When a couple signs the dotted line of their divorce agreement, they should know that the IRS is not bound by the terms of that agreement. Evidenced in the case T.C. Memo 2017-80, the Tax Court has sided with the IRS in saying that it is not bound by the terms of a couple’s divorce agreement.
Sam and Mae signed a divorce agreement in 2013 in which the parties agreed that each would both be liable for 50% of their tax liabilities from prior years. In 2013, the couple received deficiency notices for their 2008 and 2009 jointly filed tax returns. In the notice, the IRS disallowed the deductions for rental property losses claimed during those years. In 2014, Mae requested that the IRS relieve her of joint and several liability for those years. In 2015, Sam made his own request for relief. The IRS denied both requests and the parties took the matter to the US Tax Court.
Shortly before trial, the IRS conceded that for each year Mae should be relieved of her joint and several liability for the deficiencies caused by the denial of the rental losses from Sam’s rental property, 28% and 41% of the total rental losses for 2008 and 2009. The IRS also conceded that Sam should be relieved of his joint and several liability for the adjustments arising from Mae’s property, 72% and 59% respectively. Sam and Mae did not contest to the IRS’s concessions. However, they stated that as an alternative to the IRS’s concessions, they would be willing to each be liable for 50% of each year’s notice of deficiency liabilities.
Unsurprisingly, the Tax Court ruled in favor of the IRS. The Court observed that while the divorce agreement establishes the parties’ rights against each other under state law, it does not control their liabilities to the IRS. The Court quoted a General Accounting Office report which stated: “Divorcing couples may specify in their divorce decrees how future liabilities resulting from their prior returns are handled, i.e., one spouse is entirely liable, both spouses are equally liable, or some other permutation. However, the IRS is not bound by these divorce decrees because it is not a party to the decree.”
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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.