Until Death and Taxes Do Us Part
Essential Tax Planning
Before, During, and After a Texas
Divorce
By
Carol A. Cantrell & Derek Matta
Reasons for Tax Planning Before
Marriage
• Asset protection
• Past or future assessment
2
Joint v. Separate Returns
• Married individuals may file joint or
separate returns. Once they file jointly,
they may not change for that year. Reg. §
1.6013-1(a).
• Both spouses are jointly and severally
liable for the entire tax shown on a joint
income tax return. IRC § 6013(d)(3).
3
Joint v. Separate Returns
• If spouses file separately, each must
report one-half of the community
property income and deductions on their
separate return, unless they live apart for
the entire year. IRC § 66.
• New Form 8958 is used to allocate each
spouse’s income and deductions when
they file separately.
4
Joint v. Separate Returns
• If all income and deductions are reported
one-half by each spouse, the combined tax on
two separate returns is identical to the tax on
a joint return.
• However, if each spouse reports only “his” or
“her” income, their combined tax liability is
nearly always more than the tax on a joint
return. The more disparate their income, the
more the tax.
• Even though they pay more tax, it may be
cheaper in the long run to file separately.
5
Tax Impact of Obergefell v. Hodges
• For federal tax purposes, the terms “spouse,”
“husband and wife,” “husband,” and “wife”
include an individual married to a person of
the same sex. Rev. Rul. 2013-17.
• The IRS recognizes common law marriages
recognized under state law. Rev. Rul. 58-66.
• Same sex couples should consider filing a
joint return for the three open tax years. IRC
§ 6013(b)(2).
6
What is a Spouse’s “Separate”
Tax?
• Tax shown on a single or married filing
separate return.
• Tax incurred before marriage.
• Tax as reallocated by the IRS under
community property laws. IRC § 66.
• Unpaid employment taxes from a trade or
business managed and controlled by a
spouse. Reg. § 1.1402(a)-8.
7
What Can the IRS Seize?
• The IRS may seize all property and rights
to property belonging to a person who
owes taxes. IRC § 6321.
• Property rights are determined under state
law. U.S. v. Nat’l Bank of Comm., 472
U.S. 713 (1985).
8
What Can the IRS Seize?
• The IRS can seize all of a liable spouse’s
separate property plus their one-half interest in
community property.
• This applies whether the property is sole or
joint management, real or personal, income or
assets, and regardless of any state law
exemptions. Broday v. U.S., 455 F.2d 1097 (5th
Cir. 1972); Medaris v. U.S., 884 F.2d 832 (5th
Cir. 1989).
9
Marital Property Agreements
• A pre-nuptial agreement is effective
against the IRS to protect the separate
property income and assets of a “nonliable” spouse. Calmes v. U.S., 926 F.
Supp. 582 (N. D. Tex. 1996).
• Post -nuptial agreements are also
effective unless they are executed after a
federal tax lien arises.
10
Trust Income
• Trust distributions are generally separate
property of the beneficiary and not subject to a
spouse’s separate tax liability. Sharma v. Routh,
302 S.W.3d 355 (Tex. App. ─Houston [14th
Dist.] 2009, no pet.)
• Ideally, the trust should be irrevocable, contain
a spendthrift clause, the beneficiary should not
have a right to corpus distributions, and should
not be trustee. Benavides v. Mathis, 433 S.W.3d
59 (Tex. App.—San Antonio, 2014, pet denied)
11
Trust Income
• Marital property agreements can clarify
whether trust distributions are income or
principal of the beneficiary.
• The definition of trust income may be
modified by judicial determination or by
a decanting. Tex. Prop. Code §§ 112.054,
112.071-.087.
• When drafting trusts, give the trustee
broad discretion to determine income.
12
Dividing the Family Partnership
• Partnership distributions are community
property.
• Never divide a partnership between spouses
when one spouse controls the partnership.
• The transferee spouse becomes an assignee.
• If the other spouse has dominion and control
over the partnership interest transferred, the
transferee spouse may not be required to report
the K-1 income from the partnership.
13
Injured Spouse Relief
• When a joint refund is seized by the IRS and
applied to your spouse’s past due liabilities:
• Requirements
• File a joint tax return with knowledge that all
income and expenses accurately reported
• Part or all of the overpayment has been applied
to past due debts of spouse
• Form 8379 Injured Spouse Allocation
14
Tax Considerations of Divorce
15
Areas of Concern
•
•
•
•
•
IRS not bound by divorce decree
How to file a tax return during divorce
Potential tax assessments
Liens filed after divorce
Section 71 Alimony and temporary spousal
support orders
16
Innocent Spouse Protection
17
IRC § 6015
Should a spouse who merely signed a joint return
be held liable for the errors on the return
attributable to the other spouse especially when
the couple has divorced and the innocent spouse
is the only source for collection for the unpaid
taxes .
18
IRC § 66
• Section 66 provides relief from income tax
liability resulting from the operation of
community property law to taxpayers
domiciled in a community property state who
do not file a joint return and do not reside
together during the calendar year.
19
Types of Relief
•
•
•
•
Innocent spouse relief – Sec. 6015(b)
Separation of liability – Sec. 6015(c)
Equitable Relief – Sec. 6015(f) and 66(c)
Publication 971 – Innocent Spouse Relief
20
Section 6015(b) – Innocent Spouse
Relief
• Requirements
• Joint return made for tax year
• Return has an understatement of tax
attributable to erroneous items of one spouse
• The innocent spouse established in signing the
return that he/she did not know or have reason
to know of the understatement
• Under all facts/circumstances, it would be
inequitable to hold the innocent spouse liable
21
“Knowledge” of Understatement
• Innocent spouse has the burden of proof
• Reasonable person test
• Factors: Resner v. Commissioner, 112 F3d 1258
(5th Cir. 1997)
a. Level of education
b. Involvement in financial affairs/business
c. Presence of unusual/lavish expenditure
d. Culpable spouse’s deceit/evasiveness
e. Abuse or threats of violence
22
Presence of Unusual/ Lavish
Expenditures
• Sanders v. U.S., 509 F.2d 162 (5th Cir. 1975)
• One person’s luxury is another person’s
necessity
• A high standard of living does not put a spouse
on notice of omissions from the tax return.
23
IRC § 6015(c)
•
•
•
•
•
•
Separation of Liability Relief Requirements
Filed a joint tax return
No longer married or are legally separated
Not a member of same household
Burden of proof is on the taxpayer
Actual knowledge of understatement
disqualifies from relief
24
Equitable Relief
• I.R.C. § 6015(f) AND 66(c)
• if taking into account all the facts and
circumstances, it is inequitable to hold the
individual liable for any unpaid tax or any
deficiency (or any portion of either) ... the
Secretary may relieve such individual of such
liability
25
IRC § 6015(f) Equitable Relief
•
•
•
•
•
•
Revenue Procedure 2013-34 – 6 conditions
A joint return was filed
Relief not available under Sec. 6015(b) or (c)
Claim for relief must be timely
No fraudulent asset transfers
Requesting spouse must not have participated in
filing fraudulent joint return
• Tax liability attributable to item of income from
non requesting spouse
26
Equitable Relief
• Factors to be considered:
• (1) Marital status, (2) Economic hardship, (3)
Knowledge or reason to know, (4) Legal
obligation, (5) Significant benefit, (6) Compliance
with income tax laws, and (7) Mental or physical
health. The Taxpayer bears the burden of proving
that she meets the conditions for innocent spouse
relief. Haggaerty v. Commissioner, 111 AFTR 2d.
2013-411 (5th Cir. 2013)
27
Steps for Innocent Spouse Relief
• Form 8857 – Request for Innocent Spouse
Relief
• IRS Center in Covington, Kentucky
• Documents are the key
• Former spouse can contest relief
• Appeals consideration
• Tax Court
28