Family Law Taxation
Michael Asimow
Topics
Spousal & Child Support
Family Law Taxation
Spousal Support and Arbitrage
Assume a $2K payment from A toBarising out of the legal obligation of SS
If payment is non-deductible/non-taxable, it costs A $2K to give B $2K
Assume payment is deductible/taxable, and A is in 35% bracket and B is in the 15% bracket
Increase the payment to $2.7K
It now costs A $1,755 to make payment [$2.7K x 0.65]
Payment is worth $2,295 to B [$2.7K x .85]
Net arbitrage saving = $540
IRC 215: Spousal Support
(a) General rule—In the case of an individual, there shall be allowed as a deduction an amount equal to the alimony or separate maintenance payments paid during such individual’s taxable year.
(b) Alimony or separate maintenance payments defined—For purposes of this section, the term “alimony or separate maintenance payment” means any alimony or separate maintenance payment (as defined in section 71(b)) which is includible in the gross income of the recipient under section 71.
IRC 215: Spousal Support (cont’d)
(c) Requirement of identification number…[person receiving alimony must furnish ID to individual making payments; person making payments must include recipient’s ID on return for year payment is made]
Note also: IRC 62(a)(10)includes alimony in the list of “above the line” deductions
IRC 71: Disso or Separation Instrument
(a) General rule—Gross income includes amounts received as alimony or separate maintenance payments.
(b) Alimony or separate maintenance payments defined—For purposes of this section—
In general—the term “alimony or separate maintenance payment” means any payment in cash if
osuch payment is received by (or on behalf of) a spouse under a divorce or separation instrument…
IRC 71(b)(2)
Divorce or separation instrument—The term “divorce or separation instrument” means
a decree of divorce or separate maintenance or a written instrument incident to such a decree,
(B) a written separation agreement, or
(C) a decree (not described in subparagraph (A)) requiring a spouse to make payments for the support or maintenance of the other spouse.
Payments During Separation Period
IRC 71(c): Payments to Support Children
(1) In general—Subsection (a) shall not apply to that part of any payment which the terms of the divorce or separation instrument fix…as a sum which is payable for the support of children of the payor spouse.
IRC 71(c): Payments to Support Children
(2) Treatment of certain reductions related to contingencies involving child—For purposes of paragraph (1), if any amount specified in the instrument will be reduced—
on the happening of a contingency specified in the instrument relating to a child (such as attaining a specified age, marrying, dying, leaving school, or a similar contingency), or
(B) at a time which can clearly be associated with a contingency of a kind specified in subparagraph (A), an amount equal to the amount of such reduction will be treated as an amount fixed as payable for the support of children of the payor spouse.
Reductions in SS if CS is Increased
Contingency Relating to Child
Treas Reg 1.71-1T, A-18
There are two situations…in which payments which would otherwise qualify as alimony…will be presumed to be reduced at a time clearly associated with the happening of a contingency relating to a child of the payor. …[First, where] the payments are to be reduced not more than 6 months before or after the child is to attain the age of 18, 21, or local age of majority.
Treas Reg 1.71-1T, A-18 (cont’d)
[Second, where] the payments are to be reduced on two or more occasions which occur not more than one year before or after a different child of the payor spouse attains a certain age between the ages of 18 and 24, inclusive. The certain age… must be the same for each child, but need not be a whole number of years.
2 Reductions, Example of 2d Presumptions
Treas Reg 1.71-1T, A-18
The presumption in the two situations described above… may be rebutted… by showing that the time at which the payments are to be reduced was determined independently of any contingencies relating to the children of the payor [such as if the reduction is a complete cessation of alimony payments during the 6th post-separation year or by showing that the payments are made for a period customarily provided such as one-half the duration of the marriage]
IRC 71(b)(1)(D)
(1) In general—the term “alimony or separate maintenance payment” means any payment in cash if…
(D) there is no liability to make any such payment for any period after the death of the payee spouse and there is no liability to make any payment (in cash or property) as a substitute for such payments after the death of the payee spouse.
Termination on Death of Supported Spouse Substitutes for Post-death Payment
Family Support
Ambrose v. Commissioner(1996) T.C. Memo. 1996-128 (USTC)
Fam C 4337: Orders for party's support end at death or remarriage of recipient (CS would survive, but no part “fixed”)
Family support is deductible to H and taxable to W
SeeSchilling v. Commissioner (2012) T.C. Memo. 2012-256; Berry v. Commissioner (2005) T.C. Memo. 2005-91
Contra: Murphy v. Commissioner (1996) T.C. Memo. 1996-258)
Assuring Deductibility of Family Support
“Family support” is treated as SS rather than CS if it meets requirements of IRC 71
Agreement should clearly and explicitly state that payments are terminable upon death of supported spouse
Watch out for the presumptions that family support could be treated as CS because of termination dates
Designation as Non-deductible, Non-taxable Support
IRC 71(b)(1)(B)
(1) In general—the term “alimony or separate maintenance payment” means any payment in cash if …
(B) the divorce or separation instrument does not designate such payment as a payment which is not includible in gross income under section and not allowable as a deduction under section 215.
Same Household
IRC 71(b)(1)(C)
(b) Alimony or separate maintenance payments defined—For purposes of this section—
In general—the term “alimony or separate maintenance payment” means any payment in cash if…
o(C) in the case of an individual legally separated from his spouse under a decree of divorce or of separate maintenance, the payee spouse and the payor spouse are not members of the same household at the time such payment is made, …
Front-loading
IRC 71(f): Recomputation Where Excess Front-loading of Alimony Payments
(1) In general—If there are excess alimony payments—
the payor spouse shall include the amount of such excess payments in gross income for the payor spouse’s taxable year beginning in the 3rd post-separation year, and
(B) the payee spouse shall be allowed a deduction in computing adjusted gross income for the amount of such excess payments for the payee’s taxable year beginning in the 3rd post-separation year.
IRC 71(f)(cont’d)
(2) Excess alimony payments—For purposes of this subsection, the term “excess alimony payments” means the sum of—
the excess payments for the 1st post-separation year, and
(B) the excess payments for the 2nd post-separation year.
IRC 71(f)(3)(A)
(3) Excess payments for 1st post-separation year—For purposes of this subsection, the amount of the excess payments for the 1st post-separation year is the excess (if any) of—
the amount of the alimony or separate maintenance payments paid by the payor spouse during the 1st post-separation year, over…
IRC 71(f)(3)(B)
(3) Excess payments for 1st post-separation year—(cont’d)
(B) the sum of – (i) the average of—
(I) the alimony or separate maintenance payments paid by the payor spouse during the 2nd post-separation year… and
(II) the alimony or separate maintenance payments paid by the payor spouse during the 3rd post-separation year, plus
o(ii) $15,000.
Front-loading Calculation, 1st Post- Separation Year Excess Payments
Front-loading (2d Post-separation Year)
Fluctuating Payments
Exceptions to the front loading rules
IRC 71(f)(5): Front loading rules don’t apply if
Payments cease by reason of the death or remarriage of supported spouse
Payments made under temporary support order
Fluctuating payments under liability lasting at least 3 years to pay a fixed portion of the income from a business or property or from compensation for employment or self-employment
Dependency Exemptions
Family Law Taxation
Dependency Exemptions: Children
IRC 152: Dependency Exemption for Children
(a) In general…the term “dependent” means
a qualifying child, or
(2) a qualifying relative
IRC 152: Dependency Exemption (cont’d)
(c) Qualifying child—For purposes of this section—
In general—the term “qualifying child” means…an individual—
owho bears a relationship to the taxpayer described in subparagraph (2) [child, grandchild, sibling, step-sibling of TP or descendant of any of them],
o(B) who has the same principal place of abode as the taxpayer for more than one-half of such taxable year,
o(C) who meets the age requirements of paragraph (3) [under 19 or a student under 24]
o(D) who has not provided over one-half of such individual’s own support…
(4)(B)…such child shall be treated as the qualifying child of—(i) the parent with whom the child resided for the longest period of time during the taxable year…
IRC 152(c): Dependency Exemption (cont’d)
Exemption Phaseouts
If AGI exceeds “applicable amount”
Amount of personal and dependency exemptions is “phased out”
In 2017, applicable amount is $313,800 on joint return, $261,500 on single return
Exemptions are phased out at the rate of 2% for each $2,500 that AGI exceeds the applicable amount. H’s AGI is $411,500; that amount exceeds the applicable amount of $261,500 by $150K – there are 60 $2,500s in $150K
Consequently, H’s exemptions are completely phased out
IRC 152(e): Special Rule for Divorced Parents
(1) In general…if
a child receives over one-half of the child’s support during the calendar year from the child’s parents—
owho are divorced…
o(ii) who are separated under a written separation agreement, or
o(iii) who live apart at all times during the last 6 months of the calendar year, and
(B) Such child is in the custody of 1 or both of the child’s parents for more than one-half of the calendar year,
Such child shall be treated as being the qualifying child or qualifying relative of the noncustodial parent for a calendar year if the requirements described in paragraph (2)… are met.
Form 8332
IRC 152(e)(2): Exception where custodial parent releases claim to exemption for the year—For purposes of paragraph (1), the requirements described in this paragraph are met with respect to any calendar year if
the custodial parent signs a written declaration…[Form 8332] that such custodial parent will not claim such child as a dependent for any taxable year [designated in the form], and…
Form 8332
IRC 152(e)(2): Exception where custodial parent releases claim to exemption for the year (cont’d)
(B) the noncustodial parent attaches such written declaration to the noncustodial parent’s return for the [year in question]
See Armstrong v. Commissioner (8 Cir 2014) 745 F.3d 890 [Release conditioned on H’s payment of child support is not unconditional and does not shift exemption]
Exemption for Cohabitant
IRC 152(d): Qualifying Relative
(1) In general—The term “qualifying relative” means…an individual—
who bears a relationship to the taxpayer described in paragraph (2)
(B) whose gross income for the calendar year…is less than the exemption amount [$4,000 in 2015]
(C) with respect to whom the taxpayer provides over one-half of the individual’s support… and
(D) who is not a qualifying child…
(2) Relationship—…an individual bears a relationship to the taxpayer described in this paragraph if the individual is any of the following…
(H) An individual [other than a spouse] who for the taxable year of the taxpayer has the same principal place of abode as the taxpayer and is a member of the taxpayer’s household.
IRC 152(f)(3)
An individual shall not be treated as a member of the taxpayer’s household if … the relationship between such individual and the taxpayer is in violation of local law.
Property Divisions
Family Law Taxation
Property Divisions (Before & After Enactment of IRC 1041)
U.S. v. Davis (1962) 370 U.S. 65
Davis(cont’d)
Dictum: W does not include the $720K in income [SeeRev. Rul. 67-221]
Exceptions: The Davisrule did not apply to equal divisions of CP but did apply to CP divisions in which one spouse paid separate property cash for CP interest of other spouse (a “cash-out” division)
Property Divisions – Former Law
IRC 1041 (Adopted 1984)
Transfers of property between spouses or incident to divorce
(a) General rule—No gain or loss shall be recognized on a transfer of property from an individual to (or in trust for the benefit of)—
a spouse, or
(2) a former spouse, but only if the transfer is incident to the divorce.
IRC 1041(b), (c)
(b) Transfer treated as gift; transferee has transferor’s basis—In the case of any transfer of property described in subsection (a)—
for purposes of this subtitle, the property shall be treated as acquired by the transferee by gift, and
(2) the basis of the transferee in the property shall be the adjusted basis of the transferor.
(c) Incident to divorce—For purposes of subsection (a)(2), a transfer of property is incident to the divorce if such transfer—
occurs within 1 year after the date on which the marriage ceases, or
(2) is related to the cessation of the marriage.
Realization of Gain on Transfer
Treas Reg 1.1041-1T, A-7
A transfer of property is treated as related to the cessation of the marriage if the transfer is pursuant to a divorce or separation instrument…and the transfer occurs not more than 6 years after the date on which the marriage ceases. A divorce or separation instrument includes a modification or amendment to such decree or instrument.
Treas Reg 1.1041-1T, A-7 (cont’d)
[Transfers not under an instrument or more than 6 years after marriage ceases are] presumed to be not related to the cessation of the marriage.
[Presumption can be rebutted by showing] that the transfer was made to effect the division of property owned by the former spouses at the time of cessation of marriage.
Examples: Factors that hampered earlier transfer such as legal or business impediments to transfer or valuation disputes and transfer is effected promptly after such impediment is removed
Cohabitants and RDPs
Property Division Between Cohabitants or RDPs
Green v. Commissioner (1987) T.C. Memo. 1987-503: Settlement of restitution claim by a cohabitant is taxable to her
Reynolds v. Commissioner (1999) T.C. Memo. 1999-62: Cohabitants had implied joint ownership in property divided when they broke up—division of property is non-taxable
Gain on Sale of Personal Residence
IRC 121(a): Exclusion
Gross income shall not include gain from the sale or exchange of property if, during the 5-year period ending on the date of the sale or exchange, such property has been owned and used by the taxpayer as the taxpayer’s principal residence for periods aggregating 2 years or more.
IRC 121(b): Limitations
(1) In general—The amount of gain excluded from gross income under subsection (a) with respect to any sale or exchange shall not exceed $250,000.
(2) Special rule for joint returns—In the case of a husband and wife who make a joint return for the taxable year of the sale or exchange of the property—
$500,000 limitation for certain joint returns—Paragraph (1) shall be applied by substituting $500,000 for $250,000 if—(i) either spouse meets the ownership requirements of subsection (a) with respect to such property, (ii) both spouses meet the use requirements of subsection (a) with respect to such property; and (iii) neither spouse is ineligible for the benefits of subsection (a) with respect to such property by reason of paragraph (3).
IRC 121(b): Limitations (cont’d)
(2) (cont’d)
(B) Other joint returns—If such spouses do not meet the requirements of subparagraph (A), the limitation under paragraph (1) shall be the sum of the limitations under paragraph (1) to which each spouse would be entitled if such spouses had not been married. For purposes of the preceding sentence, each spouse shall be treated as owning the property during the period that either spouse owned the property.
(3) Application to only 1 sale or exchange every 2 years—
In general—Subsection (a) shall not apply to any sale or exchange by the taxpayer if, during the 2-year period ending on the date of such sale or exchange, there was any other sale or exchange by the taxpayer to which subsection (a) applied.
IRC 121(d), (f)
(d) Special rules…
(6) Recognition of gain attributable to depreciation—Subsection (a) shall not apply to so much of the gain from the sale of any property as does not exceed the portion of the depreciation adjustments…in respect of such property.
(f) Election to have section not apply—This section shall not apply to any sale or exchange with respect to which the taxpayer elects not to have this section apply.
Personal Residences & Divorce
Personal Residences & Divorce (cont’d)
IRC 121(d)
(d) (3) Property owned by spouse or former spouse—For purposes of this section—
(B) Property used by former spouse pursuant to divorce decree, etc.—Solely for purposes of this section, an individual shall be treated as using property as such individual’s principal residence during any period of ownership while such individual’s spouse or former spouse is granted use of the property under a divorce or separation instrument (as defined in section 71(b)(2)).
IRC 121(d) (cont’d)
(d) (3) Property owned by spouse or former spouse—For purposes of this section—
Property transferred to individual from spouse or former spouse—In the case of an individual holding property transferred to such individual in a transaction described in section 1041(a), the period such individual owns such property shall include the period the transferor owned the property.
Prop 13: Property Tax Consequences
Transfers of real property to a spouse or former spouse in connection with a property settlement agreement or judgment of dissolution or legal separation
Do not constitute a “change of ownership” requiring reappraisal for property tax purposes [R&T C 63(c); 18 CCR 462.220(c)]
Assignment of Income
Assignment of Pension Benefits
QDROs
A “qualified domestic relations order” (QDRO) is required to shift ownership of qualified retirement plans to the non-employee spouse (referred to as the “alternate payee”)
Creates an enforceable interest that the plan must respect and overrides anti-alienation provisions in the plan and prevents application of the assignment of income doctrine
Thus, amounts received by the non-participant spouse are taxed to that spouse, not to the employee-spouse
QDROs (cont’d)
A QDRO is a court order that contains the following elements
The name and last known mailing address of the participant and each alternate payee covered by the order
The amount or percentage of the participant’s benefits to be paid to each alternative payee or the manner in which the benefits are to be computed
The number of payments or the payment period to which the order applies, and
The identity of each plan to which the order applies [IRC 414(p)(2)]
Early Retirement
Normally, the QDRO can’t order any benefit not provided by plan or not available to plan participant