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Unmasking Today's Divorce Taxation Problems Part 2

7. Metro. Life Ins. Co. v. McDonald, ___ F. Supp. 3d ___, 2019 WL 2419659 (E.D. Mich. 2019)

(a) Facts: Husband wife were divorced in Florida. Their divorce decree incorporated a property settlement agreement providing that the husband would name the wife as beneficiary of his employer-provided life insurance.

Despite the agreement, the husband named his second wife as beneficiary of the policy. Upon his death, both wives claimed the proceeds, and the insurer filed an interpleader action in federal court.

(b) Issue: Who is entitled to the policy proceeds?

(c) Answer to Issue: The first wife.

(d) Summary of Rationale: ERISA generally prohibits the assignment of ERISA-regulated benefits, but not if the assignment is made in a QDRO. So the key question was whether the divorce decree, which incorporated the agreement, was a QDRO.

The decree expressly assigned benefits to the wife, and it did not require the plan to make payments that the employee had not earned. It stated the parties' full names. It did not state their mailing addresses, but it did state the address of the former marital home, which had not yet been sold at the time of divorce. Since the parties could actually be contacted through the home, their mailing addresses were effectively specified. The decree stated the amount assigned –100% of the policy proceeds, in one single payment.

The second wife argued that the decree did not expressly state the name of the plan. But it referred to "husband's General Motors Corporation life insurance policy." 2019 WL 2419659, at *3. The second wife noted that the husband had five or six other policies, but he had only one policy through General Motors. The agreement sufficiently indicated the name of the plan. Because the decree was a QDRO, ERISA's antiassignment provision did not apply.

The second wife argued that the insurance provision was not enforceable under state law. In contrast to most federal cases, including the Garcia and Christopoulos cases cited above, the court was willing to reach the state law issue. But the court rejected the state law argument on the merits. "The Court is unpersuaded that Florida law prevents divorcing spouses from agreeing to maintain one spouse as the primary beneficiary of the other's life‑insurance policy." Id. at *4.

Observations:

  1. Prudent parties do not gamble on whether a federal court will find after the fact that a divorce decree is a QDRO. The wife in McDonald should have insisted that the state court enter a formal QDRO directing the husband to name her as beneficiary. The wife is fortunate that the divorce decree met the QDRO requirements; many divorce decrees do not.
  2. The court made no reference to legislative history strongly suggesting that the address requirements are satisfied if the plan administrator actually knows the address from other sources:

    The Committee intends that an order will not be treated as failing to be a qualified order merely because the order does not specify the current mailing address of the participant and alternate payee if the plan administrator has reason to know that address independently of the order.

    S. Rep. No. 98-575, at 20 (1984), reprinted in 1984 U.S.C.C.A.N. 2547, 2566. But the court's emphasis on whether the administrator could actually contact the parties is quite consistent with the legislative history.

  3. The Florida state judge who entered the divorce decree obviously held that the insurance provision was permitted by Florida state law. It is unclear what authority a federal court would have to reach a contrary result. As Garcia and Christopoulos both held, ERISA was not intended to give federal courts appellate jurisdiction over state courts on issues of substantive state domestic relations law. The reference in ERISA to state domestic relations law was meant to ensure that state court orders are given under the color of state domestic relations law, not to give federal courts jurisdiction to question state court orders on questions of pure state law.
8. Schwartz v. Bogen, 913 F.3d 777 (8th Cir. 2019)

(a) Facts: Husband and wife were divorced in New Jersey in 1983. The divorce decree incorporated a settlement agreement. The agreement provided that if the wife remarried between 1986 and 1990, the husband would pay her, "as equitable distribution, a yearly sum equal to Twenty (20%) percent of [the husband's]'s Basic Bell System Management Pension Plan." 913 F.3d at 779. Since the divorce was in 1983, and the QDRO provisions were not added until 1984, no QDRO was ever obtained.

The wife remarried in 1989. The husband made voluntary payments to the wife until 2016. He then tried to argue that the payments were alimony that stopped upon the wife's remarriage. When the wife reject this argument, he then argued that the assignment of retirement benefits in the original decree violated ERISA.

A New Jersey state court found that the husband's claim was barred by laches. It further found that the payments were equitable distribution and alimony and that ERISA was not intended to prevent assignments to a spouse in need of support. The husband did not appeal the New Jersey ruling.

Instead, the husband filed a federal court action in Minnesota, arguing that the New Jersey pension division order was void. The District Court dismissed the action, finding that the New Jersey ruling was res judicata. The husband appealed to the Eighth Circuit.

(b) Issue: Was the New Jersey pension division order void?

(c) Answer to Issue: No.

(d) Summary of Rationale: The husband claimed that New Jersey had no jurisdiction to rule on issues involving ERISA. But he admitted that he did not raise this argument in New Jersey, and he admitted that he had fully participated in the New Jersey proceedings. While he did not argue lack of jurisdiction specifically, he did argue that ERISA preempted New Jersey state law, and the New Jersey court held otherwise. Its holding was binding under basic principles of res judicata.

Observation: It is quite difficult to question pension division orders in federal court after the exact same arguments have been made unsuccessfully in state court. As a practical matter, the decision to seek a state or federal remedy must be made when the case is filed. The remedy for a defeat in state court is an appeal to a higher state court, not a federal action.

9. Hoak v. Plan Adm'r of Plans of NCR Corp., 389 F. Supp. 3d 1234 (N.D. Ga. 2019)

(a) Facts: Two wives were divorced from their husbands. Both husbands were members of a senior executive retirement plan. The plan provided that survivor benefits would be paid to the "eligible spouse" of each plan participant. "Eligible spouse" was defined as "the spouse to whom the Participant is married on the date the Participant's benefit payments under the Plan commence." 389 F. Supp. 2d at 1278.

Each wife was married to the husband when their respective husbands' benefits commenced. Both wives were then divorced from their husbands. At some point after the two divorces, the employer terminated the plan and paid the benefits to the participating employees in a lump sum, thereby depriving the wives of their survivor benefits. It then formally reconstrued "eligible spouse" to mean a person married to a plan participant on the date when the plan was terminated, so that neither wife was entitled to survivor benefits. Both wives sued the plan, seeking a judgment that they were entitled to survivor benefits.

(b) Issue: Were the wives entitled to survivor benefits?

(c) Answer to Issue: Yes.

(d) Summary of Rationale: The courts defer to the plan administrator's construction of its own plan if the construction is reasonable. But the plan's construction of "eligible spouse" was not reasonable. "While the term 'Eligible Spouse' might be ambiguous standing alone, the definition of the term in the plan is not ambiguous: an Eligible Spouse is the spouse of the Participant on the day he begins to receive retirement benefits." Id. at 1279. "The Plan Administrator has impermissibly and unilaterally appended an additional requirement beyond what the Plan provides that adversely impacts the Plan's beneficiaries." Id. "The Plan Administrator's interpretation constitutes a material modification to the terms of the Plan that adversely impacts the expectations of beneficiaries who reasonably relied on the express language of the plans when they may have made decisions on their marital property division of at the end of their marriages." Id.

Obvious Lesson: Do not make changes to your company's pension plan for the purpose of taking rights away from former spouses of your employees. It seems quite possible that even if the employer had prevailed, its attorney's fees alone would have approached or exceeded the cost of paying the benefits. Since the company did not prevail, it was left liable for both the benefits and its attorney's fees –a very substantial sum. The actions of the company in Hoak were not wise business decisions.

Observation: Alternate payees under QDROs and spouses who are direct beneficiaries under the plan (as the wives were in Hoak) are members of the plan, and they have standing to sue the plan if deprived of plan benefits. A decision to sue the plan should not be made lightly, as such a suit is extremely expensive, and significant deference is given to the plan administrator's decisions. But when the plan starts denying benefits arbitrarily, there may come a point at which suing the plan is the only option. Hoak shows that it is not impossible for a former spouse to prevail in such an action.

10. In re Kiley, 595 B.R. 595 (Bankr. D. Utah 2018)

(a) Facts: Husband and wife were divorced in Utah. The divorce decree awarded the wife a lump-sum payment from the husband's retirement plan and ordered that she be named as the plan's survivor beneficiary.

The wife then declared bankruptcy. The trustee argued that the wife's interests in the retirement plan was property of the estate, subject to division among the creditors.

(b) Issue: Was the wife's interest in the plan part of her estate in bankruptcy?

(c) Answer to Issue: Yes as to the lump-sum payment, no as to the survivor benefits.

(d) Summary of Rationale: The wife's survivor benefits were an interest in a retirement plan regulated by ERISA. ERISA generally prevents the assignment of regulated benefits. Thus, the wife's survivor benefits were not part of her estate in bankruptcy.

The wife's lump-sum award was not an interest in a retirement plan after it was paid out. Thus, ERISA's antiassignment provision did not apply. Utah had a state law exemption for amounts received as an alternate payee, but federal law required the court to apply the exemptions as of the date on which the bankruptcy was filed. The bankruptcy was filed during the divorce case so that on the date of the bankruptcy filing, the wife was not yet an alternate payee. The wife's lump-sum award was therefore property of the estate.

Observations:

  1. The wife's lump-sum award was 100% of the plan balance –the husband was substantially in arrears in support, and he gave up his interest in the plan as payment of arrears –so it is unclear what remaining value the wife's survivor benefits would have.
  2. With regard to the lump sum, did the court reach the correct result? The federal court reasoned that the wife was not an alternate payee when the bankruptcy was filed, but at that time she had rights under an ERISA-regulated retirement plan that could not be assigned to another. The wife's payment was arguably protected at all times –before the decree as an unassignable interest in the plan and after the decree as benefits received by an alternate payee. The court's attempt to judge retirement plan status at one point in time, and alternate payee status at another point in time, is open to question.
I.R.C. § 152

1. General Rule.

A tax exemption is provided for each "qualifying child." A qualifying child must have "the same principal place of abode as the taxpayer for more than one‑half of such taxable year" and must have "not provided over one‑half of such individual's own support for the calendar year in which the taxable year of the taxpayer begins." I.R.C. § 152(c)(1)(B), (D). There is also a relationship requirement and an age requirement.

For divorced parents, the deduction may be taken despite the principal place of abode requirement if the exemption is transferred. A transfer is made when "the custodial parent signs a written declaration (in such manner and form as the Secretary may by regulations prescribe) that such custodial parent will not claim such child as a dependent" for that tax year and "the noncustodial parent attaches such written declaration to the noncustodial parent's return for the taxable year beginning during such calendar year." Id. § 152(e)(2). In addition, the following requirements must be met:

(A) a child receives over one‑half of the child's support during the calendar year from the child's parents –

(i) who are divorced or legally separated under a decree of divorce or separate maintenance,

(ii) who are separated under a written separation agreement, or

(iii) who live apart at all times during the last 6 months of the calendar year, and –

(B) such child is in the custody of 1 or both of the child's parents for more than one‑half of the calendar year[.]

Id. § 152(e)(1). The IRS has determined that the written declaration necessary to transfer the exemption shall be IRS Form 8332.

A tax exemption is also provided for each "qualifying relative." Id. § 152(d). A qualifying relative need not live with the taxpayer for more than one-half of the year. But the taxpayer must still provide more than one-half of the relative's support during the applicable tax year, and the relative's gross income must be less than the amount of the standard personal exemption. There is a relationship requirement, and a qualifying relative must not be the qualifying child of any taxpayer. There is no age requirement.

2. Statutory Changes

(a) The child dependency exemption remains in the Internal Revenue Code. But "[i]n the case of a taxable year beginning after December 31, 2017, and before January 1, 2026... [t]he term 'exemption amount' means zero." I.R.C. § 151(d)(5)(A).

Thus, for tax years 2018 to 2025 inclusive, the dependency exemption has no value. The exemption has not been repealed or eliminated; its amount has simply been reduced to zero. The question of transferring the exemption has become less important; there is no direct benefit to transferring the exemption. But there might be an indirect benefit.

3. Child Tax Credit

There shall be allowed as a credit against the tax imposed by this chapter for the taxable year with respect to each qualifying child of the taxpayer for which the taxpayer is allowed a deduction under section 151 an amount equal to $1,000.

I.R.C. § 24(a). This section gives a tax credit (not a deduction) to every "qualifying child" of the taxpayer. "Qualifying child" is defined in I.R.C. § 152, the same section that governs the dependency exemption.

Courts and commentators before 2018 commonly spoke of transferring the dependency exemption. But what § 152(e) really does is to authorize the transfer of a right to claim "qualifying child" status. Before 2018, the primary financial consequence of "qualified child" status was the dependency exemption. Starting in 2018, the primary financial consequence of "qualifying child" status is the child tax credit.

There are not yet any cases on point because the new changes took effect only in the 2018 tax year. But it appears that if Form 8332 is filed, and "qualifying child" status is therefore validly transferred, the transferee parent will have not only the right to claim the zero-value dependency exemption but also the right to claim the child tax credit.

"The child tax credit goes hand‑in‑hand with the dependency exemption, which means that it can be assigned (using IRS Form 8332) between parents who are divorced, separated or unmarried." Brian Vertz, "Get the Child Tax Credit for Divorced, Separated or Unmarried Parents in 2018," https://familylawtaxalert.com/child‑tax‑credit‑divorced‑separated‑unmarried‑2018.

Pre-2018 case law supports this construction. For example, in George v. Commissioner, 139 T.C. 508 (2012) (discussed fully in the 2013 version of this outline), the Tax Court held that Form 8332 had been properly filed. It then held that the mother, who signed the Form and transferred the dependency exemption, could not claim either the exemption or the child tax credit; both had been transferred away. See also IRS Publication 596, at 14 ("A child will be treated as the qualifying child of his or her noncustodial parent (for purposes of claiming an exemption and the child tax credit [if the standard requirements are met and] [t]he custodial parent signs Form 8332[.]" (emphasis added)).

The amount of the exemption is now zero, but Form 8332 transfers more than just the exemption; it transfers the right to claim "qualifying child" status. If Form 8332 is filed, therefore, the right to claim the child-care tax credit is also transferred, and the value of the child-care tax credit is much more than zero.

Indeed, the amount of the tax credit is doubled, from $1,000 to $2,000, for tax years 2018 to 2025, inclusive.

It could be argued in response that the actual text of Form 8332 speaks of transferring the exemption. But pre-2018 case law still held, e.g., George, that when Form 8332 is filed, both the exemption and the child tax credit are transferred. There is no logical reason why the result should be different merely because the value of the tax exemption has been reduced to zero. In other words, the reduction in value of the exemption does not change prior law holding that Form 8332 also transfers the child tax credit.

But this issue will remain less than 100% certain until authoritative guidance is provided by the IRS or the courts.

It could also be argued that where the underlying state court order speaks only of transferring the dependency exemption, perhaps there is no basis under state law for finding that the child tax credit has been transferred. But federal law was clear before 2018 that Form 8332 transferred both the exemption and the credit. E.g., id. Once again, the form really transfers "qualified child" status. Thus, if a state court order requires the filing of Form 8332 –and that is the only way to transfer the exemption –then the same form also, by operation of federal law, also transfers the credit.

Perhaps it will be possible to get state courts to distinguish more carefully between the exemption and the credit under post-2018 law. But the expanded tax credit under post-2017 law is really a form of replacement for the pre-2018 dependency exemption, so it seems more likely that state courts will consider the exemption and the credit as two different but similar ways in which federal tax gives a tax benefit to those who spend time and money taking care of children, and then allows transfer of that tax benefit between divorcing parents.

The practical effect of the tax credit given by I.R.C. § 24 is, of course, much greater than a tax deduction of similar size. The credit is a direct offset against taxes otherwise due.

4. Proposed Regulations

In early 2017, the IRS announced a proposed revision of the regulations under I.R.C. § 152. See 82 Fed. Reg. 6370 (Jan. 19, 2017). As of this writing, these proposed regulations have neither been finalized nor formally withdrawn.

In the Demar case discussed infra, the court gave at least limited weight to the proposed regulations and seemed to suggest that it might be open to treating the regulations as persuasive (although of course not binding) guidance on open questions. Ultimately, however, the court decided that the regulations had not been complied with, so the point was moot.

The main divorce-related change made by the proposed regulations will be discussed below, in the context of the Demar case.

5. I.R.S. Notice 2018-70

In late 2018, the IRS released I.R.S. Notice 2018-70, 2018‑38 I.R.B. 441. The notice states that the IRS intends to issue new regulations under I.R.C. § 152, addressing the effect of the above statutory changes. No proposed regulations have actually been introduced as of the present writing.

Given that new regulations are coming, the IRS may well allow the 2017 proposed changes to remain in proposed status for the time being and then combine them into the forthcoming new regulations.

The Notice discusses current law for several pages and then states that "[b]efore the issuance of the proposed regulations described in this notice, taxpayers may rely on the rules described in section 3 of this notice." Id. § 4. The Notice is therefore official guidance on the effect of tax reform on § 152.

Two points in the Notice are noteworthy. First, the IRS notes that under current law, "the term 'exemption amount' means zero, thereby suspending the deduction for personal exemptions." Id. § 2. Use of the word "suspending" confirms the suggestion made above that the exemption continues to exist for a host of secondary purposes, even though the exemption itself has no present value.

Second, the Notice addresses a real problem with the definition of a qualifying relative. One requirement in that definition, as noted above, is that the relative's gross income must be less than the amount of the standard personal exemption. Since the value of the personal exemption is now zero, a literal construction of the statutory language would render it functionally impossible for anyone to be a qualifying relativeCthe relative would have to have negative gross income. The IRS does not believe that this is what Congress intended:

Construing § 152 in light of the structure of the statute, the Treasury Department and the IRS believe that the exemption amount referenced in that section must be $4,150 (adjusted for inflation), rather than zero, for purposes of determining who is a qualifying relative.

Id. § 3.

A zero exemption amount would thus effectively render § 152(d)(1)(B) inoperable and eliminate an entire category of dependents. The Treasury Department and IRS do not believe Congress intended to make such a significant change in such an indirect manner.

Id.

In short, the exemption amount will be treated as zero only for purposes of the exemption itself. For purposes of other provisions referring to the exemption amount, the former amount will be used, as indexed for inflation.

6. Cook v. Comm'r, T.C. Memo. 2019‑48, 2019 WL 2011087 (2019)

(a) Facts: An unmarried couple had a child. A New York court awarded custody to the mother. The order was silent on the tax exemption for the child. The parties orally agreed that the father could claim the exemption.

The father took the exemption. The IRS disallowed the exemption and assessed a deficiency. The husband appealed to the Tax Court.

(b) Issue: Was the husband entitled to claim the exemption?

(c) Answer to Issue: Clearly not.

(d) Summary of Rationale: The child was not a qualifying child of the father because the child did not live with the father for more than half of the year. "Despite the oral agreement between petitioner and Mrs. Taylor and petitioner's related assertions, the statute is clear that, because petitioner is C.D.C.'s noncustodial parent, C.D.C. cannot be his qualifying child." 2019 WL 2011087, at *2.

The child could not be the father's qualifying relative because the child was the mother's qualifying child.

The mother could have transferred the exemption to the father, but only if she gave the father Form 8332 or its substantial equivalent and he attached the form to his return. The mother did not give the father the form. The father argued that the mother had no income and could not use the exemption, but that is not the test; the test is whether Form 8332 was filled out and filed. Plainly, it was not.

Observations:

  1. The only way to transfer the exemption is Form 8332 or its substantial equivalent. The oral agreement of the parties was not a sufficient substitute.
  • Cook was not a difficult case, and it is hard to see how the taxpayer could reasonably have hoped to prevail.
  • 7. Skitzki v. Comm'r, T.C. Memo. 2019‑106, 2019 WL 3946102 (2019)

    (a) Facts: Husband and wife were divorced. The divorce decree gave the father custody two weekends each month, one weekday per week if the mother was in Ohio, and three (before age four) or four weeks in the summer. It described both parents as "residential parent and legal custodian." The decree further stated that the father "shall take" the child as a dependent for tax purposes in even-numbered years.

    Three years later, the decree was modified so that the father would have the child every other week and every other holiday. Four months later, another modification gave the father custody 6 out of every 14 nights during the school year and every other week in the summer. The father provided more than half of the child's support; the child resided more than 50% of the time with the mother.

    For tax year 2014, both parents claimed the dependency deduction. The mother did not sign Form 8332. The IRS disallowed the father's deduction and assessed a deficiency. The father appealed to the Tax Court.

    (b) Issue: Was the father entitled to the dependency exemption?

    (c) Answer to Issue: Clearly not.

    (d) Summary of Rationale: The child was not the father's qualifying child as the child resided with the mother for more than half of 2014. The child was not the father's qualifying relative as the child was the mother's qualifying child.

    The divorce decree awarded the exemption to the father. But again, the only way to transfer the exemption is to file Form 8332. A state court order alone is not sufficient.

    The father argued that the divorce decree was the substantial equivalent of Form 8332. But to be a substantial equivalent of Form 8332, a document "must be a document executed for the sole purpose of serving as a written declaration." Treas. Reg. § 1.152‑4(e)(1)(i). The divorce decree was not executed for the sole purpose of transferring the exemption. It was therefore not the substantial equivalent of Form 8332.

    Observations:

    1. Again, Form 8332 is the only way to transfer the exemption. If there is no Form 8332, there is no transfer. The law is as simple as that.
  • The tax regulations have provided for years that a document cannot be the substantial equivalent of Form 8332 unless it is executed for the sole purpose of transferring the exemption. That means that divorce settlement agreements and divorce decrees are never the substantial equivalent of Form 8332. Federal law on this point is completely settled, and yet Tax Court reports are still full of cases in which parties argue to the contrary. Only Form 8332 can transfer the exemption.
  • Given the previous point, the proper procedure is simple. The noncustodial parent should never claim the exemption without Form 8332. If the custodial parent has been ordered to transfer the exemption and will not sign the form, the remedy is a contempt petition in state court. The exemption is not transferred unless the custodial parent signs the form.
  • There is a reasonable argument that federal law on this point is too strict. But that is an argument for changing a very well-settled rule of tax law. The argument must be made in Congress, not in the courts.
  • Skitzki was not a difficult case, and it is hard to see how the taxpayer could reasonably have hoped to prevail.
  • The IRS is very good at detecting situations in which both parties claim the dependency exemption on their tax returns. It is highly likely in this situation that one of the exemptions will be disallowed.
  • 8. Demar v. Comm'r, T.C. Memo. 2019‑91, 2019 WL 3244301 (2019)

    (a) Facts: Husband and wife were divorced. The divorce decree, which was a consent judgment, provided that the child would reside primarily with the wife. The husband was permitted to claim the child as a dependent for tax purposes in odd-numbered years but only if he was current on child support and the wife's income was less than $15,000. "If these conditions were met, Ms. DeMar agreed to execute Form 8332 or a similar written declaration." 2019 WL 3244301, at *1.

    Both parties claimed the exemption on their 2015 returns. The IRS disallowed the husband's exemption and assessed a deficiency. After the husband received the notice of deficiency, the wife executed Form 8332 after the fact, but the form was obviously not attached to the husband's return. The husband challenged the deficiency in the Tax Court.

    (b) Issue: Was the husband entitled to claim the exemption?

    (c) Answer to Issue: No.

    (d) Summary of Rationale: The husband did not contest that the child was not a qualifying child. Thus, the husband could claim the exemption only if he attached Form 8332 to his return. But he did not do that. Therefore, he could not claim the exemption.

    The husband's belated filing of Form 8332 was not sufficient:

    The current regulations do not explicitly allow (or prohibit) Form 8332 or a similar written declaration to be submitted during examination or with an amended return. Sec. 1.152‑4, Income Tax Regs. A proposed regulation explicitly permits a noncustodial parent to submit Form 8332 or a similar written declaration during examination or with an amended return. Sec. 1.152‑5(e)(2)(i), Proposed Income Tax Regs., 82 Fed. Reg. 6387 (Jan. 19, 2017). But that regulation requires that the custodial parent either did not claim the dependency exemption or filed an amended return removing the claim to the dependency exemption. Id. We have no such facts in the record.

    Id. at *2.

    Observations:

    1. Many, many parties fail to file Form 8332. Current federal tax law on transfer of the exemption is in many ways a trap for the unwary: The requirements are so counterintuitive that taxpayers regularly fail to meet them.

    2. At a minimum, the reform proposed in the Regulations should be adopted –the law should permit a noncustodial parent to file Form 8332 after the fact.

  • The reform proposed in the Regulations is not sufficient, because the custodial parent is unlikely to file an amended return. There should be a way to file Form 8332 after the fact even if the noncustodial parent has not filed an amended return. To allow a late filing only after the filing of an amended return is functionally to reject the late filing in most cases.
  • There is also, as noted above, a strong argument for amending federal law on Form 8332 generally. The law is imposing too many obstacles on parents who wish to transfer the exemption. An unacceptably high number of transfer attempts fail for technical reasons. If the law is going to permit the transfer of the exemption, it should not impose procedural requirements that are so difficult to meet.
  • That having been said, present law is clear, and there is no excuse for not complying with it.
  • Note that the state court imposed conditions on the transfer of the exemption. The IRS consistently takes the position that the exemption can only be transferred without conditions. In particular, yet another perennial problem with transferring the exemption is the requirement that the noncustodial parent be current on child support. The IRS is not a child support collection agency; it has no way to know whether the noncustodial parent is current on child support.
  • The state court in Demar appears to have handled this issue exactly correctly; it ordered the wife to sign Form 8332 if the requirements were met. That is entirely proper; the wife would know whether the father is current in support. But the courts should not expect the IRS to know whether the noncustodial parent is current on support. The IRS does not have that information.

    I.R.C. § 6015 1. General Rules

    (a) When the parties file a joint tax return, they are generally jointly liable for any tax problem, and the IRS is free to collect the full amount owed from either of them. I.R.C. § 6015(d)(3)(A).

    (b) Section 6015 allows either spouse to petition for innocent spouse relief. If relief is granted, the innocent spouse is not liable for the tax problem.

    (c) There are three types of innocent spouse relief:

    (1) Under I.R.C. § 6015(b), the IRS must grant innocent spouse relief if "the other individual filing the joint return establishes that in signing the return he or she did not know, and had no reason to know, that there was [a tax] understatement" and "it is inequitable to hold the other individual liable for the deficiency." Id. § 6015(b)(1)(C), (D).

    (2) Under I.R.C. § 6015(c), the IRS must grant innocent spouse relief from a tax understatement if the innocent spouse is legally separated or divorced from the other spouse or was separated from the other spouse for 12 months at the time innocent spouse relief was requested. There is an exception if the IRS proves that the allegedly innocent spouse had actual knowledge of the tax problem, and there is an exception to the exception if the joint tax return was filed under duress. Relief is allowed only as to understatements attributable to the income of the other spouse.

    (3) Under I.R.C. § 6015(f), the IRS may grant innocent spouse relief if "it is inequitable to hold the individual liable for any unpaid tax or any deficiency (or any portion of either)" and relief is not available under § 6015(b) or (c).

    (d) The former two types of relief are known generally as mandatory innocent spouse relief, and the last type of relief is known generally as discretionary innocent spouse relief.

    2. Background and Statute of Limitations

    (a) A two-year statute of limitations applies to mandatory innocent spouse relief; relief must be requested within two years of the filing of the return. There is no express statute of limitations for discretionary innocent spouse relief.

    (b) By regulation, the IRS ruled that the two-year limitations period on requests for mandatory innocent spouse relief under § 6015(b) and (c) also applies to § 6015(f). Treas. Reg. § 1.6015-5(b)(1).

    (c) The Tax Court, sitting en banc, held that the regulatory statute of limitations violated § 6015 and was invalid. Lantz v. Comm'r, 132 T.C. 131 (2009). Lantz was reversed on appeal, Lantz v. Comm'r, 607 F.3d 479 (7th Cir. 2010), but the reversal applied only in the Seventh Circuit. The Tax Court held in Hall v. Commissioner, 135 T.C. 374 (2010), that the Seventh Circuit was wrong and that it would continue to follow Lantz in cases arising outside of the Seventh Circuit. At least two other Circuits then agreed with the Seventh Circuit that the regulatory limitations period was within the IRS's authority. See Mannella v. Comm'r, 631 F.3d 115 (3d Cir. 2011); Jones v. Comm'r, 642 F.3d 459 (4th Cir. 2011).

    (d) Congress was not happy, and there was a strong bipartisan move to reject the regulatory statute of limitations. Legislation was introduced stating expressly that there should be no limitations period on requests for discretionary innocent spouse relief. See H.R. 1450, 112th Cong. (2011). There was particular concern that many innocent spouses could not meet the two-year deadline because they were kept in financial ignorance by the other spouse and perhaps even subject to physical abuse for trying to learn more about finances and taxes.

    (e) The IRS blinked. InI.R.S. Notice 2011‑70, 2011‑32 I.R.B. 135, it announced that it would no longer apply the regulatory two-year statute of limitations. The notice applies retroactively and even permits reconsideration of certain requests previously denied. The spouse who started the whole issue rolling, the wife in Lantz, was ultimately granted innocent spouse relief. See http://www.nytimes.com/2012/02/12/business/yourtaxes/innocent‑spouses‑get‑more‑relief‑ from‑irs.html. But see Haag v. United States, 736 F.3d 66, 67 (1st Cir. 2013) (IRS may deny retroactive relief where case was fully litigated before Notice 2011-70, and IRS did not stipulate that the request was denied solely due to untimeliness).

    (f) The notice states that the IRS will revise Treas. Reg. § 1.6015-5(b)(1) in a manner consistent with the notice. Proposed regulations were published in 2013, see 78 Fed. Reg. 49242‑01 (Aug. 13, 2013), and the proposal was revised in 2015, see 80 Fed. Reg. 72649‑01 (Nov. 20, 2015), but no final regulation has been published as of this writing.

    (g) The basic framework for resolving requests for discretionary innocent spouse relief was set forth in Revenue Procedure 2003-61,2003‑32 I.R.B. 296. In I.R.S. Notice 2012-8, 2012‑4 I.R.B. 309, the IRS announced that it would issue a new Revenue Procedure setting forth a revised test. A tentative Revenue Procedure was attached for public comment. The proposed changes generally made the law more sensitive to claims of fraud and abuse by dominant spouses.

    (h) The Tax Court held that the proposed new language was only proposed, and it continued to apply Revenue Procedure 2003-61. See Yosinski v. Comm'r, T.C. Memo. 2012‑195, 2012 WL 2865808, at *4 n.9 (2012).

    (i) The new framework was formally published as Revenue Procedure 2013‑34, 2013‑43 I.R.B. 397on October 21, 2013.

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