Posts by Joseph W. Cunningham, JD, CPA

April 2015 : Four Federal Income Provisions Relating to Divorced or Legally Separated Parents Providing Child Support

Posted by Joseph W. Cunningham, JD, CPA
Michigan Family Law Journal : TAX TRENDS AND DEVELOPMENTS Feature

by Joseph W. Cunningham, JD, CPA

Excerpt:

The following presents basic information on four federal income provisions relating to divorced or legally separated parents providing child support for one (or more) dependent child. These provisions (1) often provide significant tax savings – particularly to parties of modest means – and (2) are often overlooked by divorce counsel who can provide a valuable service by advising clients to check to see if they qualify for any of such tax benefits.

Dependency Exemptions General Rule

IRC Section 152(e) provides that if the parents, on a combined basis, (1) provide more than half a child’s support for the year and (2) have physical custody for more than half the year, then the parent having physical custody for more than half the year (the custodial parent) is entitled to the exemption.

The custodial parent may “release” the exemption to the other parent by executing a written waiver for (1) one year, (2) a specific number of years, or (3) all future years. IRS Form 8332 is the waiver that the custodial parent must execute to release the exemption. e non-custodial parent must attach the executed Form 8332 to his/her tax return for the year(s) for which the exemption has been released.

Other Aspects of the Dependency Exemption

  • The above applies to parents living apart for the last six months of the year as well as to divorced or legally separated parents.
  • “Physical custody” for more than half the year is deter- mined based on overnights. If overnights are equal, the parent with the higher adjusted gross income is deemed the custodial parent.
  • The waiver can be used to, effectively, provide that the parents will claim the exemption in alternating years.
  • Support provided by a parent’s new spouse, or his/her parents, is deemed provided by the parent.
  • The custodial parent may revoke the waiver by executing Part III of Form 8332. Such a revocation applies to the succeeding tax year.
  • The federal income tax exemption amount is $4,000 for 2015.

Phase-Out of the Tax Benefit of Personal and Dependency Exemptions

The tax benefit of personal and dependency exemptions is phased out for high income taxpayers.

The adjusted gross income (AGI) amounts at which the phase-out applies are as follows for 2015:
(Table shown in PDF below)

A taxpayer’s deduction for personal and dependency exemptions is reduced by 2% for each $2,500, or fraction thereof, that his/her AGI exceeds the above threshold amounts.

Example: A single individual has a $300,000 AGI. In addition to his personal exemption, his ex-wife has released the dependency exemption to him for their minor child who lives with her. The phase-out works as follows:

  • Two exemption deductions unreduced – 2 x $4,000 = $8,000
  • Number of $2,500 amounts, or a fraction there- of, by which AGI exceeds threshold – $300,000 – $258,2500/$2,500 = 17
  • Percent reduction in exemption deduction – 2% x 17 = 34%
  • Reduced exemption deductions – 100% – 34% = 66% x $8,000 = $5,280

Practice Pointers
…..

Continued in PDF file below… “Four Federal Income Provisions Relating to Divorced or Legally Separated Parents Providing Child Support”
View / Download April 2015 Article – PDF File

Complete Michigan Family Law Journal available at: Michigan Bar website – Family Law Section (subscription required)

Read More “April 2015 : Four Federal Income Provisions Relating to Divorced or Legally Separated Parents Providing Child Support”

March 2015 : Overview of the Division of Retirement Benefits in Divorce – Part 1

Posted by Joseph W. Cunningham, JD, CPA
Michigan Family Law Journal : TAX TRENDS AND DEVELOPMENTS Feature

by Joseph W. Cunningham, JD, CPA

Excerpt:

Introduction

  1. Under Michigan law, every judgment of divorce (JOD) must provide for the rights of the parties to both vested and unvested pensions, annuities, and retirement benefits. MCL 552.101(4)
    1. Vested benefits must be taken into account in property settlements. MCL 552.18.
    2. Unvested benefits may be considered “where just and equitable.” MCL 552.18
  2. Age of specialization
    1. Certainly applicable to handling retirement benefits in divorce.
    2. Many traps for the unwary
  3. As with taxation, the key is awareness of issues
    1. Obtain necessary knowledge or assistance
    2. Better serves clients and avoids unpleasant surprises down the road

Defined Benefit (DB) Plans

  1. DB Plans – Traditional pensions – Monthly payment for life often based on (1) final average compensation, (2) years of service, and (3) plan formula.
    1. E.g., $3,500 a month for life.
    2. Many units of government and large employers – such as the “Big 3 Automakers” – have DB plans.
    3. But, the trend is definitely to defined contribution (DC) – or, “account balance” plans, such as 401(k) plans.
  2. Division of interests in DB plans is achieved via (1) offset method or (2) deferred division.
    1. Offset method involves (1) determining the present value of the pension and (2) awarding the other party property equal value. E.g., The after-tax, present value of W’s pension is $50,000. H shall receive $50,000 of other property as an offset.
    2. Deferred division refers to actually splitting the marital portion of the pension between the parties pursuant to a Qualified Domestic Relations Order. E.g., H and W will equally share his $4,000/month pension by means of assignment of half of his share to W pursuant to a QDRO.
  3. Offset method – Valuation
    1. Many professionals calculate the present value of a pension by using the discount rates published and updated monthly by the Pension Benefit Guaranty Corporation (PBGC).
      1. The PBGC, a federal government agency, uses the rates for the same purpose–that is, to determine the present value of future pension payments.
      2. The updated monthly rates can be accessed at the PBGC website (www.pbgc.gov) by clicking on “Practitioners.”
    2. Generally, it is appropriate to reduce the present value of the pension by the tax rate to which it will be subject when it becomes payable after retirement.
      1. Rationale – The pension cannot be used in any beneficial way until received, at which time it is taxable.
      2. The federal and state tax rates used to “tax affect” retirement benefits are those projected to apply after retirement.
      3. Because of the certainty of taxation, case law supports valuing retirement interests net of future tax. Nalevayko v Nalevayko, 198 Mich App 163, 497 NW2d 533 (1993)
    3. In some cases, there may not be sufficient other property suitable to award the other party as an offset.
  4. Deferred division method – QDROs/EDROs
    ……
Continued in PDF file below… “Overview of the Division of Retirement Benefits in Divorce – Part 1”
View / Download March 2015 Article – PDF File

Complete Michigan Family Law Journal available at: Michigan Bar website – Family Law Section (subscription required)

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February 2015 : 2015 Federal Income Tax Rates & Brackets, Etc., and Selected IRS Publications

Posted by Joseph W. Cunningham, JD, CPA
Michigan Family Law Journal : TAX TRENDS AND DEVELOPMENTS Feature

by Joseph W. Cunningham, JD, CPA

Excerpt:

2015 Federal Income Tax Rates & Brackets and Related Information

The following presents the 2015 tax rates applicable to taxable income of taxpayers filing tax returns as single, married filing jointly, or head of household.
(Table shown in below PDF file)

Standard Deduction

  • Single … $6,300
  • Married Filing Jointly … $12,600
  • Head of Household … $9,250

Personal Exemption

The personal exemption for 2015 is $4,000. However, 2% of the personal exemption is “phased out” – or reduced – for each $2,500 – or part of $2,500 – a taxpayer’s adjusted gross income (AGI) exceeds the statutory threshold for subject ling status, as follows:
(Table shown in below PDF file)

Selected IRS Publications
……

Continued in PDF file below… “2015 Federal Income Tax Rates & Brackets, Etc., and Selected IRS Publications”
View / Download February 2015 Article – PDF File

Complete Michigan Family Law Journal available at: Michigan Bar website – Family Law Section (subscription required)

Read More “February 2015 : 2015 Federal Income Tax Rates & Brackets, Etc., and Selected IRS Publications”

January 2015 : Michigan Court of Appeals Rules on Trial Court’s Decision Concerning the Value of an Interest in an Inn in the Upper Peninsula: BAIRD-PETERSON V PETERSON, Mich App No. 319938 (10/16/14)

Posted by Joseph W. Cunningham, JD, CPA
Michigan Family Law Journal : TAX TRENDS AND DEVELOPMENTS Feature

by Joseph W. Cunningham, JD, CPA

View Full PDF file

Facts

  • During the marriage, W invested $30,000 of marital funds in an LLC which was constructing the Mather Inn (Inn) in Marquette, Michigan, an endeavor initiated by W’s father.
  • The LLC agreement provided that a member’s interest would be lost–without compensation–incident to a member’s divorce.
  • Construction of the Inn “fell through” leaving debts reportedly exceeding the value of the property.
  • H claimed the business was worth $100,000.
  • The trial court ruled that the evidence did not support a value of $100,000 and, further, that W’s interest in the Inn had “no present value.”
  • The trial court also ruled, however, that if W ever realized a return on the parties’ $30,000 investment, she had to reimburse H his half of the investment
  • H appealed.

Court of Appeals Decision

In an unpublished opinion, the Court of Appeals (Court) upheld the trial court’s decision on the Inn.

The Court noted that the uncertainty of both (1) whether W’s interest had been lost and (2) whether outstanding debts exceeded value of the property supported the trial court’s decision.

Comment on the Case—Use of Value at Date of Divorce

As a rule, trial courts have a responsibility to determine value as close to date of divorce (DOD) as possible. Such value is used in the division of the marital estate.

One reason for the court’s responsibility to determine a value is the need for finality in divorce settlements. If a value were subject to change based on the occurrence or non-occurrence of future events, there could be a number of disadvantages:

  • Risk that post-divorce efforts are included in value divided between the parties. This generally relates to business enterprises in which a party has meaningful active involvement.
  • Need for the non-owner to “look over the shoulder” of the owner–not generally a welcome prospect after divorce.
  • Constrain the owner from taking certain actions, such as expanding.

In Peterson, the trial court found that the Inn had no value as of DOD. However, the trial court also ruled that if the Inn subsequently–that is, post-divorce–acquired value and, accordingly, W received a return on investment, such would be shared equally with H.

As indicated, value arising after DOD is not divided be- cause such value is typically attributable to events and/or efforts occurring after marriage.

Further, as ruled in Skelly v Skelly, 286 Mich App 578, 780 NW2d 368 (2009) and its progeny (Hoskins Mich App 309237 (5/28/13)–see October 2013 Tax Trends article), value attributable to events and/or efforts during marriage is not divisible if subject to a condition satisfied after marriage.
But, the objective of a divorce settlement is to achieve as equitable a result as possible. While some rules—including those established in case law—are necessary, so is the discretion to take into account the unique facts and circumstances of each case. In Peterson, although we cannot tell from the COA opinion, it is possible the trial court considered factors such as the following:

  • The Mather Inn LLC was owned by W and her father–a family LLC. The provision regarding losing one’s interest in the event of divorce is not found in most model commercial LLC agreements.
  • The investment of the $30,000 and signing the LLC agreement may have occurred a relatively short time before W filed for divorce.
  • The investment was in real estate which, in general, was recovering value lost in the recession as of the July 2013 divorce trial.

These are the type of factors a family court should have the discretion to consider in fashioning a fair settlement. In Peterson, the trial court did not assign any value to the Inn for the division of the estate, but did, evidently, believe that fairness compels H to receive half a return on W’s investment of marital funds should she ultimately receive same.

While finality is a laudable goal in divorce settlements, now and then–particularly in long term marriages–equity will not be achieved without a provision for sharing presently undeterminable value attributable in considerable part to years of marriage.

Example: A formula for dividing incentive compensation received for a set number of post-divorce years by an executive whose long, successful career overlapped the years of a long term marriage.

Though not allowed under Skelly, counsel are certainly free to include such a provision in a divorce settlement where compelled by fairness.

View full PDF file below… “Michigan Court of Appeals Rules on Trial Court’s Decision Concerning the Value of an Interest in an Inn in the Upper Peninsula: BAIRD-PETERSON V PETERSON, Mich App No. 319938 (10/16/14)”
View / Download January 2015 Article – PDF File

Complete Michigan Family Law Journal available at: Michigan Bar website – Family Law Section (subscription required)

Read More “January 2015 : Michigan Court of Appeals Rules on Trial Court’s Decision Concerning the Value of an Interest in an Inn in the Upper Peninsula: BAIRD-PETERSON V PETERSON, Mich App No. 319938 (10/16/14)”

December 2014 : Michigan Court of Appeals Rules on Availability for Support of (1) Undistributed S Corporation Earnings and (2) S Corp Distributions to Cover Taxes on Undistributed “Pass Through” Income: DIEZ V. DAVEY, Mich App No. 318910 (10/23/14)

Posted by Joseph W. Cunningham, JD, CPA
Michigan Family Law Journal : TAX TRENDS AND DEVELOPMENTS Feature

by Joseph W. Cunningham, JD, CPA

Excerpt:

Facts

  • The case, involving unmarried parents (Dad and Mom) of three children, was focused on child support, custody, and parenting time.
  • Dad is the sole owner of SGC, a manufacturer of equipment used in the aerospace industry.
  • SGC is operated as an S Corporation for federal tax purposes – that is, its income is “passed through” and taxed to Dad individually, whether actually distributed to him or not.
  • The Friend of the Court (FOC) conducted an evidentiary hearing and made a recommendation based on testimony of Mom’s CPA expert regarding Dad’s “money … available for support.”
  • Included in the FOC’s determination of Dad’s funds available for support were:
    • His W-2 income;
    • Various perks paid by SGC on his behalf;
    • All distributions he received from SGC, some of which were, evidently, made to provide Dad funds to pay the tax on undistributed SGC income; and
    • SGC’s “excess working capital” – that is, funds retained by SGC in excess of what the company needed to operate the business. The excess working capital was determined by application of (1) a formula used in some federal tax cases and (2) the CPA’s judgment.
  • The trial court adopted the FOC’s recommendation.
  • Dad appealed objecting, in pertinent part, to the inclusion of funds he allegedly had available for support as (1) excess working capital and (2) SGC distributions to pay tax on undistributed income, for the following reasons:
    1. Excess Working Capital – SGC was “capital intensive” and had to regularly purchase new equipment to remain competitive. Historically, such purchases were made with cash retained by the company. The amount of cash maintained by SGC was approximately the same year to year. Thus, the so-called excess working capital in fact consisted of funds that would similarly be used to acquire new equipment, continuing a long established SGC operating practice.
    2. Distributions to Pay Tax on “Pass-Through,” Undistributed Income—Distributions to pay tax on SGC income taxable to—but not received by—Dad were simply not funds available to him for support. Since the money was paid to federal and state tax authorities, it clearly was not “available” to him.

Court of Appeals Decision

In a published split opinion, the Court of Appeals (Court) agreed with Dad on the two issues noted above.

Excess Working Capital

The Court referenced the Michigan Child Support For- mula Manual (MCSFM) in which it is stated that “income (or losses) from a corporation should be carefully examined to determine the extent to which they were historically passed on to the parent.” (Emphasis added.)
……

Continued in PDF file below… “Michigan Court of Appeals Rules on Availability for Support of (1) Undistributed S Corporation Earnings and (2) S Corp Distributions to Cover Taxes on Undistributed “Pass Through” Income: DIEZ V. DAVEY, Mich App No. 318910 (10/23/14)”
View / Download December 2014 Article – PDF File

Complete Michigan Family Law Journal available at: Michigan Bar website – Family Law Section (subscription required)

Read More “December 2014 : Michigan Court of Appeals Rules on Availability for Support of (1) Undistributed S Corporation Earnings and (2) S Corp Distributions to Cover Taxes on Undistributed “Pass Through” Income: DIEZ V. DAVEY, Mich App No. 318910 (10/23/14)”