DIVORCE TAX & FINANCIAL PLANNING. A Presentation By Alan Zipp CPA-Attorney

Transcription

1 DIVORCE TAX & FINANCIAL PLANNING A Presentation By Alan Zipp CPA-Attorney 1

2 Alan Zipp, Speaker Bio Certified Public Accountant Attorney at Law AICPA Accredited in Business Valuation Certified Business Appraiser Certified Fraud Examiner Author, Lecturer, AICPA Discussion Leader 2

3 Alan Zipp, Speaker Bio Masters Degree in Taxation Author of RIA s Divorce: Valuation, Tax, and Financial Strategies Bar Association of Montgomery County, Maryland, served as: Treasurer, Executive Committee member, and Chair of the Taxation Section. 3

4 DIVIDING THE MARITAL PROPERTY PIE State Law Defines Marital Property Generally: All property, however titled, acquired during the marriage Except: gifts from third parties; inheritances; property acquired before the marriage; and property excluded by agreement 4

5 DIVIDING MARITAL PROPERTY Divorce Court Three Step Process 1. Identify all marital property 2. Value each item of marital property 3. Equitably allocate the property between the spouses (Not necessarily equally) 5

6 THE ROLE OF THE CPA Identify and Value Marital Property Use pro-forma worksheets to list property Use Fair Market Value for marketable property Use State law rules to value intangible property, such as business interests (i.e. intrinsic value, divorce value, etc.) 6

7 THE ROLE OF THE CPA Allocate marital property based on value and title, i.e. separate and joint Identify difference in value between husband s property and wife s property Identify amount needed to transfer to one party to make property values equal Assume equal division for analysis purposes 7

8 STANDARD OF VALUE Divorce Valuation Standards Vary Virginia Intrinsic worth to the parties New Jersey Fair value for divorce Wyoming Discounts for minority and marketability are not appropriate in divorce where no sale is anticipated 8

9 STANDARD OF VALUE Colorado Partnership agreement is not controlling where no sale is expected New Jersey Professional goodwill is marital property Pennsylvania Professional goodwill of a sole practitioner is not marital property Maryland Professional goodwill is not marital, but business goodwill is marital property 9

10 STANDARD OF VALUE California Marketable assets use fair market value, but non-marketable assets use a different standard California Goodwill in divorce valuation is not necessarily fair market value Wisconsin Fair market value is not the required standard for business interests San Diego A professional practice is its value to the spouse retaining it. 10

11 TAXATION OF PROPERTY Property received in a divorce is subject to taxation on subsequent sale Ordinary income taxation on section 1245 and 1250 recapture Capital Gains Tax: 28% on collectibles; 25% on real property depreciation; and 15% on other long-term capital gain (20% if in 39.6% bracket) 11

12 NO TAX ON PROPERTY TRANSFERS General rule of section 1041: No gain or loss shall be recognized on a transfer of property from an individual to: --a spouse, or a former spouse, if the transfer is incident to divorce 12

13 INCIDENT TO DIVORCE Within 1 year of divorce, or Related to the cessation of the marriage. --Transfer is required under divorce instrument --And, transfer takes place within 6 years TIP: A divorce instrument includes a modification or amendment to the instrument. 13

14 TRANSFERS TO THIRD PARTIES To or for the benefit of a spouse will apply nonrecognition rules of section 1041, IF: -- Divorce instrument requires the transfer, or -- Spouse makes a written request, or -- Spouse makes written ratification 14

15 BUT, SPOUSE MAY HAVE GAIN Transfer is treated as made directly to the spouse by the transferor and the spouse will be treated as immediately transferring the property to the third party. [ T(c) Q9] But, the deemed transfer from the spouse to the third party will not be treated as a 1041 transaction. So, spouse may recognize gain or loss on the transfer. 15

16 GAIN RECOGNIZED ON THIRD PARTY TRANSFER Wife owes her attorney $100,000 Divorce agreement requires Husband to transfer property worth $100,000, with a basis of $9,000, to the Wife s attorney Transaction is deemed 1041 transfer of property from Husband to Wife. Wife s deemed transfer to her attorney for debt is a taxable disposition. Wife will recognize $91,000 taxable gain 16

17 STOCK REDEMPTIONS Assume These Facts: Husband transfers shares to Wife Corporation redeems Wife s shares for cash Who is taxed on the redemption for cash? 17

18 STOCK REDEMPTIONS Substance versus Form Form = Wife is taxable on her redemption Substance = Husband is treated as redeeming his shares and transferring cash to Wife under section Husband is taxed under substance test 18

19 STOCK REDEMPTIONS Step Transaction Doctrine A taxpayer may not alter the tax consequences of a transaction by creating intermediate steps that have no effect on the ultimate outcome of the transaction. The intermediate steps are ignored and only the beginning and ending elements are considered relevant. 19

20 STOCK REDEMPTIONS IRS and Tax Court historically treated stock redemptions as taxable to the redeeming spouse. [TAM LTR , Blatt 102 T.C. No. 5] District Court and Ninth Circuit held that substance was more important. [Arnes, 981 F.2d 456 (1992] Tax Court changed its view and held that substance was more important. [Reed, 114 T.C. 2 (2000)] 20

21 MODERN VIEW OF CORPORATE STOCK REDEMPTIONS In 2000 the Tax Court reversed itself and ruled that a corporate redemption to the wife, on behalf of the husband, was taxable to the husband as a constructive dividend. [Read, Carol, 114 T.C. 2 (2000)] In 2003, the IRS issued final regulations to deal with corporate redemptions in divorce. First, tax the party on whose behalf the redemption was made. Second, permit the parties to elect which of them will be taxed. [ ] 21

22 STOCK REDEMPTIONS Regs Governs Corporate Stock Redemptions after 2003 Assume Husband transfers stock to Wife and Corporation pays cash to Wife in redemption of her shares. Who pays tax on the redemption? 22

23 STOCK REDEMPTIONS If Husband had an obligation to pay cash to the Wife for the shares, the Husband will be taxed as a constructive dividend. If Husband did not have an unconditional obligation to purchase the Wife s shares, the Wife will be taxed as a redemption. The Regulations permit the parties to elect who will be taxed. 23

24 STOCK REDEMPTIONS The issue of whether the Husband had a primary and unconditional obligation may be a subjective interpretation of the facts. The better procedure is for the Husband to borrow the money from the corporation and pay it to the Wife under section In that case, no one is taxed. 24

25 1041 TAX CONSEQUENCES No gain or loss recognized, BUT: -- Carryover basis (built-in gain) -- Section 179 recapture (lack of 50% business use) -- Depreciation recapture (1245 ordinary) -- Listed property recapture (50% business use) -- Suspended Passive Activity Losses (basis adjustment and no deduction 469(j)(6)) 25

26 CARRYOVER BASIS Husband transfers property to Wife worth $200,000 with a $10,000 basis and a mortgage of $150,000. Wife sells the property for $200,000 and recognizes a capital gain of $190,000. Wife pays capital gains tax of $28,500 and mortgage of $150,000. Net cash to Wife $21,

27 RECAPTURE Recapture can mean immediate recognition of income Recapture can mean classification of gain as ordinary rather than capital gain Transferee receives property subject to all recapture rules applicable to the property 27

28 RECAPTURE UNDER SEC 179 Husband transfers to Wife $100,000 worth of furniture he purchased for use in his office for which he claimed a section 179 deduction. Wife puts the furniture in her new house. As the furniture was not used predominately for business purposes by the Wife, the Wife will recognize ordinary income of $100,

29 RECAPTURE UNDER 280F Husband transfers to the Wife his business automobile, used over half the time for business purposes, depreciated under MACRS. Wife does not use the car in her business over 50% of the time. Wife will recapture the excess of the Husband s MACRS depreciation over his straight line allowable depreciation. 29

30 RECAPTURE UNDER 1245 and 1250 Husband transfers to the Wife appreciated property for which he claimed accelerated depreciation. Wife sells the property expecting 15% capital gains taxation. Under section 1245 Wife will recognize ordinary income on all depreciation taken under section Under section 1250 Wife will pay 25% tax on all straight line depreciation taken. 30

31 SUSPENDED LOSSES and PASSIVE ACTIVITIES Suspended losses on passive activities transferred in a divorce are not allowable as a deduction in any tax year. Basis is increased for suspended passive losses, except for S-Corporations. 31

32 Suspended Losses and S-Corporations Where S-Corporation stock with suspended losses is transferred to a spouse under section 1041, any disallowed losses or deductions are carried over to the transferee spouse. The transferee spouse is able to use the suspended losses against passive income 32

33 TAX LIENS AGAINST SPOUSE STAY WITH PROPERTY Transfer of marital property also transfers tax liens owed by other spouse. The federal tax lien remains on jointly-owned property awarded to a non-liable spouse in a divorce decree. [U.S. v. Craft, 535 U.S. 274 (2002)] The IRS will deem the value of the taxpayer s interest in the property to be one-half of the total value of the property. [IRS Notice ] 33

34 TAX LIENS ATTACH TO SALE PROCEEDS OF PROPERTY A federal tax lien can attach to property held in tenancy by the entirety and the lien against one spouse can attach to half of the proceeds from the sale of the property. [Popky, Howard v. U.S., 326 F.Supp. 2d 594 (Pa. 2005)] 34

35 IRS GUIDANCE: LIENS ON JOINTLY-OWNED PROPERTY The spouse of the debtor taxpayer acquires property in the divorce subject to the Federal tax lien if the lien occurred before the divorce. The Federal tax lien remains on entireties property awarded to a non-liable spouse in a divorce decree. The IRS will deem the value of the taxpayerdebtor s interest to be one-half the value of the property. [IRS Notice ] 35

36 TAXES ARE A KEY ISSUE Stock valued at $100,000 with a basis of $40,000 is not equal to raw land valued at $100,000 with a basis of $80,000. A transfer after one year following the divorce and not within 6-years pursuant to a divorce instrument will not be presumed tax free under section No gain or loss will be recognized even if cash is paid for the property between the spouses. Regardless of consideration given, the basis or the transferor will become the basis of the transferee. The deferred gain of an installment note will escape current taxation in a section 1041 transfer. 36

37 TRANSFER IRAs TAX FREE Individual Retirement Accounts can be transferred between spouses free of current income recognition, if: -- Made pursuant to a written agreement between the parties incident to divorce [408(d)(6)] Transfer from one IRA to IRA of the other 37

38 TRANSFER OF PENSION PLANS REQUIRE SPECIAL CARE The transfer of a Keogh or other qualified pension plan cannot be transferred tax free into the IRA of the spouse. MUST: Withdraw Keogh and roll into IRA first, then transfer IRA to spousal IRA, OR USE Qualified Domestic Relations Order 38

39 BASIS IN PENSION ALSO TRANSFERS Any cost or other basis in the pension transfers to the spouse under 1041(b)(2) Where an annuity is transferred incident to divorce or separation, the transferee will be entitled to the usual annuity treatment, including recovery of the transferor s investment in the contract under sec. 72. House Committee Report on P.L

40 ASSIGNMENT OF INCOME A taxpayer cannot transfer property with accrued income to another and avoid taxation on the accrued income. For example: U.S. Savings Bonds with accrued interest income cannot be transferred without recognition by the transferor. [Rev. Rul ] 40

41 ASSIGNMENT OF INCOME IRS current position is that assignment of income doctrine does not apply in divorce transfers of accrued income items. [Rev. Rul ] This 2002 ruling reversed the IRS longstanding position that accrued income is taxable to the one who earned it, not the one who receives it. [Rev. Rul ] 41

42 ACCRUED INCOME ITEMS Stock options and deferred compensation transferred in a divorce, although accrued deferred income of the employee spouse, is taxable to the recipient spouse when she receives the proceeds. [Rev. Rul ] The former spouse, and not the employee, realizes income when she exercises the stock options or when the deferred compensation is paid or made available. 42

43 INCENTIVE STOCK OPTIONS Under Rev. Rul , an employee who transfers non-statutory stock options and nonqualified deferred compensation to a former spouse incident to a divorce does not realize income on the transfer. When the former spouse exercises the stock options, she realizes ordinary income. 43

44 INCENTIVE STOCK OPTIONS Incentive stock options can be transferred without current income recognition to the transferor. Before the IRS changed its view, section 83 required the employee to treat the transfer of stock options as a disposition requiring recognition of ordinary income which increased the basis transferred to the spouse. Under Rev. Rul the IRS ruled that the assignment of income doctrine does not apply to divorce-related transfers of non-statutory options.. 44

45 EXERCISE OF STOCK OPTIONS When the former spouse exercises the stock options, she will be treated as receiving wages for purposes of income tax withholding. [Rev. Rul ] The transfer of restricted stock is a nontaxable event according to the IRS. [IRSLetter ruling , January 15, 2010] 45

46 MARITAL STATUS DETERMINES TAX FILING STATUS Determined on the last day of the tax year under State law [7703] Married File Jointly or Separately Unmarried - Single or Head of Household 46

47 SAME-SEX MARRIED COUPLES Treated as married for all Federal tax purposes IF they were married in a State that recognized same-sex marriages EVEN IF they reside in a State that does not recognize same-sex marriages Rev. Rul [U.S. v. Windsor, 570 U.S. (2013 S.Ct.)] 47

48 TO AMEND OR NOT? After September 16, 2013, same-sex couples MUST file as married people. Prior year returns MAY be amended, (but are not required to be amended) in order to claim a refund of previously paid taxes. Rev. Rul

49 LEGALLY SEPARATED IS UNMARRIED [7703(a)(2)] State law defines Legal Separation PA requires decree of absolute divorce LA requires at least a limited divorce Support Order is NOT a legal separation nor is Use & Possession Order 49

50 ABANDONED SPOUSE RULE [7703(b)] Married Person Considered Unmarried Maintain her home as residence of her child for more than six months Entitled to claim dependency exemption Pay over ½ cost of maintaining household Spouse not living in house during last six months 50

51 APPEAL OF DIVORCE DECREE Generally does not permit joint return as it treats parties as divorced at year-end Some States treat the appeal as a postponement of the divorce: District of Columbia; Louisiana; Missouri; Nebraska Parties are considered married at yearend 51

52 JOINT RETURN MEANS JOINT LIABILITY [6013(d)(3)] Joint and several liability Entire tax liability may be assessed against either spouse 52

53 INTENT DETERMINES WHETHER THERE WAS A JOINT RETURN A spouse cannot be held jointly and severally liable if there is no joint return Absence or presence of signature does not, by itself, conclusively establish intent or lack of intent 53

54 FORGED SIGNATURE [6064] Rebuttable presumption that the named individual actually signed the return [Hennen, 35 TC 74] IRS will rely on the signature unless notified that the signature is not bona fide [Service Center Advice /9/98] 54

55 DURESS AS A DEFENSE TO SIGNING A JOINT RETURN Must show lack of voluntary intent to sign a joint tax return Mental & physical intimidation [Lee, TC Memo ] Lack of intent and intimidation [Pirnia, TC Memo ] 55

56 RELIEF FROM JOINT LIABILITY [6015] Innocent Spouse Relief [6015(b)] Separation of Liability [6015 (c)] Equitable Relief [6015(f)] 56

57 MARITAL STATUS FOR RELIEF Innocent Spouse: No Divorce Required Separation of Liability: Divorced/Separated Equitable Relief: Divorced or Separated 57

58 INNOCENT SPOUSE RELIEF [6015(b)] Joint return filed Understatement of tax due to other spouse No knowledge of the understatement Inequitable to hold taxpayer liable 58

59 MUST TIMELY FILE FOR RELIEF Within 2 years of first collection activity Collection Activity: [Regs (b)(2)(1)] IRS Notice of Intent to Levy Offset of tax refund to a joint liability IRS lawsuit against taxpayer for joint debt IRS filing of a claim in a court proceeding 59

60 Tax Court Says 2-Year Rule Does Not Apply to Equitable Relief Pullins v. Comm r., 136 TC No. 20 (2011) Sec. 6015(f) Does Not Contain Time Limit Only the IRS Regulation places a 2-year time limit on Equitable Relief The Code applies a 2-year time limit to innocent spouse and separation of liability IRS Commissioner told the Congress the IRS would review the regulation. 60

61 IRS ELIMINATES 2-YEAR RULE FOR EQUITABLE RELIEF IRS announced that Equitable Relief applications MUST be filed before the expiration of the statute of limitations on collection under section 6502 Generally 10 year collections period after assessment under section 6502 Notice (Proposed Rev. Proc.) 61

62 NOT COLLECTION ACTIVITIES [Regs (b)(2)(1)] Notice of Deficiency Notice of Filing a Federal Tax Lien Demand for Payment of Tax 62

63 APPEAL TO TAX COURT [6015(e)] Taxpayer not satisfied with IRS decision IRS fails to decide within 6 months of the filing of Form 8857 Must file petition within 90 days of IRS decision 63

64 PARTIAL RELIEF AVAILABLE [6015(b)(2) Some knowledge of understatement Relief from liability to extent of unknown understatement Must not know or have reason to know 64

65 BANKRUPTCY OF ONE SPOUSE DOES NOT AFFECT THE OTHER [Kovitch v. Comm r. 128 TC 108 (2007)] Automatic stay against IRS actions where husband files bankruptcy does not prevent the Tax Court from deciding wife s innocent spouse status. The determination of the wife s liability does not affect the husband s liability. 65

66 SEPARATION OF LIABILITY [6015(c)] Liability Allocation Between the Spouses As if Separate Tax Returns Were Filed Allocate Items to Spouse Getting Benefit Must be Unmarried or Separated all year 66

67 EQUITABLE RELIEF [6015(f)] Not Qualified for Innocent Spouse or Separation of Liability Inequitable to Hold Spouse Liable Must be Unmarried or Separated All Year 67

68 EQUITABLE RELIEF Request must be made within 10-year Collection Period [Notice and Pullins, 136 TC No. 20 (2011)] Tax Liability is Still Outstanding No Fraudulent Transfer of Assets No Fraudulent Intent to File Jointly 68

69 EQUITABLE RELIEF IRS Considers Factors In Favor of Relief: Did not know tax would not be paid Would suffer economic hardship Evidence of spousal abuse Whether other spouse has a legal obligation to pay the tax, i.e., divorce decree or agreement 69

70 KEY DIFFERENCES Equitable Relief can get relief from underpayment of tax while Innocent Spouse or Separation of Liability cannot Innocent Spouse and Equitable Relief can generate a tax refund while Separation of Liability cannot 70

71 INJURED SPOUSE Injured Spouse is different from Innocent Spouse IRS Intercepts Joint Refund to pay taxes owed by the other spouse Form 8379 used to separate tax liability to claim refund owed to the injured spouse Tax calculated as if married filing separately and separate refund identified Can attach 8379 with Original Tax Return 71

72 DEPENDENCY EXEMPTION Qualifying Child No Income Test for Qualifying Child Qualifying Relative Income Limited to Exemption Amount 72

73 UNIFORM DEFINITION OF CHILD Child or Sibling of Taxpayer (or descendant of child or sibling) Lived with Taxpayer over 6-months Under age 19 (24 if student) Did not provide over 50% of own support 73

74 SPECIAL RULES Parent does not have to provide over half of child s support Parent does not have to provide over half the cost of maintaining the household 74

75 ELIGIBLE TO CLAIM CHILD More than one taxpayer may be eligible to claim a qualifying child Where a child lives with his father and grandmother for more than 6 months of the year and the grandmother provides 75% of the child s support, while the father provides 25% Both father and grandmother are eligible to claim the qualifying child 75

76 TIE BREAKING RULES Where two or more people are eligible to claim a child, the following is the order: Custodial parent if both parents are eligible The parent, as against a non-parent The taxpayer with the highest AGI if neither are a parent 76

77 IN YEAR OF SEPARATION Where parents are separated for less than 6 months No separation agreement regarding exemption for children Child lived with both parents over 6 months Then, parent with custody the longest gets the exemption [152 (c)(4)(b)(i)] 77

78 DIVORCE COURT CAN AWARD EXEMPTIONS [Miller, Cheryl v. Com r., 114 TC 184 (2000)] Tax Court ruled that State divorce courts have the authority to award dependency exemptions to noncustodial parents. The custodial parent is required to sign the Form 8332 waiver. 78

79 QUALIFYING RELATIVE One who is not a qualifying child Whose gross income is less than the exemption amount Who receives over half of his support from the taxpayer Who is related OR a member of the household all year 79

80 HEAD OF HOUSEHOLD Automatic with a Qualifying Child Qualifying Relative Requires: Gross income less than exemption amount Relative must live with Taxpayer over 6 months, non-relative must live with taxpayer all year Must provide over half of relative s support Must pay over ½ cost of maintaining household 80

81 TRANSFER EXEMPTION Form 8332 Required Custodial parent can transfer exemption to non-custodial parent Release may be revoked for future years by providing written notice [ (e)(3)(ii)] 81

82 FORM 8332 [Powers, Paul v. Com r., TC Memo ] Failure to attach Form 8332 or equivalent is fatal to dependency exemption Even where Divorce Court orders spouse to sign Form 8332, failure to do so results in loss of dependency exemption [ (g)(ex.18)] 82

83 BENEFITS GO WITH EXEMPTION The transfer of the dependency exemption also transfers the following benefits: -- Child Tax Credit -- Education Credits -- Student Loan Interest Deduction 83

84 TRANSFER DOES NOT AFFECT: -- Earned Income Credit -- Dependent Care Credit -- Head of Household status -- Medical Expense deduction 84

85 SETTLEMENT TAX PLANNING Where there are two or more children: -- Give each parent custody of one child for over 6 months during the year -- Each parent will qualify for Head of Household filing status 85

86 WHO OWNS TAX REFUNDS? Joint Tax Return Shows a Refund: Each spouse has a separate interest in any overpayment [Rev. Rul ] Apportioned to each spouse to the extent that they contributed to the overpayment [Ragan v. Com r., 135 F.3d 329 (5 th Cir. 1998) ] 86

87 HOW TO ALLOCATE IRS -- Separate Tax Formula: [Rev. Rul 80-7] [ (f) and (e)] Each spouse s share of the joint liability is based on the tax liability for which each would have been liable had each spouse filed a separate return for the tax year. Each spouses contribution toward the payment of tax must be established. [IRS Legal Memorandum ] 87

88 JOINT ESTIMATED TAX PAYMENTS -- BUT FILING SEPARATE TAX RETURNS The IRS position is that, in the absence of an agreement between the spouses, the estimated tax payments are allocated in proportion to the spouses separate tax liabilities. [IRS Legal Memorandum ] 88

89 JOINT REFUND CREDITED TO NEXT YEAR ESTIMATED TAXES If treated as joint refund, then each party gets credit for his/her established contribution toward the payment of tax. If treated as a joint estimated payment, then allocated by separate tax liability. 89

90 PAYMENT ON ACCOUNT A payment on account is different from a refund, as it becomes the property of the United States. [ (a)(5)] A refund is an overpayment which belongs to the taxpayer who made the overpayment. [6402(a)] 90

91 CREDITED OVERPAYMENT BECOMES A PAYMENT ON ACCOUNT IRS treats overpayments credited to estimated taxes as apportioned based on the separate tax liability formula. 9 th Circuit Court of Appeals treated the amount credited as an overpayment which must be allocated according to the spouse s contributions. [U.S. v. Elam, 112F.3d 1036 (9 th Cir. 1997)] 91

92 ALIMONY Deductible by the payor [71] Taxable to the recipient [215] MUST be payable under a Divorce Instrument AND meet four alimony tests 92

93 DIVORCE INSTRUMENT Divorce Decree, including a decree of separate maintenance or a written instrument thereto. Written Separation Agreement Support Order, including pendente lite alimony awards, other than a divorce decree 93

94 4 REQUIRED ALIMONY RULES Cash payments to/for the benefit of a living spouse After divorce the parties cannot live together Payments cannot be labeled as not-taxable Payments cannot be for child support 94

95 PAYMENTS TO THIRD PARTIES Qualify as alimony if made pursuant to the divorce instrument, request, consent, or ratification by the spouse for an obligation of the spouse, such as payments of the spouse s rent, mortgage, tax, or tuition liabilities. [1.71-1T-Q6 &Q7] 95

96 CANNOT LIVE TOGETHER AFTER DIVORCE If the parties are not divorced under a Divorce Decree, but are subject to a Written Separation Agreement or a Support Order, they can remain members of the same household and deduct alimony paid. [1.71-1T-Q9] 96

97 PAYMENTS CANNOT BE LABELED AS NOT-TAXABLE A major tax planning tool of the statute permits the parties to designate payments as not taxable or deductible. [71(b)(1)(B)] The Divorce Instrument must specifically designate the alimony payments as nottaxable and not deductible. [1.71-1T-Q8] 97

98 PAYMENTS CANNOT BE FOR CHILD SUPPORT Payments fixed as child support are not deductible as alimony Payments treated as child support are not deductible as alimony -- Payments reduced on the happening of a contingency relating to a child; -- Payments reduced at a time which can clearly be associated with a child contingency. 98

99 CHILD CONTINGENCY Attaining a specified age Death Marriage Leaving School Leaving the Household Attaining a Specified Income Level Gaining Employment [71(c)(2)] 99

100 ALIMONY RECAPTURE Alimony recapture is the recognition of phantom income in the third postseparation year, resulting from the deduction of excess alimony paid during the two preceding years. The intent is to prevent the deduction of property settlements disguised as alimony. 100

101 RECAPTURE MECHANICS Recapture occurs when year 1 alimony payments are more than $15,000 greater than year 2 alimony payments AND / OR When year 2 alimony payments are more than $15,000 greater than year 3 alimony payments. 101

102 RECAPTURE EXAMPLE YEAR ALIMONY PAID $50,000 $20,000 $ -0- Total alimony recapture in 2014 is $32,

103 EXCEPTIONS TO RECAPTURE Death of either party Remarriage of recipient spouse Support Order required payments Fluctuating payments not in the control of either spouse, i.e., a fixed percentage of income from employment, selfemployment, or business activity NO OTHER EXCEPTIONS [1.71-1T-Q25] 103

104 CHILD SUPPORT Fixed, as an amount, pursuant to a Divorce Instrument Reduced at a time related to a child contingency Reduced at a time clearly associated with a child contingency 104

105 AGE OF MAJORITY REDUCTION If payments are to be reduced within 6 months, before or after, a child is to attain the age of 18, 21, or local age of majority. The reduction will be presumed to be clearly associated with a child contingency. [1.71-1T-Q18] 105

106 COMMON AGE REDUCTION If the payments are to be reduced at a time within one year, above or below, the common age of each child between age 18 and 24, the payments will be presumed to be clearly associated with a child contingency. [1.71-1T-Q18] 106

107 COMMON AGE EXAMPLE Mutt, born 7/15/92 Jeff, born 6/23/96 Alimony of $2,000 per month beginning 1/1/08. Alimony of $1,500 per month beginning 1/1/12 Alimony of $1,000 per month beginning 1/1/14, until wife remarries or dies 107

108 BOTH REDUCTIONS ARE TREATED AS CHILD SUPPORT Because both reductions take place within 1-year of the common age of the children: --Only $1,000 per month will be deductible as alimony --The other $1,000 per month will be retroactively treated as nondeductible child support 108

109 COMMON AGE REDUCTIONS On 1/1/12, at the first reduction, Mutt will be 19 years, 5 months, and 17 days old On 1/1/14, at the second reduction, Jeff will be 17 years, 6 months, and 9 days old Adding 1 year to Jeff s age at the second reduction will overlap Mutt s age minus 1 year at the first reduction: i.e., 18 years, 6 months 109

110 IRS CHILD SUPPORT ENFORCEMENT Code Section 6305 authorizes the IRS to use its collection power to enforce the collection of arrearages in State Court ordered child support payments. A State Court certifies an arrearage in child support payments to DHHS, who then certifies same to IRS, who collects the child support as if it were a tax debt. 110

111 STATUTE OF LIMITATIONS ON COLLECTIONS 10 years under Code section 6502 Can be extended by Agreement of Taxpayer Can be reduced to Judgment under state court action and be renewed forever Collection on Tax Debt is different from Collection on Judgment 111

112 LEGAL FEES Legal fees are generally not deductible for personal activities, i.e., divorce [Gilmore, 372 U.S. 53 (1963); Patrick, 372 U.S. 39 (1963)] Legal fees are deductible if they are related to seeking alimony, even if alimony is never collected. [Dalton, 34 TC 879; (a)(1)(i)] An attorney could not deduct legal and accounting fees incurred in the valuation of his partnership interest. [Melat, TC Memo ] 112

113 BANKRUPTCY AND DIVORCE The automatic stay provisions generally operate to prevent the commencement or continuation of a judicial action against a debtor. [11 USC 362(a)(1)] The filing of a bankruptcy petition does not stop any state court s divorce litigation for: alimony, child support, custody, or dissolution of marriage. [11 USC 362(b)(2)] 113

114 BANKRUPTCY AND PROPERTY The automatic stay provisions of the Bankruptcy Code operate as a stay to the divorce proceeding to the extent that such proceeding seeks to determine the division of property that is property of the bankruptcy estate. [11 USC362(b)(2)] 114

115 NON-DISCHARGEABLE DEBTS Domestic Support Obligations are not dischargeable in bankruptcy. -- A debt established under the terms of a separation agreement, divorce decree, property settlement agreement, or court order, in the nature of alimony, maintenance, or support. [ 11 USC 101(14A), 11 USC 523(a)(5)] 115

116 DIVORCE-RELATED NON-DISCHARGEABLE DEBTS Divorce-related debts of a property settlement nature, while not considered a Domestic Support Obligation, are nondischargeable under section 523(a)(15) as incurred in connection with a divorce or separation proceeding. 116

117 LEGAL FEES IN DIVORCE Attorney fees awarded in a divorce decree where alimony or support was awarded, is generally held to be in the nature of alimony, maintenance, or support and therefore nondischargeable. [In re Williams, 703 F.2d 1055, and DuPhily v. DuPhily, 52 B.R. 971] 117

118 ESTATE ISSUES Claims against the estate can be made for divorce-related agreements: -- An agreement to sell property and divide the proceeds [Bruce v. Dyer, 524 A.2d 777 (Md. 1987)] -- An agreement to maintain a life insurance policy for the former spouse. 118

119 ALIMONY TRUST Tax burden shifted to beneficiary spouse Income from property paid to spouse Income taxed as character of flow through Corpus reverts to grantor at termination No deduction for alimony paid Not taxed as alimony income Taxed solely under section 682(a) 119

120 CHILD SUPPORT TRUST Property to trust for benefit of child Tax shifting does not apply Grantor is taxed as a grantor trust Corpus reverts to grantor upon termination Do not combine alimony trust and child support trust in a single trust document 120

121 OTHER FINANCIAL MATTERS Health Insurance Investment Planning Retirement Planning Estate Planning Insurance Planning Credit Planning Educational Planning Emotional Planning 121