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Tax Issues 2007

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Presented by Brian C. Vertz, Esq., MBA, AVA for the National Constitution Center teleconference in 2007. Describes federal tax issues encountered in the context of divorce

Presented by Brian C. Vertz, Esq., MBA, AVA for the National Constitution Center teleconference in 2007. Describes federal tax issues encountered in the context of divorce

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  • 1. Tax Issues in Divorce: Traps for the Unwary! Brian C. Vertz, Esq., MBA, AVA BVSource.com Pittsburgh
  • 2. Syllabus Alimony – 15 minutes   Taxpayer Filing Status, Deductions, Exemptions and Credits – 10 minutes  Marital and Community Property – 15 minutes  Food for Thought – 5 minutes
  • 3. Alimony IRC § 71 – Alimony is taxable to recipient   IRC § 215 – Alimony is deductible to payor  8 Elements of Deductibility BVSource.com
  • 4. Alimony: 8 Elements of Deductibility Payment must be made in cash 1. Written order or agreement 2. Not designated as non-deductible 3. Spouses not living together 4. Must terminate upon payee’s death 5. Must not be designated as child support 6. Spouses must not file joint tax return 7. Must not be front loaded 8. BVSource.com
  • 5. Third Party Payments Must benefit the alimony recipient   Rent, tuition, auto loan, credit cards  Payments on a joint mortgage loan ½ alimony (payor pays recipient’s share)  ½ not alimony (payor pays own share)  Conflict with mortgage interest deduction? Utilities (even if joint)   Life insurance (if recipient is owner) BVSource.com
  • 6. Arrears and Voluntary Payments Is a letter an agreement?   Voluntary increase or extension of alimony  Payments made after support action is filed but before an order is entered  Arrears paid according to order or agreement  Agreement to recharacterize arrears BVSource.com
  • 7. Imputed Child Support Termination or modification of alimony  within 6 months of a child turning 18 or 21 or local age of majority  Modification on 2 or more occasions that are within 1 year of a different child attaining a certain age between 18 and 24 BVSource.com
  • 8. Illustration: Imputed Child Support 1/1/1991 1/1/1995 First Reduction Date Second Reduction Date Child’s Carl David Carl David Ages 20 yrs, 5 mo 18 yrs, 3 mo 24 yrs, 5 mo 22 yrs, 3 mo 1 year 19 yrs 21 yrs 17 yrs 19 yrs 23 yrs 25 yrs 21 yrs 23 yrs after/ 5 mo 5 mo 3 mo 3 mo 5 mo 5 mo 3 mo 3 mo prior Midpoint – 21 yrs, 4 months Less than one year apart for each
  • 9. Using Allocation to Settle Cases Alimony shifts tax burden from higher tax  bracket to lower tax bracket  Keeps more money “on the table” BVSource.com
  • 10. Unallocated Alimony/Child Support Imputed child support rules   Pivotal question: would payment continue after death of custodial parent?  Language of order or agreement  State support statute  Abatement of divorce action BVSource.com
  • 11. Termination Upon Death Johanson v. Com, T.C. Memo 2006-115   Marital settlement agreement silent  California law: “spousal support” terminates upon payee’s death BVSource.com
  • 12. Termination Upon Death II Kean v. Com, 407 F.3d 186 (3d Cir. 2005)   Support order silent  New Jersey law silent  New Jersey law: divorce abates upon death of a spouse BVSource.com
  • 13. Kean v. Com. “Where support payments are unallocated, as in this case, the  entire amount is attributable to the payee spouse’s income. Otherwise, we would be left with a situation in which the portion of the unallocated payment intended for the support of the payee spouse would be taxable to the payor spouse. This treatment of support payments is not accidental, and can benefit families going through a divorce. “By ordering the payor spouse to make an unallocated support  payment taxable in full to the payee spouse, the couple may be able to shift a greater portion of their collective income into a lower tax bracket. Consequently, an unallocated payment order not only frees the parents from restrictive court instructions that dictate who pays for what, but may allow the parties to enjoy a tax benefit at a time when they face increased expenses as they establish independent homes. This advantage would be lost by taxing all unallocated payments to the payor spouse.” BVSource.com
  • 14. Alimony Recapture Prevents divorcing spouses from  disguising their property settlements as tax-deductible alimony  Does not apply to temporary support  No recapture if:  Y2 ≥ Y1 - $7,500 ….and  Y3 ≥ Y2 - $15,000 BVSource.com
  • 15. Legal Fees Salesky - T.C. Memo 2006-162   Court ordered Husband to pay CF directly to Wife’s law firm  Husband claimed alimony deduction  NJ law: Obligation to pay CF terminates upon death of payee  Not tax-deductible BVSource.com
  • 16. Resources Publication 504, “Divorced or Separated  Individuals”  Frumkes on Divorce Taxation  Marjorie O’Connell, Divorce Taxation  CCH Family Law Tax Guide BVSource.com
  • 17. Taxpayer Filing Status, Deductions, Exemptions and Credits Qualifying as Head of Household   Separated Parents: Who Gets the Dependency Exemptions and Tax Credits  Separated Homeowners: Who Gets the Deductions BVSource.com
  • 18. Head of Household Must be divorced or separated 6 months   Must pay at least ½ cost of housing  Must have custody at least ½ of time  Must be eligible to claim dependency exemption (even if assigned to other parent) BVSource.com
  • 19. Married Filing Jointly Can aggregate certain deductions   No alimony deduction  Phase out of deductions  Hazard: joint liability  Innocent Spouse Relief  Separation of Liabilities  Equitable Relief BVSource.com
  • 20. Dependency Exemption Five Tests:   Relationship  Age  Citizenship/Residency  Principal Place of Abode  Support IRS Form 8332  BVSource.com
  • 21. Credits Child Tax Credit   Child Care Tax Credit  Earned Income Credit  Tuition Credits  Hope Scholarship  Lifetime Learning BVSource.com
  • 22. Mortgage Interest Deduction IRC § 163(h)(3)   Acquisition mortgage loan up to $1MM  Home equity mortgage loan up to $100K  “Qualified residence”  Principalresidence  1 other residence BVSource.com
  • 23. Tax Consequences of Marital and Community Property Property Transfers in Divorce   Distinguishing Pre-Tax from After-Tax Assets in Divorce  Quantifying After-tax Value of Property in Divorce BVSource.com
  • 24. Property Transfers in Divorce Non-recognition of income or gain upon  transfer  Retention of transferor’s basis BVSource.com
  • 25. Pre-tax or After-tax? Real Estate   Retirement Plans  Bank accounts  Stock, stock options, mutual funds  Life Insurance  Tangible Personal Property BVSource.com
  • 26. Quantifying After-tax Value Real Estate   Stocks, stock options  Defined contribution retirement plans  Defined benefit retirement plans BVSource.com
  • 27. Installment Payments Interest on Deferred Equitable Distribution  Payouts BVSource.com
  • 28. Food for Thought Tax Assets – Carryforwards   Tax Refunds  Forgiveness of Debt  Heavily Depreciated Assets  Indemnification Agreements BVSource.com
  • 29. Thank You! Brian C. Vertz, Esq., MBA, AVA  Pollock Begg Komar Glasser LLC Pittsburgh, PA  BVSource.com  Brian@BVSource.com BVSource.com