Posts by Joseph W. Cunningham, JD, CPA

May 2018 : Court of Appeals Rules on Effect of Corporate Business Debt on Spousal Support. BOCKART V BOCKART, Mich App No 335833 (3/20/18) (Unpublished)

Posted by Joseph W. Cunningham, JD, CPA

View / Download May 2018 Article – PDF File

— Facts

  • During the parties’ 11 year marriage, H operated a successful business of which he was the sole corporate shareholder.
  • W was a stay-at-home mom tending to the parties’ two young children.
  • At the time of the divorce, W was earning $11,000 annually for part-time work at a charter school. She testified she was seeking a full-time job.
  • H drew $43,216 from the business in the most recent year.
  • During the pendency of proceedings, H paid W $500/month spousal support and paid all household/family bills pursuant to a status quo order.
  • H incurred substantial debt (1) to make the required support and status quo payments, (2) to pay his and W’s attorney fees, and (3) to pay business expenses. At the time of divorce, the business owed $108,000 including rent in arrears and tax deficiencies.
  • The trial court imputed $20,000 earnings to W and $40,000 to H.
  • The trial court awarded no spousal support to W because:
    • She had a Bachelor’s Degree in Fine Arts while H had just a high school education.
    • H had paid all family expenses during the pendency by incurring substantial business debt.
    • Since W benefitted from this, she was “partially responsible” for such debt.
    • Because H was assuming full responsibility to repay the debt, the trial court viewed this as a “favorable outcome” for W.

Court of Appeals (Court) Decision

  • The Court stated that the trial court failed to make a determination (1) “as to the origin of the debts” of H’s business and (2) “who was responsible for their creation.”
  • Further, the Court noted that W had little, if anything, to do with H’s business and, hence, likely had little, if anything, to do with incurring the debts.
  • The Court remanded the case for reconsideration of (1) W’s responsibility, if any, for the debts after thoroughly reviewing the origin of the debts and (2) the lack of a spousal support award to W.

Comments on the Case and on Treatment of Debts in Determining Money Available for Support

  • The Michigan Child Support Formula Manual (Manual) provides in Section 2.01(B):

    “The objective of determining income is to establish, as accurately as possible, how much money a parent should have available for support. All relevant aspects of a parent’s financial status are open to consideration when determining support.”
    (Emphasis added.)

  • Thus, if H in Bockart had to incur debts to pay family expenses, money used to make payments on the debts is simply not “available for support.”
  • If a business is required to pay on business loans incurred in the ordinary course of business, such as working capital loans or equipment purchase installment payment loans, then the money used to make payments is not available for support.
  • Such payments are not deductible in determining business net income and so must be separately identified when determining money available for support.
  • This is the flip side of adding back deductible depreciation (1) above straight line on personal property or (2) on real property – that is, converting net income to money available.
  • The Court’s focus on the “origin” of the debt seems misplaced. Whether W had any “responsibility” for creation of the debts should not be a deciding factor. Neither should whether the debts were incurred by H or by his company.
  • Rather, of significance is whether the funds from the debts were used for marital purposes. If so, they are debts of the marriage, however incurred.
  • This may not apply to debts to provide for payment of divorce attorney fees. Responsibility for such fees is generally separately considered in divorce settlements.

Concluding Comments

  • Like so many matters in divorce, determining money available for support is a case specific exercise.
  • This is particularly so if one party owns a business or professional practice – both (1) to ensure all items of “indirect” income (excessive perks, etc.) are identified and (2) that legitimate debt payments are excluded from money available for support.
  • Often balance sheets need to be reviewed in addition to income statements.

About the Author

Joe Cunningham has over 25 years of experience specializing in financial and tax aspects of divorce, including business valuation, valuing and dividing retirement benefits, and developing settlement proposals. He has lectured extensively for ICLE, the Family Law Section, and the MACPA. Joe is also the author of numerous journal articles and chapters in family law treatises. His office is in Troy, though his practice is statewide.

Download the PDF file below… “Court of Appeals Rules on Effect of Corporate Business Debt on Spousal Support. BOCKART V BOCKART, Mich App No 335833 (3/20/18) (Unpublished)”
View / Download May 2018 Article – PDF File

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

Read More “May 2018 : Court of Appeals Rules on Effect of Corporate Business Debt on Spousal Support. BOCKART V BOCKART, Mich App No 335833 (3/20/18) (Unpublished)”

April 2018 : 2018 Presents a Window of Opportunity for a Tax Smart Method for a Buyout of a Business Interest

Posted by Joseph W. Cunningham, JD, CPA

View / Download April 2018 Article – PDF File

— A business (or professional practice) owned by a divorcing party may present tax problems in structuring a property settlement. The business is often the parties’ largest marital asset and will usually be retained by the owner spouse. If other marital property is insufficient to balance the settlement, some form of installment payments is generally used to buy out the nonowner spouse’s marital interest in the practice.

It is sometimes appealing to a divorcing business owner to have the company make payments buying out the other spouse’s marital interest in the business on a tax deductible basis. Attempts to do this include labeling such payments for the ex-spouse’s consulting services or administrative assistance.

If examined by the Internal Revenue Service (IRS), however, the deduction is likely to be disallowed if the other spouse did not in fact provide services commensurate with payments received. Rather, the IRS would treat the payments as step transactions (1) constructive dividend distributions to the business owner spouse followed by (2) nondeductible property settlement payments to the other.

For such arrangements to withstand IRS scrutiny, the spouse receiving payments must in fact perform services. If the wife did not work for the practice during the marriage, such arrangements would generally be viewed as sham transactions.

And, even if the wife had previously worked at the practice, she must actually perform duties commensurate with the amount of payments. This is often unlikely in view of the strained relationship generally prevailing between the husband and the wife as a result of the dissolution of their marriage.

The Tax Court has upheld IRS disallowance of practice deductions for payments to the owner’s ex-spouse that in fact represented part of the divorce related buy-out of his or her interest in the company. [1]

For this article, it is assumed that H is the business owner.

For divorces completed before December 31, 2018, there is a better way to achieve the same result (i.e., the use of deductible payments by the company to buy out the W’s marital interest in the business). As indicated, however, this method is available only for divorces and separations finalized in 2018.

“Section 71 payments,” as they are sometimes referred to, resulted from the Tax Reform Act of 1984’s elimination of the requirement that payments must in fact discharge the payor’s obligation to support the payee. The subjective “support” requirement (which had given rise to an ever-increasing number of tax disputes) was essentially replaced by more objective strictures. First, payments must terminate on the payee’s death and, second, payments must not be excessively front-loaded (i.e., disproportionately bunched in the years immediately succeeding the divorce).

These changes opened a vista of planning opportunities for divorce practitioners. Payments in settlement of property rights or for legal fees of the other spouse may be made on a taxable/deductible basis provided the alimony requirements of Section 71 are satisfied. They are used as a means of dividing non-qualified retirement benefits to which QDROS do not apply. Such flexible uses of Section 71 payments are especially beneficial where the payer is in a considerably higher tax bracket than the payee.

But, the alimony deduction under Section 71 has been eliminated by the 2017 Tax Cuts and Jobs Act (Tax Act) effective for divorces and separations finalized after December 31, 2018. The Tax Act also provides, however, that the prevailing deductible treatment of alimony will be grandfathered for divorces finalized before December 31, 2018. Thus, 2018 is a “window” for using Section 71 payments to advantage, including one spouse buying out the other spouse’s marital interest in a business (or professional practice) on a taxable/deductible basis.

Example

Assume that H and W agree that he will pay her $25,000 annually for ten years in consideration of her marital property interest in his business and, further assume that H’s marginal tax bracket averages thirty percent, the W’s fifteen percent. In view of bracket disparity, H and W decide to share a “tax subsidy” provided by Uncle Sam.

Thus, as an alternative to the $25,000 nondeductible/nontaxable annual payments for ten years, they agree that the H will make taxable/deductible payments to W of $32,500 annually for ten years, subject to termination in the event of the wife’s death, which will qualify the payments under Section 71. H will draw additional salary from the business to fund his payments to W. By converting the payments to taxable/deductible, H and W each end up with $2,000 plus more per year after tax, compliments of Uncle Sam, as follows:

Husband Wife Uncle
Sam
Payments of $32,500 (32,500) 32,500 0
Tax Benefit (Cost) 9,750 (4,875) 4,875
After-Tax 22,750 27,625 4,875
Annual Benefit Via Section 71 Payments 2,250 2,625 4,875
Ten Year Benefit 22,250 26,250 48,750

So, by using Section 71 Payments, Uncle Sam effectively paid $48,750 of the $250,000 obligation – almost twenty-five percent.

Planning Opportunity

For 2018 divorces in which a business or practice owner is in a meaningfully higher tax bracket than the non-owner spouse, consider the use of Section 71 payments as a means of structuring buyout installment payments.

This tax saving technique will no longer be available for divorces entered after December 31, 2018.

Neither will other uses of Section 71 payments such as those noted above.

About the Author

Joe Cunningham has over 25 years of experience specializing in financial and tax aspects of divorce, including business valuation, valuing and dividing retirement benefits, and developing settlement proposals. He has lectured extensively for ICLE, the Family Law Section, and the MACPA. Joe is also the author of numerous journal articles and chapters in family law treatises. His office is in Troy, though his practice is statewide.

Endnote

1 Greenwood v. Commissioner, 57 TCM 1058 (1989).

Download the PDF file below… “2018 Presents a Window of Opportunity for a Tax Smart Method for a Buyout of a Business Interest”
View / Download April 2018 Article – PDF File

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

Read More “April 2018 : 2018 Presents a Window of Opportunity for a Tax Smart Method for a Buyout of a Business Interest”

March 2018 : Remaining Tax Benefit for Payment of Divorce Related Fees under the 2017 Tax Reform Act

Posted by Joseph W. Cunningham, JD, CPA

View / Download March 2018 Article – PDF File

— Prior to the 2017 Tax Reform Act (TRA), signed into law in December 2017, divorce related attorney fees and accounting fees were deductible as miscellaneous itemized deductions to the extent attributable to:

  1. Efforts to obtain taxable alimony, whether successful or not, and
  2. Tax advice.

This was beneficial to divorcing parties who saved taxes by deducting such fees. And, it was beneficial to attorneys to inform their clients that, in effect, Uncle Sam was going to subsidize payment of their fees, hence, making them more affordable.

But, under the TRA, the deduction of miscellaneous itemized deductions is eliminated effective January 1, 2018.

However, there does remain a little-known tax benefit available incident to the payment of divorce related attorney fees and accounting fees. To the extent such fees are attributable to the property settlement, they increase the tax basis of
assets received or retained by a divorcing party. This reduces taxable gain on future disposition.

Exception– The portion of fees allocable to cash cannot increase tax basis since cash can never have a basis higher than face value. Also, the portion allocable to all forms of compensation – payable currently (bonus) or deferred (pension, 401(k) account, IRA) – does not increase the tax basis of such assets.

Further, the amount allocated to a principal residence often will provide no benefit due to the large gain exclusion
available incident to sale.

Fees attributable to property settlement include–at least in part–time devoted to discovery, valuation, separate property issues, negotiations, preparation and participation in settlement negotiations, mediation, arbitration, and trial
proceedings.

Regarding valuation, if the asset valued is awarded to subject party, the entire fee for the valuation should be specifically allocated to the tax basis of that asset.

Otherwise, the “property settlement’” fee should be allocated among assets awarded to subject party proportional to their respective values. Assets for which an increase in tax basis is beneficial include a business, second home, stock portfolio, and other forms of investment holdings.

Example: A divorce in which each party paid $5,000 for an appraisal of H’s business

Attorney Fees Paid by Each Party:

– Attributable to child support and spousal support $2,000
– Attributable to working with business appraiser 500
– Attributable to other property settlement matters 2,500
– Attributable to other aspects of the divorce proceeding 2,500
– Total $7,500

Accountant/Business Appraiser Fees Paid by Each Party:

– Business valuation $5,000
– Tax advice 500
– Total $5,500

Fees Attributable to Property Settlement:

– Attorney $3,000
– Accountant 5,000
– Total $8,000

Fees Paid by W, the Non-Business Owner:

  • The $8,000 is allocated among assets awarded to W, including cash and any retirement benefits, proportional to their respective values.
  • Fees allocated to cash and retirement benefits do not increase their tax basis and, hence, no tax benefit is received from such fees.

Fees Paid by H, the Business Owner:

  • The $5,500 in fees attributable to the business valuation should be added to the tax basis of the business.
  • The $2,500 balance is allocated among assets awarded to H, including cash and any retirement benefits, proportional to their respective values.

Notification to Clients

Many attorneys provide clients with a letter of “to do’s” at the end of a case. These include changing beneficiary designations, executing deeds, obtaining a QDRO, etc.

Such letter should also include the specific portion(s) of the attorney’s and any expert’s fees attributable to property settlement with the suggestion to consult with a tax specialist to learn how to obtain a tax benefit from such fees.

Michigan Family Law Journal : TAX TRENDS AND DEVELOPMENTS Feature

About the Author:

Joe Cunningham has over 25 years of experience specializing in financial and tax aspects of divorce, including business valuation, valuing and dividing retirement benefits, and developing settlement proposals. He has lectured extensively for ICLE, the Family Law Section, and the MACPA. Joe is also the author of numerous journal articles and chapters in family law treatises. His office is in Troy, though his practice is statewide.

Download the PDF file below… “Remaining Tax Benefit for Payment of Divorce Related Fees under the 2017 Tax Reform Act”
View / Download March 2018 Article – PDF File

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

Read More “March 2018 : Remaining Tax Benefit for Payment of Divorce Related Fees under the 2017 Tax Reform Act”

February 2018 : Highlights of 2017 Tax Reform Act’s Effects on Divorce

Posted by Joseph W. Cunningham, JD, CPA

View / Download February 2018 Article – PDF File

— The 2017 Tax Reform Act was signed into law in December 2017. Some of its significant effects on divorcing couples are summarized below.

Alimony Deduction:

New Law

Alimony, that is, spousal support, will not be deductible by the payer or taxable to the payee for divorce and separation
judgments and decrees entered on or after December 31, 2018.

This also applies to modified judgments of divorce or separation effective after 2018.

And, it applies to divorce and separation decrees entered before December 31, 2018 if the parties elect to have the new law apply.

But, it does not apply to other divorce and separation decrees entered before December 31, 2018. Thus, for all existing divorce settlements and those entered by year-end, alimony will continue to be taxable/deductible.

Comments on the New Law

1. Window for Creative Use of Section 71 Payments— Because most alimony payers are typically in a considerably higher tax bracket than most payees, the tax saved by the payer usually exceeds the tax paid by the payee. This has set the stage for creative uses of “Section 71 payments” under which the disparity in tax brackets can be used to provide a tax subsidy.

Examples include using Section 71 payments to:

  • Divide non-qualified deferred compensation on a taxable/deductible basis.
  • Structure installment payments of a business buy-out of the non-owner spouse’s marital interest on a taxable/deductible basis.
  • Pay attorney fees on a taxable/deductible basis. However, after 2018, these opportunities and similar others will no longer be available. So, in situations where there is significant disparity in brackets, consider whether using Section 71 payments would be beneficial.

2. Fundamental Change in the Dynamic of Alimony/Spousal Support— When the alimony deduction was enacted in 1948, the theory was that, if a former family’s income is split between the parties in some manner post-divorce, the tax treatment should correspond.

As noted, the result in many cases has been less combined tax paid on the payer’s income. Because of budgetary concerns – including the enormous cost of 2017 TRA – eliminating the alimony deduction became a revenue raising option to help alleviate the deficit increasing effect of the TRA.

This creates a new paradigm for divorce practitioners and alimony guideline providers, that is, thinking in terms of aftertax dollars for spousal support, similar to child support.

3. Effect of Post 2018 Judgment Amendments— If a pre-2019 divorce or separation judgment or decree is amended on or after December 31, 2018, the new nontaxable/nondeductible law applies.

Query: Would this be the result even if the amendment does not pertain to spousal support? If the answer has not become clear by year-end, the distinct possibility of losing taxable/deductible status of spousal support payments must be considered before advising the post-2018 amendment of a pre-2019 judgment providing for taxable/deductible alimony.

Personal And Dependency Exemptions:

New Law

The federal personal and dependency exemption – $4,050 in 2017 for each taxpayer and each of his/her dependents – is repealed beginning in tax year 2018.

The $4,000 Michigan income tax personal and dependency exemption is based on the number of exemptions claimed on a taxpayer’s federal return. Thus, it too would be lost incident to the federal repeal. But, at the time this article is written, there is reason to believe that Governor Snyder will push legislation to preserve the Michigan exemption.

Comments on the New Law

1. Michigan Exemptions— Since the Michigan income tax personal and dependency exemptions are likely to be preserved, it still is advisable to specifically provide for who is entitled to the exemption for dependent children.

2. Need for a Michigan Form 8332?— As noted, the entitlement to Michigan exemptions has been tied directly to the number of exemptions claimed on a taxpayer’s federal return and there is no Michigan income tax provision allowing the custodial parent to release an exemption to the non-custodial parent.

Thus, it seems that, accompanying new Michigan law to preserve the exemption for state tax purposes, should be a provision allowing the release of the exemption from one parent to the other.

Perhaps by a Michigan counterpart to federal Form 8332, the execution of which has allowed for such releases for federal tax purposes.

Standard Deduction:

New Law

The standard deduction—used in lieu of itemizing deduction—was almost doubled under the 2017 TRA. For joint filers, it is $24,000 in 2018; single – $12,000; head of household – $18,000.

Comment on the New Law

Offset, More or Less, by Repeal of Exemptions— The benefit of the increased standard deduction is reduced, or eliminated, by the loss of personal and dependency exemptions.

Example:

For a family of 4 filing a joint return: Under TRA  Pre TRA
Standard Deduction $24,000 $13,000
Personal & Dependency Exemptions 0  16,200
Total Deduction $24,000  $29,200

The decrease in the total deduction is offset in part by the TRA’s lower tax rates (see below).

Miscellaneous Itemized Deductions:

New Law

Currently, certain expenses are deductible as miscellaneous itemized deductions to the extent they exceed 2% of adjusted gross income (AGI). Such expenses include tax preparation fees, investment advisory fees, unreimbursed employee expenses.

They also include attorney and accounting fees incurred in divorce that are attributable to (1) efforts to obtain spousal support and (2) tax advice.

Under the TRA, effective January 1, 2018, deduction of all such fees and expenses is eliminated.

Comment on the New Law

The deduction of a portion of divorce related fees has made them less expensive for clients who itemized deductions.

However, except for higher asset cases, more clients will be using the higher standard versus itemizing deductions.

New Tax Rates:

New Law

Tax rates have been, in the main, modestly reduced and are as follows effective January 1, 2018:

Taxable Income
Tax
Rates		 Single Married Filing
Jointly		 Head of
Household
10% 0-9,525 0-19,050 0-13,600
12% 9,526-38,700 19,501-77,400 13,601-51,800
22% 38,701-82,500 77,401-165,000 51,801-82,500
24% 82,501-157,500 165,001-315,000 82,501-157,500
32% 157,501-200,000 315,001-400,000 157,501-200,000
35% 200,001-500,000 400,001-600,000 200,001-500,000
37% Over 500,000 Over 600,000  Over 500,000

Comments on New Law

1. Lower Rates— The 7 tax rates ranging from 10% to 37% are 2%-3% lower than previous rates. For instance, a married couple with $75,000 of taxable income will pay $8,619 versus $10,297.

2. Tempered by Loss of Certain Deductions— The lower rates are offset, to varying degrees for different taxpayers, by the elimination of personal and dependency exemptions and loss of some itemized deductions.

Michigan Family Law Journal : TAX TRENDS AND DEVELOPMENTS Feature

About the Author:

Joe Cunningham has over 25 years of experience specializing in financial and tax aspects of divorce, including business valuation, valuing and dividing retirement benefits, and developing settlement proposals. He has lectured extensively for ICLE, the Family Law Section, and the MACPA. Joe is also the author of numerous journal articles and chapters in family law treatises. His office is in Troy, though his practice is statewide.

Download the PDF file below… “Highlights of 2017 Tax Reform Act’s Effects on Divorce”
View / Download February 2018 Article – PDF File

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

Read More “February 2018 : Highlights of 2017 Tax Reform Act’s Effects on Divorce”

January 2018 : Court of Appeals (1) Rules on Marital Property Status of Gift of a Vet Practice and (2) Rejects a Bright-Line Rule Re Excluding Personal Goodwill from Practice Value – Brusach No. 334550 (10/17/2017)

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

by Joseph W. Cunningham, JD, CPA

Facts

  • W purchased a veterinarian practice from her father at a substantially discounted price. The discount was a gift from dad to daughter.
  • H assisted W in various capacities in maintaining the vet practice during the marriage.
  • The vet practice was valued by experts working on behalf of H and W, respectively.
  • The trial court selected a value within the two calculated by the two experts and found that the gift component of the value had lost its separate property character due to (1) H’s active involvement and (2) the commingling of practice income with the marital estate.
  • W objected to this finding and to the inclusion of her personal goodwill in the practice value.
  • In her appeal on the personal goodwill issue, she claimed personal goodwill should be excluded from the marital estate because:
    1. It is the equivalent of future earning ability, which is not marital; and,
    2. It results in double-dipping since future earnings are factored in to setting spousal support.

Court Of Appeals (COA/Court) Decision

  • In an unpublished opinion, the COA upheld the trial court decision.
  • Regarding the gift component of the practice value, the Court, on reviewing the record, stated that it could not conclude that “the trial court made a mistake in finding that the gift lost any characteristic of being separate property.”
  • It agreed that the gift portion of the practice had essentially been transformed to marital property during the marriage.
  • Regarding W’s personal goodwill claim, the COA cited the 2012 Loutts decision, 298 Mich App 21, in ruling that double-dipping issues are determined on a case by case basis and, accordingly, “there is no room for *** rigid and arbitrary formulas when determining *** spousal support.”
  • Further, the Court stated: “Accordingly, there is no brightline rule for whether the value of a business can be used in determining property distribution and awarding spousal support.”

Comments on the Case

  • Whether separate property is transformed into marital property is a “facts and circumstances” determination.
  • Commingling of income from the separate property with marital income, as occurred in this case, is one factor suggesting property has been converted to marital.
  • The Court has previously indicated that personal goodwill is includable in value for divorce purposes, stating: “We are unpersuaded of the need to adopt a distinction between personal and business goodwill for purposes of valuing business assets in the context of a divorce action.” Conger, Mich App No. 219373 (12/26/00).

About the Author

Joe Cunningham has over 25 years of experience specializing in financial and tax aspects of divorce, including business valuation, valuing and dividing retirement benefits, and developing settlement proposals. He has lectured extensively for ICLE, the Family Law Section, and the MACPA. Joe is also the author of numerous journal articles and chapters in family law treatises. His office is in Troy, though his practice is statewide.

Download the PDF file below… “Court of Appeals (1) Rules on Marital Property Status of Gift of a Vet Practice and (2) Rejects a Bright-Line Rule Re Excluding Personal Goodwill from Practice Value – Brusach No. 334550 (10/17/2017)”
View / Download January 2018 Article – PDF File

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

Read More “January 2018 : Court of Appeals (1) Rules on Marital Property Status of Gift of a Vet Practice and (2) Rejects a Bright-Line Rule Re Excluding Personal Goodwill from Practice Value – Brusach No. 334550 (10/17/2017)”