From October 2001 Supplement
INTRODUCTION
1. PRELIMINARY ISSUES
1.1 Responsibility to Present Tax Issues
1.2 Manner of Representation
1.3 Divorce Court's Orders Do Not Control Tax Consequences
1.4 Tax Consequences Should Be Considered in Divorce Agreements
1.5 Unknown Tax Consequences
1.6 Tax Court Decisions
1.7 Authoritative Tax Resources
2. PROPERTY ASPECTS
2.1 Property Transfers
2.1.1 Internal Revenue Code Section 1041
2.1.1.1 Non-Recognition of Tax for a Transfer From a Spouse or Former
Spouse to a Spouse or Former Spouse Incident to Divorce
2.1.1.1.1 Transfer Incident to Divorce; Presumption
2.1.1.1.2 Non-Applicability of I.R.C. §1041
2.1.1.1.3 Tax Consequences of Transfer of Property from a Spouse or
Former Spouse
2.1.1.2 Capital Gain Rates
2.1.1.3 Transfers to Third Parties on Behalf of a Spouse or Former
Spouse
2.1.1.4 Disposition of Closely Held Corporate Stock by Stock Redemption
2.1.2 United States Savings Bonds; Accrued Interest Taxable to
Transferor
2.1.3 Stock Options
2.1.4 Record Requirements
2.1.5 Accounts Receivable; Value Reduced by Income Taxes
2.1.6 Tax Liabilities on Future Sale or Transfer
2.1.6.1 Some Possible Solutions to Consideration of Contingent Tax
Liabilities
2.1.6.2 Variations on Majority Rule
2.1.6.3 Valuation of Marital Estate; Reduction in Value for Potential
Tax
2.2 Sale of Principal Residence Pre-August 5, 1997 - Two Rules to Avoid
Gain
2.2.1 Deferral of Gain Prior to August 5, 1997 - I.R.C. § 1034
2.2.1.1 Gain Was Postponed, Not Forgiven
2.2.1.2 Purchase Price Less Than Sales Price
2.2.1.3 Postponement of Gain Was Mandatory
2.2.1.4 Occupied as Principal Home
2.2.2 Pre-August 5, 1997 - Exclusion of Gain
2.2.2.1 Ownership and Use Test
2.2.2.2 Ownership and Use Tests Met at Different Times
2.2.2.3 Exclusion of Gain Only Once - Taint Rule
2.3 Sale of Principal Residence - Avoidance of Portion of Gain
2.3.1 Excerpts of I.R.C. § 121
2.3.2 Exclusion of $250,000 of Gain
2.3.3 Ownership and Use Test
2.3.3.1 Title Controls Liability for Tax
2.3.4 Principal Residence
2.3.5 Joint Filers, Exclusion up to $500,000
2.3.6 Exclusion Every Two Years
2.3.7 Exercise of $125,000 Exclusion Under Previous Act
2.3.8 Tacking on Ownership of Spouse in I.R.C. § 1041 Transaction
2.3.9 Use Test Satisfied by Use of Spouse under Divorce or Separation
Instrument
2.4 Interest on Deferred Equitable Distribution Payouts
2.4.1 Amount of Interest
2.4.2 Tax Consequences of Interest Payments
2.4.2.1 Interest Taxable to Payee
2.4.2.2 Interest Deductible to Payor
2.4.3 Solutions to Tax Treatment of Personal Interest
2.4.3.1 Treat as Alimony
2.4.3.2 Gross Up Deferred Payments
2.5 Mortgage Interest on Home
2.5.1 Excerpts from I.R.C. § 163(h) and I.R.C. § 280A(d)(1)
2.5.2 Deductible Portion
2.6 Carry Forwards
3. ALIMONY/SEPARATE
MAINTENANCE PAYMENTS
3.1 Taxability/Deductibility
3.1.1 Payments after Remarriage
3.2 Summary of Provisions of I.R.C. § 71 (The 7 “D”s)
3.3 Cash Payments
3.4 Divorce or Separation Instrument
3.4.1 A “Decree” or Judgment, or Written Instrument Incident
Thereto
3.4.2 A Written Separation Agreement
3.4.3 A Decree (Order or Judgment) Requiring Support
3.5 Designation as not Taxable, not Deductible
3.5.1 Designation by the Parties
3.5.2 Temporary Support Order, Designation by Court
3.5.3 Final Decree of Divorce or Separate Maintenance, Designation by
Court
3.6 Different Households
3.7 Termination on Death
3.8 Child Support
3.8.1 Alimony Must Not Be Fixed as Child Support
3.8.1.1 Insufficient Amount to Cover Both Alimony and Child Support
3.8.2 Alimony Not Fixed as to Child Support
3.8.3 Advantage of Designating Child Support as Alimony
3.8.4 Child Support Guidelines; Basis to Deviate
3.8.5 Future Spousal Support Reduced by Court Ordered Child Support
3.8.6 Unallocated Alimony and Child Support (Family Support)
3.9 Third Year Recomputation Rule
3.9.1 Recomputation - Recapture
3.9.2 Recomputation Rule
3.9.2.1 Exceptions
3.9.2.2 Potential Danger
3.9.2.2.1 Solution I: Fixed Portion or Portions of Income
3.9.2.2.2 Solution II: Designate the Payments as Non-Taxable
3.9.2.2.3 Arrearage Recapture Avoidance
3.10 Alimony Payments to Non-Resident Aliens, Withholding Requirements
3.11 Payments by Business in Lieu of Alimony
3.12 Joint Returns
4. PENDENTE LITE
(TEMPORARY) SUPPORT
4.1 Temporary Order for Support
4.2 Exceptions Applicable to Temporary Support
4.2.1 Separate Households
4.2.2 Recomputation Inapplicable
4.3 Litigation Required
4.4 Designation Non-Taxable, Non-Deductible
4.5 Separate Streams of Payment
4.6 Cash to or on Behalf of a Spouse
4.7 Payments Must Cease on Death of Payee
4.8 Unallocated Alimony and Child Support
4.8.1 Fixed as Child Support?
4.8.2 Advantage of Unallocation
4.8.2.1 Child Support Guidelines, Effect
4.9 Modification or Correction of Temporary Orders
4.10 Attorney’s Fees Awarded for Adverse Party
5. CHILD-RELATED
EXEMPTIONS, CREDITS AND DEDUCTIONS
5.1 The Dependency Exemption
5.1.1 Entitlement
5.1.2 Applicability to Paternity Actions
5.1.3 Exceptions
5.1.4 Modification of Qualified Pre-1985 Instrument
5.1.5 Relinquishment of Exemption by Custodial Parent
5.1.6 Excerpts from I.R.C. § 152
5.1.6.1 Form 8332
5.1.6.2 Terms and Conditions
5.1.6.3 Attachment to Tax Return
5.1.6.4 Social Security Number Required
5.1.6.5 Revocation of Release of Dependency Exemption
5.1.7 Court's Power as to the Relinquishment
5.1.7.1 Requirement of Relinquishment
5.1.7.2 Courts Lack Power to Allocate Exemption
5.1.8 Requirement to Execute Waiver to Allocate Dependency Exemption
5.1.9 Modification of Allocation Order
5.1.10 No Minimum Support Requirement
5.1.11 The Benefit of the Dependency Exemption
5.1.12 Phase Out of Personal (Dependents) Exemption
5.1.13 Dependency Exemption Considered as Property
5.1.14 Dependency Exemption Award Impermissible in Lieu of Alimony
5.2 Child Tax Credit
5.2.1 Excerpt from Child Tax Credit Code Provision
5.2.2 $500 Child Tax Credit ($400 for 1998)
5.2.3 Phase-Out Thresholds
5.3 Household and Dependent Care Credit
5.4 Medical Expenses for Dependents
6. REVENUE RECONCILIATION
ACT OF 1993: THE EFFECT UPON DIVORCE TAXATION
6.1 Introduction
6.2 Individual Income Tax Rate Increase
6.3 Additional 1993 Tax Can Be Paid over Three Years
6.4 Limit on Medicare Deduction Eliminated
6.5 Limitation and Reduction in Itemized Deductions
6.6 Amortization of Goodwill and Other Intangibles
7. DEDUCTIBILITY OF
ATTORNEYS' FEES
7.1 Fees Attributable to the Dissolving Marriage
7.2 Fees Related to Tax Advice
7.3 Fees Related to the Production or Collection of Taxable Income
7.4 Fees for Obtaining or Protecting Income Producing Property
7.5 Fees Paid By One Spouse to the Attorney of the Other Spouse
7.6 Limitation on Deductibility of Fees
7.7 Fees Paid Out of Spouse's Business Entity
7.7.1 Fees for Profit Seeking Activities
7.8 Allocation of Fees
7.8.1 Factors in Arriving at Allocated Fee
7.8.1.1 Time
7.8.1.2 Complexity
7.8.1.3 Legal Issues in Case
7.8.1.4 Fee Customarily Charged in the Locality for Similar Services
7.8.1.5 The Results Obtained in the Divorce Negotiations
7.8.2 Kind and Weight of Evidence
7.8.3 Practice
7.8.4 Time Records
7.8.5 Caveats
8. THE KIDDIE TAX
8.1 Tax for Children under Age 14
8.2 Parental Taxable Income
8.2.1 If Parents Are Married and Filing Separate Return
8.2.2 If Parents Are Divorced
8.2.3 If Parent Remarries
8.3 Responsibility for Filing
8.4 Practice Tip
8.5 Obtaining Necessary Information
8.5.1 Consent for Information to Another
8.5.2 Power of Attorney
8.6 Estimates Permissible
9. JOINT RETURNS - MARRIED
FILING SEPARATELY
9.1 Tax Rates - Four Tax Schedules
9.1.1 Head of Household
9.1.2 Legally Separated Spouses; Entitled To File As Unmarried
Individuals
9.1.2.1 Excerpts From I.R.C. § 7703
9.1.2.2 Decree of Separate Maintenance Required Which Legally Separates
Spouses
9.1.3 Separation Agreements
9.1.4 Householders with Children, Living Apart
9.1.5 Judgment of Dissolution
9.2 Generally Beneficial to File Jointly
9.3 Joint Return Not Always Beneficial
9.3.1 Medical Expenses
9.3.2 Itemized Miscellaneous Deductions
9.3.3 IRA Contributions
9.3.4 Casualty Loss
9.4 Marriage Penalty
9.5 Allocation of Income and Deductions on Separate Return
9.6 Joint and Several Liability
9.7 Deficiency Notice
9.7.1 Last Known Address
9.7.2 Deficiency Notice Regarding Joint Return
9.7.3 Change of Address
9.7.4 Form 8822
9.8 Election to File Joint Return
9.8.1 Changing From Single to Joint
9.8.2 Extensions
9.8.3 Estimated Tax Payments
9.8.4 Following Switch From Joint to Separate Filing
9.8.5 Effect of Agreement
9.9 Net Operating Losses
9.10 Other Carryovers
9.10.1 Charitable Contribution Carryover
9.10.2 Investment Interest Expense Carryforward
9.10.3 Capital Loss Carryforwards
9.11 Court's Requirement to Sign Joint Return
9.11.1 Courts Should Not Require Signing Joint Return
9.11.2 Court Can Require Compliance with Agreement to Sign Joint Return
9.11.3 Authority for Requiring Execution of Joint Return
9.11.4 IRS Not Bound By Court-Ordered Requirement of Joinder
9.12 Joint Returns: What Qualifies?
9.12.1 Non-Signing By One Spouse Does Not Preclude Joint Return Status,
Especially When Used As “Bargaining Chip”
9.12.2 Intent Is Controlling
9.12.2.1 Facts Supporting Intent
9.12.2.2 Facts Rebutting Intent
9.12.3 Forging Spouse’s Signature Precludes Joint Status
9.13 Filing Separate Return Precludes Joint Status
9.14 Obtaining an Indemnification and Hold Harmless Agreement for
Signing a Joint Return
9.15 Practice Tips
9.16 Form of Indemnification and Hold Harmless Agreement
9.17 Court Imposition of Income Tax Liability
9.18 Non-Marital Asset - Effect of Converting to Marital by Filing Joint
Return
10. ASSIGNMENT OF INCOME
DOCTRINE
10.1 Overview
10.2 Background
10.3 Historical Case Summary
10.4 Internal Revenue Service Position
10.5 Counter-Arguments to IRS Position
10.5.1 Involuntary
10.5.2 Business Purpose
10.5.3 Tax Avoidance Secondary
10.5.4 Lack of Control
10.6 Internal Revenue Service Rulings
10.6.1 Revenue Ruling 87-112
10.7 Private Letter Rulings
10.7.1 Transfer of Individual Retirement Account
10.7.2 Division of Business
10.7.3 Division of Contingent Legal Fee
10.7.4 Division of Non-Qualified Deferred Compensation Account
10.8 Tax Court Cases
10.8.1 Division of Lottery Winnings
10.8.2 Division of Business
10.8.3 Division of Contingent Legal Fee
10.8.4 Division of Retirement Benefits
10.8.5 Distribution of Pension Benefits
10.8.6 Distribution of Retirement Savings Account
10.9 Specific Code Sections that Override Assignment of Income Doctrine
10.9.1 Installment Obligations
10.9.2 Alimony Trusts
10.9.3 Investment Tax Credit Recapture
10.9.4 Depreciation Recapture
10.9.5 Assets with Liabilities in Excess of Basis
10.9.6 Stock Options
10.9.7 Imputed Interest
10.9.8 Transfer of Individual Retirement Account
11. 1998 INNOCENT SPOUSE
RELIEF (AND SEPARATION OF LIABILITY AND EQUITABLE RELIEF)
11.1 Introduction
11.2 Pre-1998 Innocent Spouse Rules
11.3 1998 Changes to Rules - Generally
11.3.1 Internal Revenue Code Section 6015
11.4 Request to IRS for Relief (Form 8857)
11.5 Time for Election
11.6 Innocent Spouse Election
11.7 Separate Liability Election
11.7.1 Examples by Conference Committee
11.7.2 Practice Tip
11.7.3 Limitations on Use of Separate Liability Election
11.8 Equitable Relief
11.8.1 Relief Provided
11.8.2 IRS Interim Guidance
11.8.2.1 Eligibility to be Considered for Equitable Relief
11.8.2.2 Circumstances under Which Equitable Relief Will Ordinarily Be
Granted
11.8.2.3 Factors for Determining Whether to Grant Equitable Relief
11.9 Effect upon Signing Joint Returns
12. TAX PROBLEMS OF
“LIVE-IN” RELATIONSHIPS
12.1 Dependency Exemption
12.2 Medical Expenses
12.3 Payments or Transfers of Property: A Gift or Taxable Income?
12.4 Property Division
12.5 Gifts
12.6 Estate Taxes
12.7 Retirement Funds/Death Benefits
12.8 Filing Status
13. QUALIFIED RETIREMENT
BENEFITS
13.1 General Background
13.2 Anti-alienation Provisions of ERISA
13.3 Retirement Equity Act, Purpose
13.4 Failure to Include Retirement Benefits in Distribution
13.5 Definitions
13.5.1 Alternate Payee
13.5.2 Beneficiary
13.5.3 Contributory Plan
13.5.4 Defined Benefit Plan
13.5.5 Defined Contribution Plan
13.5.6 Domestic Relations Order
13.5.7 Earliest Retirement Age
13.5.8 Non-Contributory
13.5.9 Non-Qualified Plans
13.5.10 Participant
13.5.11 Pay Status
13.5.12 Plan Administrator
13.5.13 Qualified Domestic Relations Order
13.5.14 Qualified Plans
13.5.15 Surviving Spouse
13.5.16 Survivor Benefit
13.5.17 Vested Benefits
13.5.17.1 Graduated Vesting
13.5.17.2 “Cliff” Vesting
13.5.17.3 Accrued Benefit
13.6 Rules for the Qualified Domestic Relations Orders (QDROs)
13.6.1 I.R.C. § 414(p)
13.6.2 Discussion of Rules for QDROs
13.6.2.1 Summary of QDRO Requirements
13.6.2.2 QDRO Requirements
13.6.2.2.1 Benefits, Amounts or Percentage Must Be Stated
13.6.2.2.1.1 When a QDRO Can be Entered
13.6.2.2.2 Fixed Amount of Payment
13.6.2.2.3 Percentage of Benefits
13.6.2.2.4 Inclusion of a Formula
13.6.2.2.5 Early Distribution Option
13.6.2.2.6 Benefits: As Provided Under Plan and Limited to Participant's
Benefits
13.6.2.2.7 Number of and Period For Payments
13.6.2.2.8 Plan to Which the Order Applies
13.6.2.2.9 Participant and Alternate Payee Identified
13.6.2.2.10 Priority of Prior QDROs
13.7 Payment of Benefits to Alternate Payee
13.7.1 Earliest Date of Payments
13.7.1.1 Definition of “Earliest Retirement Age”
13.7.1.2 Examples
13.7.2 Special Provisions in Plan
13.7.3 Latest Date of Payment of Benefits
13.7.4 Death, Disability or Separation From Service of Employee Spouse
13.7.4.1 Special Rules Upon Death of Participant
13.7.5 Other Plan Eligibility Requirements
13.7.6 Complexities of Defined Benefit Plans
13.8 Surviving Spouse Designations
13.8.1 Form of Benefit
13.8.1.1 Post-Starting Date of Payments; Qualified Joint and Survivor
Annuity (QJSA)
13.8.1.2 Pre-retirement; Qualified Pre-retirement Survivor Annuity
(QPSA)
13.8.1.3 Consent to Waiver
13.8.1.4 Marriage of Less Than One Year Duration
13.8.2 Death of Alternate Payee
13.9 Procedural Rules
13.9.1 Steps to Take
13.9.2 Compliance with State Law
13.9.3 Disputes with Plan Administrator
13.9.4 Fees for Plan Administrator Impermissible
13.10 Additional Use of QDROs
13.10.1 Security for Future Payments
13.10.2 Arrearages, Attorney's Fees, Temporary Support and Taxes Thereon
13.10.2.1 Use of a QDRO for Alimony in Arrears 20 Years after Judgment
from Another State
13.10.2.2 QDRO Entered in Same State to Collect Alimony in Arrears Nine
Years Subsequent to Divorce
13.10.2.3 Use of a Subsequent QDRO to Collect Delinquent Alimony and
Child Support Held to be a Permissible Modification of a Prior Judgment
13.10.2.4 Use of a QDRO to Collect Required Payment for Equitable
Distribution of Property
13.10.2.5 Minority Holding that Subsequent QDRO Constitutes
Impermissible Modification Notwithstanding for the Collection of Arrearage in Spousal
Support
13.11 Form for Court to Reserve Jurisdiction
13.12 Qualified Domestic Relations Order Checklist
13.13 Joinder of the Plan, Trust and Plan Administrator as Third Party
Defendants Under State Law
13.13.1 Attorney’s Fees Cannot be Awarded Out of or Against the
Plan
13.14 Taxation of Payments of Retirement Funds
13.14.1 Payments from Plan without QDRO
13.14.2 Taxation as Annuity
13.14.3 Taxation of Lump Sum Distribution
13.14.3.1 Five-Year Averaging
13.14.3.2 Distributions to Participants Who Meet the Above Lump Sum
Distribution Requirements and Were Age 50 Before January 1, 1986
13.14.3.3 Ten-Year Averaging
13.14.3.4 Combined Capital Gain Treatment With Ten-Year Averaging
13.14.4 “Roll-over” Alternative
13.14.5 Loans From Plan
13.14.6 Ten Percent Early Distribution Penalty
13.14.7 Excess Distribution Tax
13.14.8 Taxation Payments Received By Alternate Payee
13.14.8.1 Lump Sum Payments
13.14.8.2 Ten Percent Early Withdrawal Penalty
13.14.9 Distribution to Alternate Payee Who is the Participant's Child
13.14.10 Twenty Percent Withholding on Distributions From Qualified
Plans After 12/31/92
13.14.11 Exempt From Withholding Requirements
13.14.12 Rollovers
13.14.13 Required Distributions
14. INDIVIDUAL RETIREMENT
ACCOUNTS, TAX IMPLICATIONS
14.1 Introduction
14.2 Transfers Incident to Divorce or Legal Separation
14.3 Ten Percent Penalty
14.4 Waiver of Penalty for Early IRA Withdrawal for Higher Education
Expense and First Time Home Purchase
14.4.1 Higher Education Expense
14.4.2 First Time Homebuyer
14.5 Twenty Percent Withholding on Distribution
14.6 Transfers During Marriage
14.7 Agreement Alone Not Sufficient to Avoid Tax
14.8 How to Effectuate a Tax Free IRA Transfer
14.9 Withdrawals From an IRA After Transfer
14.10 Required Distributions
14.11 Excess Distributions
14.12 Borrowing or Pledging Prohibited
14.13 Consideration of IRA in Determining Ability to Pay in Contempt
Proceedings
14.14 Beneficiary Designation upon Divorce, Effect
15. SUSPENDED PASSIVE ACTIVITY LOSSES
15.1 Excerpt from I.R.C. § 469
15.2 Limitations on Deductibility of Passive Activity Losses
15.2.1 Active Participation in Rental Real Estate, Allowed up to $25,000
Offset
15.3 Attribution to Each Spouse
15.4 Material Participation by Spouse
15.5 Disposition of Passive Activity
15.6 Disposition in Community Property States
15.7 Discovery of Existence of Suspended Passive Activity Losses
15.8 Consideration in the Value of Marital Assets
15.9 Planning with Passive Activity Loss Property
15.10 As a Deduction from Income to Determine Child Support Under the
Guidelines Statute
APPENDICES
1. Proposed forms of orders and judgments with income tax consideration
under DRTRA
I. Temporary - All payments taxable/deductible
II. Final Judgment Provisions - Permanent periodic alimony
deductible/taxable
III. Final Judgment - Lump sum alimony deductible/taxable
IV. Alimony under either temporary order or final judgment not to be
taxable to the wife nor deductible to the husband
V. Alternative to preceding clause (short form-no provision for
adjustment) payments to be non-taxable and non-deductible
VI. Clause for final judgment to designate certain payments of cash to a
third party on behalf of a spouse as non-deductible/non-taxable
VII. Clause for final judgment for a fixed percentage of payor's income
- deductible to the payor and taxable to the payee
VIII. Clause for insertion in final judgment whenever there is to be a
transfer of property
2. Recapture Computation Schedules
3. IRS Form 8332, Release of Claim to Exemption for Child of Divorced or
Separated Parents
4. IRS Form 2120, Multiple Support Declaration
5. IRS Form 8615, Computation of Tax for Children Under Age 14 Who Have
Investment Income of More Than $1,000
6. IRS Form 8857, Request for Innocent Spouse Relief
7. Some Clauses to Achieve Lester Results
8. Temporary Regulations on Domestic Relations Tax Reform Act
9. Internal Revenue Service Notice 97-10 and 97-11, issued December 30,
1996 Reform Act
I. Internal Revenue Service Notice 97-10 Sample Language for a
spouse’s
waiver to a QJSA or a OPSA
II. Notice 97-11 Sample Language for a Qualified Domestic Relations
Order
10. DuCanto's Calculation of Effective Federal Tax Rate (2001) In
Percentage of Taxable
11. Field Service Advice 20005006
12. 2001 and 2002 Tax Brackets (Table I)
13. Deductions from Income (Table II)
14A. Beneficiary Designation or Change
14B. Individual Retirement Account Change of Account Information |
