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FAMILY LAW/TAX HUB: Congressional Tax Proposals and the Questionable Future of the Alimony Tax Deduc

The Family Law/Tax Hub

This posting will be dedicated to covering developments in taxation which intersect with issues of domestic relations law and/or individual and family financial planning.

This entry addresses four recent IRS pronouncements which serve as warning to the unwary and further demonstrate the effect that uncertainty over the legal definition of terms such as “family” and “marital status” continues to have in resolution of individual taxpayer matters before the Service. Yet, possibly the most significant domestic relations-related tax development of recent months comes off the front pages, namely, the Congressional tax proposals coming out of the House (“H.R.1”), and the Senate.

Traditionally alimony payments have been income tax deductible by the payor spouse (more aptly, ex-spouse), under IRC §71, and includible in the recipient spouse’s income (whereas child support payments are non-deductible). A possible rationale for this disparate treatment—whereas alimony derives theoretically from notions of economic partnership and the mutual entitlement to proceeds of that enterprise, a parent’s obligation for the support of a child pre-exists any court-ordered support obligation and thus applies equally in marriage, divorce and separation of the non-marital household. H.R.1 would make alimony non-deductible. The Senate proposal, by contrast, keeps the §71 alimony deduction. The proposed change would be prospective, but it would have an enormous impact in terms of existing statutory support guidelines such as those in place in New York, which utilize a formula approach to determine the amount of alimony payments. It would also deprive parties of a highly useful settlement tool, sometimes employed to shift income from the higher earning spouse to a spouse in a lower income tax bracket so as to maximize family resources. But, from a tax policy perspective, enabling this kind of income shifting is less than desirable in terms of maximizing revenue.

Moving away from tax policy, a recent interesting Tax Court Memorandum decision, issued on October 24, 2017, involved Taxpayer’s claim to her entitlement to the child dependency exemption for the grandchildren of her significant other residing in her household. This led Tax Court to consider whether TP fit within the legal/tax definition of the term “family”. T.C. Memo, 2017-208. The Tax Court decided that the child dependency exemption was properly disallowed. The children were neither “children” of Taxpayer nor linear descendants of her “children”. It further noted that TP was a California resident, which does not recognize common law marriage, and that the children were not legally the TP’s grandchildren—thus, a different result might be expected in a common law marriage state. TP’s claims to the child tax credit, earned income tax credit, and head of household status, were also disallowed.

Common law marriage was also the subject of an IRS Technical Advice Memorandum (“TAM”), decided May 1, 2017. In these circumstances, however, the parties resided in one of the few common law marriage states that remain (the particular state is left unnamed). The parties were deemed, after one of their deaths, to have been married for federal tax purposes (though they had never entered into a ceremonial marriage). This was because they were viewed as having entered into a common law marriage under the law of the state of domicile. TAM-104049-17. Thus, parties who never affirmatively opted for formalities of marriage during lifetime may still be subject to subsequent determination that they were married pursuant to common law marriage precedent of their jurisdiction of domicile.

Another U.S. Tax Court decision found Taxpayer-Husband was not entitled to relief from joint and several liability—even though his spouse with whom he had filed a joint return for the year in question had settled her liability through offer-in-compromise with the Service. The Court held that “he had remained married to his spouse”, and because of that fact and the fact that he had not joined in her application for relief on Form 656, his individual liability remained. T.C. Summary Opinion 2017-77.

The Taxpayer fared better in a recent Private Letter Ruling, which considered her request for relief from the 60-day roll-over requirement set forth in I.R.C. §408(d) (3) with respect to transfer of interest in an IRA incident to divorce. Taxpayer’s proffered explanation, accepted by the Service, was that such failure had been caused solely by her spouse’s failure to fulfill the legal requirements under the laws of her state during divorce proceedings. PLR 201742034, I.R.S. 7/24/17. N.B.—For taxpayers finding themselves in a similar predicament (that is having run afoul of the §408(d)(3) 60-day rule), the Service announced in 2016, a new self-certification procedure for taxpayers who inadvertently let the 60-day period lapse for certain retirement plan distribution roll-overs. See Rev. Proc. 2016-47.

For questions, or more information, contact: Jonathan K. Pollack

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