Family Law Tax Update

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Dawson_Leslie_webAs we head into tax season, this is a great time to look at some of the tax changes affecting our family law cases. This article will discuss a few of the interesting tax rulings from 2013.

The BIG News: Same Sex Marriages

On June 26, 2013, the United States Supreme Court released their ruling in United States v. Windsor.[1] The Windsor ruling struck down, as unconstitutional, Section 3 of the Defense of Marriage Act (DOMA),[2] that required same-sex spouses to be treated as unmarried for federal purposes.

That same day, the Supreme Court also dismissed Hollingsworth v. Perry[3] for lack of standing. This case appealed a lower court ruling,[4] that California’s Proposition 8, which limited marriage to opposite-sex couples, was unconstitutional. The dismissal of this case cleared the way for same-sex marriages in California.

Both of these rulings were groundbreaking. They allow many benefits to same-sex married couples that were previously only allowed for opposite-sex spouses. However, there are many questions pertaining to the implementation and timing of these benefits. There are also questions regarding the interplay of various state same-sex marriage laws, property laws and tax filings.

The above-referenced cases were followed by a number of rulings, including the following:

  • IRS News Release 2013-72: All same-sex couples must file as married after 9/15/13.
  • IRS Revenue Ruling 2013-17:
    • 1. Redefined a spouse as one in a legal marriage under state law, and specifically included persons of the same sex.
    • 2. Adopted a “state of celebration” rule. This means that if the marriage is valid in the state in which the marriage is performed, the federal government will recognize the marriage, regardless of where the parties reside.
    • 3. It is anticipated further guidance on retroactive application of employee benefit plans will be issued.
  • Obergefell v. Kasich, No. 1:13-CV-501, 2013 WL 3814262 (S.D. Ohio July 22, 2013): Ohio must recognize a same-sex marriage if valid in the state where it was “celebrated.”
  • Cozen O’Connor v. Tobits, No. 11-0045, 3878688 (E.D. Pa. July 29, 2013): Same-sex spouse was entitled to ERISA survivor benefits even though the death occurred before the Windsor ruling.

The effect of Windsor and subsequent rulings on same-sex spouses:

  • File as married for federal tax purposes.
  • Ability to receive spousal tax-free health benefits.
  • Ability to use unlimited marital deduction for gifts and estates.
  • Opportunity to split gifts.
  • Tax-free property division under IRC §1041.
  • Deductible alimony.
  • Ability to divide pensions via QDRO.
  • Ability to receive spousal benefits under ERISA plans.
  • Ability to divide IRAs tax-free.

It should be noted that the IRS has issued “Answers to Frequently Asked Questions” for California Registered Domestic Partners and Civil Unions in other states. These unions are NOT recognized as married for federal tax purposes and do not receive the above benefits.

There are still a number of unanswered questions, such as filing status for a federally recognized same-sex marriage in a state that does not recognize these marriages. Also, if the gift tax exclusion was used in a prior year to make a gift to a same-sex spouse, can that exclusion now be recovered? Stay tuned as more rulings will hopefully address some of these questions.

Innocent Spouse Relief

In the fall, the IRS issued new rulings liberalizing the requirements for “equitable” innocent spouse relief. Equitable relief is one of three types of innocent spouse relief available—a “facts and circumstances”-based decision by the IRS, reviewable by the Tax Court.

The rulings—Treas. Reg. §1.6015-5, Prop.Reg. §1.6015-9 and Rev.Proc. 2013-34—provide for a longer period of time to request relief. This provision is intended to provide relief to those divorced or separated spouses who may not have even been aware they owe taxes because they did not receive copies of the notices.

The new rulings also allow taxpayers to submit additional information during the reconsideration process—the reviewing court is not limited to the administrative record. Presumably, this provision is designed to assist those spouses who are not sophisticated with finances, taxes and tax collection procedures.

Why did the IRS issue more “friendly” rulings? In recent years, there have been a number of cases involving spouses that would have received innocent spouse relief but for missing the filing deadline, or some other technical reason. These rulings were most likely in response to this perceived inequity. Said rulings are probably a response to a number of cases where the IRS’ innocent spouse determinations were overturned by the courts.

piggybanks_webFamily Support

In a somewhat disturbing case, DeLong v. Commissioner (T.C.M. 2013-70), the IRS raised the obvious issue with “family support”—namely, that the unallocated support is designed to cover both spousal and child support. In this case, Husband was ordered to pay $3,000/month as family support in a California divorce judgment. The court acknowledged the family support included both child and spousal support.

The IRS challenged Husband’s deduction with the following arguments:

  1. The judgment did not specifically state that the support terminates on Wife’s death—as required by Internal Revenue Code §71(b)(1)(D). However, under California law, spousal support automatically terminates upon the recipient’s death. Also, the 2005 Berry case (Berry v. Comm’r, T.C.M. 2005-91) ruled that family support automatically terminates upon the recipient’s death if custody of the children automatically reverts to the paying spouse. For these reasons, the Tax Court ruled against the IRS on this argument.
  2. A certain amount of the support is “fixed” as child support and excluded under §71(c)(1). The judgment, however, did not contain any child support figures. Nor did it contain an automatic reduction in family support based on a contingency related to a child (18th birthday, graduation from high school, death, etc). For these reasons, the Tax Court ruled against the IRS on this argument as well.

So while Husband was ultimately allowed the deduction, he had to incur the expense and hassle of taking his case to Tax Court to do so. This is disturbing because the IRS has, for years, accepted that family support contains unallocated spousal and child support.

Their position has been that if the payments meet the requirements of §71, it is deductible; and if it doesn’t meet the requirements, it’s not deductible—period. This appears to be a garden-variety family support order and there is no indication why the IRS decided to challenge it. It is unclear if this was an isolated case resulting from an overzealous IRS agent, or if the IRS is going to continue attacking family support orders.

Alimony

There were at least two cases in 2013 which reaffirmed the necessity of having a written support agreement in place before the payment is made to have deductible alimony. In Faylor v. Commissioner (T.C.M. 2013-143), Husband made payments while the temporary order was being drafted.

In Martin v. Commissioner (T.C. 2013-31), Husband voluntarily increased his payments without changing the order. The Tax Court noted that while these were both noble gestures, they were still non-deductible.

While this seems very unfair, Internal Revenue Code §71(b)(1)(A) is very clear—a written agreement requiring a specific alimony amount must be in place prior to the payment.[5] There have also been a number of cases where the IRS has rejected the family court’s retroactive characterization of payments as alimony.

However, there is a way to protect a spouse that wants to do the right thing. A written agreement does not have to be a court order—the parties can enter into an agreement that they both sign. The document should state that the payments will terminate upon the recipient’s death, just to be safe.

These are just a few of the recent rulings and cases involving family law tax issues. As with most areas of tax, the family law tax landscape is constantly changing. Family law attorneys and tax preparers alike should be aware of the current tax consequences of support, property division and other issues affecting their divorcing clients.


Leslie Dawson is the owner of Dawson CPA Firm, which specializes in family law and taxation services.


[1] United States v. Windsor, No.12-307, 570 U.S. ___ 2013 WL 3196928 (June 26, 2013).
[2] Pub. L. 104-199 §3, codified at 1 U.S.C. §7.
[3] Hollingsworth v. Perry, No. 12-144, 570 U.S. ___, 2013 WL 3196927 (June 26, 2013).
[4] Perry v. Schwarzenegger, 704 F.Supp.2d 921 (N.D. Cal. 2010).
[5] Id. §(b)(2) (defining “divorce or separation instrument”).

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