was no need to spend gobs of money for professional fees and that their mutual understanding and cooperation would cover most situations that arose. As a result, the divorce agreement, which they signed and gave to the court was very informal and silent as to the disposition of the marital home. As far as they were concerned, this was no problem. They continued to share ownership and both contributed to the mortgage and property taxes. Jordan paid for most of the maintenance and upkeep.
What did the CPAs say about the exclusions?
As a condition for claiming the full exclusion on the sale of a principal residence a taxpayer must have, among other things, owned the property and used that property as a principal residence for at least two of the last five years. While Pat continued to own the property after the divorce, only Jordan used the property as a principal residence.
Because the divorce instrument was silent with regard to Jordan’s continued use of the marital residence, at the time of sale Jordan may claim the $250,000 but Pat gets no benefit of an exclusion and must report the entire gain. Pat no longer was eligible for the exclusion since Pat didn’t reside in the home for at least two of the past five years prior to sale.
Was there a way Pat could have also excluded $250,000 of the gain?
Yes! Special rules covering the sale of a principal residence in divorce provide that a taxpayer is treated as using the property as the taxpayer’s principal residence for any period the taxpayer has an ownership interest in the property, and the taxpayer’s former spouse is granted use of the property under a divorce or separation instrument, provided the former spouse uses the property as a principal residence. Simply by stipulating in the divorce instrument that Jordan was granted use of the property for a number of years or until some event related to the children (e.g., graduating high school, turning 18, etc.) Pat would have also been able to exclude $250,000 on an individual tax return in the year of sale.
Could the result have been even better?
Yes, again! If Jordan had been married to longtime partner Taylor for two of the five years prior to the sale, then they would have been eligible to claim a $500,000 exclusion for the sale on their joint return, while Pat would still be eligible for the $250,000 exclusion on a single taxpayer’s return.
For more information regarding Aronson’s Financial Advisory Services Practice and the forensic accounting and litigation support services we provide click here or call Sal Ambrosino at 301.231.6272.
Having payments structured as alimony can be an effective tax planning tool. Why? Because alimony is deductible by the payor (typically the higher earning spouse) and taxable to the recipient; the former family unit can reduce, often significantly, its overall tax burden. As we have been exploring in this blog series, sometimes payments the parties identified as alimony turn out to be something else…
The CPA preparing Pat’s tax returns just called to say that $96,000 of the payments made under the agreement will be presumed as child support by the IRS. Pat is dumbfounded. The payments were made according to the separation agreement; they were made in cash to the former spouse. All alimony and child support payments have been made on time. The agreement indicated that the payments were to be alimony and the parties expected that they would be deductible by Pat and taxed to Jamie.
How did this happen?
As required by the separation agreement, Pat paid Jamie $6,000 per month for three years until Taylor turned 18, then paid $4,000 per month for one year until Avery turned 18, at which time the payments were reduced to $3,500 per month.
Under these circumstances, the rebuttable presumption is that the payments in excess of $3,500 per month are deemed child support.
Certain spousal support payments (alimony) are deemed to be child support regardless of how they are described in a divorce decree or separation agreement. When a written instrument calls for a reduction in payments as a result of a contingency relating to a child, those payments will be treated as child support for income tax purposes regardless of the description in the written instrument. Examples of contingencies related to a child include the child attaining a specified age, marrying, dying, leaving school, or a similar contingency.
Careful planning may have avoided these consequences.
For more information regarding Aronson’s Financial Advisory Services practice and the forensic accounting and litigation support services we provide, click here or call Sal Ambrosino at 301.231.6272.
Sound familiar? The payments in post-separation Years One, Two, and Three were made according to the separation agreement; they were made in cash to the former spouse. The agreement indicated that the payments were alimony and the parties expected that they would be deductible by the payor and taxed to the recipient. The CPA preparing the payor’s tax returns for Year Three just called to say that $35,000 of the payments made in Year Two will be recaptured in Year Three as income.
How did this happen?
As required by the separation agreement, the recipient received $100,000 per year in the first and second years, respectively. In the third year, the recipient received a total of $50,000. There was no child support.
Unfortunately, the answer is an easy one. The Internal Revenue Code calls for alimony recapture if, within the first three post-separation years, payments in years two or three have decreased by more than $15,000 from the prior year. Recapture is calculated and recognized, if necessary, in the third post-separation year. The calculation is purely mathematical.
In this case:
Year 1 payments $ 100,000
Year 2 payments (100,000)
Difference $ -0-
Year 2 payments $ 100,000
Year 3 payments (50,000)
Permitted variance (15,000)
Alimony subject to recapture $ 35,000
The $35,000 deducted in Year Two as alimony must now be reported as income on the payor’s return in Year Three. Sadly, this could have been avoided with proper planning.
For more information regarding the forensic litigation support and valuation services provided by Aronson’s Financial Advisory Services Group, or for questions and assistance related to divorce click here or call Sal Ambrosino at 301.231.6272.
Often divorce decrees or separation agreements describe the nature and amount of payments and transfers to be made between divorcing individuals. Having payments structured as alimony can be an effective tax planning tool in this process. Why? Because it is deductible by the payer, which is typically the higher earning spouse and taxable to the recipient, thus reducing the former family units overall tax burden. However, sometimes payments the parties identified as alimony turn out to be something else. This blog series looks at some of the ways in which alimony can be reclassified.
First, the basics. In order to be considered alimony, payments must:
In general, if you follow the formula: have the terms in writing, be sure that the writing does not say the payments are not alimony, terminate upon the recipients death, and make the payments to or on behalf of a former spouse then in most cases the payments should qualify as alimony on the tax returns.
But what happens if the alimony payments change over time? What if the payments began prior to the creation of the written instrument? What happens if the payments are combined with child support or property transfers? Or, if the payer is behind in child support?
All of these circumstances may affect the characterization of the payments. In the following weeks we’ll look at each of these scenarios to determine how they might impact your situation.
For information on how Aronson can help you find the answers to your tax questions related to divorce, or for information regarding the forensic litigation support and valuation services provided by Aronson’s Financial Advisory Services Group, click here or call Sal Ambrosino at 301.231.6272.