Dec 2021 : Year-End Tax Considerations – File Joint or Separate; Estimated Tax Payments; Tax Refunds/Overpayments

View / Download December 2021 Article – PDF File

Tax Trends and Developments Column – Michigan Family Law Journal


As the year-end approaches, there are various “below the radar” tax matters that can be relatively significant.

Filing Status for Year of Divorce

Whether divorcing parties can file a joint return or must file separate returns depends on their marital status as of December 31. If divorced as of that date, they must file separate returns for their respective separate incomes and deductions.

It is advisable to “run the numbers” both ways to know the filing option with less tax and, further, how much less tax.

If the lion’s share of income is attributable to one party, filing a final, joint return generally results in a lower overall tax liability. So, other considerations aside, the divorce should be deferred to after December 31.

But, there are instances where a spouse may not want to file a joint return for a good reason, such as questionable tax positions taken by the other spouse.

In this regard, a spouse generally cannot be compelled to file a joint tax return. In a 2014 published Court of Appeals case (Butler v. Simmons Butler, Mich App, No. 321445 11/18/14,) the Court ruled:

  • In a situation where considerable tax would be saved by filing a joint return and one spouse will not agree to file jointly without good reason, the trial court could redistribute property to take into account the additional tax attributable to separate filing.
  • However, if there is insufficient property to do so, “as a last resort”, the court could compel a spouse to file a joint return under the following circumstances:
  • There is no history of tax problems with the other spouse;
  • There is a history of the parties filing joint returns; and,
  • The reluctant spouse is indemnified and held harmless by the other spouse.

Estimated Tax Payments and Tax Withheld During Marriage Are Marital Funds

Estimated tax payments made – and/or taxes withheld – during the year of divorce are generally made with marital funds and, hence, are a marital asset. Tax refunds or, overpayments applied to next year’s tax, attributable to tax payments made during marriage are similarly a marital asset.

Or, it may cut the other way – that is, estimated tax payments and/or taxes withheld may be less than the actual tax on marital income received and shared during the year of divorce.

Estimated Payments Automatically are Credited to the Husband

Since the husband’s social security number (SSN) is generally listed first on joint estimated payment vouchers (Form 1040ES) made during marriage, such payments will automatically be credited to him unless there is a written alternative provision agreed on by the parties.

The same applies to tax overpayments on the parties’ last joint return applied to the following year’s tax.

The above matters are often not addressed in divorce settlements.

The following presents (1) observations on such tax payments and (2) applicable tax law.

Tax Payments Made During the Year of Divorce

Example – Assume the following alternative facts for joint estimated tax payments made by – and/or withheld on behalf
of H – during the year of a divorce for which the judgment is entered on December 30.

So, in Case #1, H will receive a windfall unless W’s attorney identifies the overpayment and makes an offsetting adjustment. Half of H’s $10,000 overpayment was made with W’s share of marital funds.

In Case #3, it is H’s attorney who needs to (1) identify that H will pay $10,000 of his own funds on income equally shared with W and (2) make an offsetting adjustment. When paying the $10,000, H will, in effect, be paying both his and W’s $5,000 shares of the tax on marital income.

Agreement to Apportion Joint Estimated Tax Payments

IRS Publication 504 – “Divorced or Separated Individuals” – provides that divorced parties may agree on the division of joint estimated tax payments made during marriage.

Because the IRS credits the account of the spouse who’s SSN appears first on the estimated tax voucher (Form 1040ES) – almost always the husband’s – if the other spouse (assume W) claims any of the joint estimated tax payments on a separate return, W should indicate the ex-spouse’s SSN on page one of his or her IRS Form 1040 in the designated space. If W has remarried, she should enter the current spouse’s SSN in the appropriate space and enter the ex-spouse’s SSN, followed by “DIV” to the left of 1040, line 26.

Tax Refunds and Overpayments Applied to Next Year’s Tax

It is common practice to provide in the divorce settlement for division of refunds resulting from the parties’ final joint
income tax return.

But, in some cases, parties filing a joint return will apply all or a part of any tax overpayment to the following year’s tax rather than having it refunded. This frequently occurs when a return is on extension and filed after April 15 and the prior year overpayment is needed to cover current year tax to avoid the underpayment penalty.

The IRS has ruled that it will abide by an agreement of spouses who are no longer married regarding the apportionment of an overpayment of tax on a prior year’s joint income tax return that the parties elected to apply to the following year’s tax liability. Rev Rul 76-140.

However, here, too, because the IRS credits the account of the spouse who’s SSN appears first on the tax return, if the other spouse claims any of the applied overpayment, the other spouse should indicate the ex-spouse’s SSN on page one of his or her IRS Form 1040 in the designated space. If the other spouse has remarried, he or she should enter the current spouse’s SSN in the appropriate space and enter the ex-spouse’s SSN, followed by “DIV” to the left of 1040, line 26.

Practice Pointers

  1. Discover Tax Situation – As part of discovery, the tax overpayment or underpayment status of the parties should be determined. This can often be provided by the parties’ tax preparer.
  2. Over Withholding – The owner of a closely-held business can arrange excessive tax withholding. If undetected, the money that should be in marital accounts to divide will instead accrue 100% to the owner as a tax refund. The excessive withholding can be done on the last day of the year. So, the fact that withholding was not excessive on a September 30 pay stub is not a reliable safeguard against withholding manipulation. Rather, the owner’s W-2 should be reviewed for the relationship between (1) income and (2) income tax withheld to discover whether there is excessive withholding.
  3. Specific Divorce Settlement Provisions – In addition to discovering the parties’ “tax situation,” the settlement agreement should include express provisions regarding matters such as division of refunds, splitting joint estimated tax on separate returns, and ensuring an equitable sharing of tax on marital income for the year of divorce.

IRS Publication 504 – “Divorced or Separated Individuals”

This an excellent 30 page summary of divorce taxation. It covers the following topics:

  • Filing Status
  • Exemptions
  • Alimony
  • QDROs & IRAs
  • Property Settlements
  • Costs of Getting a Divorce
  • Tax Withholding and Estimated Tax

Publication 504 was updated in February 2021 and has a two-page detailed index. It is available for download at http://www.irs.gov/pub/irs-pdf/p504.pdf


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… “Year-End Tax Considerations – File Joint or Separate; Estimated Tax Payments; Tax Refunds/Overpayments”
View / Download December 2021 Article – PDF File

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

Nov 2021 : Court of Appeals Rules on Double-Dipping Issue Fort v Fort, Mich App No. 351568 (4/22/21) – Unpublished

View / Download November 2021 Article – PDF File

Tax Trends and Developments Column – Michigan Family Law Journal


Facts

H and W were divorced in 2019 after 14 years of marriage and three children.

  • Per their agreement, W was a stay-at-home mom.
  • H owned and worked at a business (Company), which was valued for the divorce settlement.
  • The trial court used the appraised value of the Company and ordered H to pay W spousal support.
  • H appealed, claiming that the property award and spousal support award, taken together, “constitute an impermissible “double-dip” that results in an inequitable outcome.”

Court of Appeals Decision (Unpublished)

  • The Court of Appeals (Court) noted that “double-dipping” – or tapping the same dollars twice – refers to situations where a business or professional practice is valued by capitalizing its income, some or all of which is also treated as income for spousal support.
  • The Court referred to the published Loutts case (Loutts v Loutts, 298 Mich App 21 (2012), in which the Court stated “[s]pousal support does not follow a strict formula” and “there is no room for the application of any rigid and arbitrary formulas when determining the appropriate amount of spousal support.”
  • Thus, the Court in Loutts “declined to adopt a bright-line rule” with respect to double-dipping.
  • The Loutts decision is consistent with preceding Court of Appeals cases on the issue.
  • However, the Court in Loutts indicated that if an appropriate spousal support award can be made without double-dipping, then such should be done.
  • The Court in the Fort case stated that it was unclear whether the trial court engaged in an inequitable “double-dip” because it did explain how it calculated spousal support.
  • Thus, the Court remanded the case so that the trial court could make factual findings concerning the relevant factors in a determination of spousal support.

Comments on the Case

  • The Court once again affirmed that spousal support is the be determined based on the factors set forth in Sparks v Sparks, 440 Mich App 141, (1992) and in Olson v Olson, 256 Mich App 619 (2003).
  • In doing so, income used in valuing a business or professional practice should not automatically be excluded from income for spousal support to avoid double-dipping.
  • However, if a proper balancing of the parties’ needs and income, taking all relevant circumstances into account, can be achieved without double-dipping, then such should be done in determining spousal support.

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 Double-Dipping Issue Fort v Fort, Mich App No. 351568 (4/22/21) – Unpublished”
View / Download November 2021 Article – PDF File

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

Aug/Sep 2021 : Thoughts on Start-Up Companies in Divorce Settlements

View / Download Aug/Sept 2021 Article – PDF File

Tax Trends and Developments Column – Michigan Family Law Journal


Intro

Start-up companies require considerable thought in divorce settlements. Some reasons:

  1. Some will go great guns and become quite valuable.
  2. Others will fizzle and flop.
  3. And, since we do not have crystal balls, it is often impossible to know how a particular new company will fare.
  4. A considerable investment of time and/or finances may have been made during marriage, by one or both parties.
  5. Experience a party has had during marriage may equip him/her with a set of skills & and/or specialized knowledge that will be advantageously brought to bear on the new enterprise.
  6. Some start-ups have projections – often required to obtain financing – while many do not.

Methods for Handling in a Divorce Settlement

Postema Equitable Award Approach

If a considerable amount of funds has been expended in preparing the launch of the new enterprise, repaying the non-owner spouse half the amount spent may be satisfactory in some instances.

  • This is somewhat akin to the Postema1 reimbursement approach to establishing an equitable award for a spouse who made sacrifices, efforts, and contributions to enable the other to attain an advanced degree and certifications, as the case may be.
  • As with a Postema award, however, it is appropriate to consider non-financial sacrifices, efforts, and contributions made by a spouse to the establishment of the other’s start-up business.

“Structured Settlement”

  • Provide for the owner spouse to receive an agreed on reasonable compensation for his/her efforts.
  • Then pay a portion of what the company earns after paying the compensation – that is, profit – to the non-owner spouse, usually, on a declining scale basis.
  • For example – 50% in the first 2 years, then 40% for a year or two, then 30% for a year.
  • The declining scale takes into account that, as time goes by, less of the profit is attributable to the marriage and more to post-divorce efforts.

Defer the Valuation

On rare occasions, it may be best to provide that the business value will be determined at a set time after the divorce.

  • This approach provides the valuable benefit of hindsight.
  • But, it is not often used because (1) it leaves a part of the settlement unresolved and (2) it will be problematic to determine the portion of the value attributable to postdivorce efforts.
  • Another negative is that it often involves the non-owner spouse “looking over the shoulder” of his/her ex to ensure everything is on the up and up.
  • But, in some instances – particularly where there is sufficient trust and/or the lack of ability to manipulate operating results – it may be a good fit.

Case Specific Approach

As the above indicates, it is clear that – like so many aspects of divorce – dealing with a start-up company in divorce is a case-specific proposition.

All relevant circumstances should be considered in fashioning an appropriate provision in the settlement.


Endnote

1 Postema v Postema, 189 Mich App 89; 471 NW 912 (1991).


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… “Thoughts on Start-Up Companies in Divorce Settlements”
View / Download Aug/Sept 2021 Article – PDF File

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

Jun/Jul 2021 : Court of Appeals Affirms Trial Court Holding that the Award to W of a Portion of H’s Federal Pension Did Not Include a Survivorship Benefit Gray v Gray, Mich App No. 344636 (June 25, 2020) Unpublished

View / Download June/July 2021 Article – PDF File

Tax Trends and Developments Column – Michigan Family Law Journal


Facts

  • In their Consent Judgment of Divorce, it was provided that W would receive a coverture fraction share of H’s Civil Service Retirement System (CSRS) pension plan (Plan).
  • The Judgment also provided that W would be “entitled to her prorated share of any and all other ancillary benefits associated with the Plan.”
  • W submitted a proposed Court Order Acceptable for Processing (COAP—essentially a QDRO for CSRS plans—which provided her with a survivor benefit.
  • H objected, claiming that in the divorce negotiations it was noted that his pension did not provide a survivor annuity for W.
  • He further claimed that creating a survivor benefit for W would reduce his pension benefit by 10%.
  • H’s counsel stated that a survivor annuity was not a regular part of the Plan and that such a benefit “would be a separate and distinct benefit.”
  • W’s counsel stated that under MCL 552.101(4), all components of a pension plan are assigned with a retirement plan benefit divided in divorce.
  • The trial court noted that the parties negotiated the specific percentage that W would receive and, further, that they made no provisions applicable on the death of either party.
  • Hence, the court ruled that the parties did not contemplate survivor benefits and that the COAP should not provide for any.
  • W appealed.

Court of Appeals Decision

  • In an unpublished decision, the Court upheld the trial court’s ruling.
  • In doing so, the Court noted that the situation was similar to that in the published case of Hudson v. Hudson, 314 Mich App 28 (2016).
  • In Hudson, the Court ruled that H, an alternate payee of 39.5% of W’s state pension, could not elect a benefit option of a single life annuity based on his life, an option to which W was not entitled to elect on her share of H’s federal pension.
  • H claimed that pursuant to MCL 552.101(4), he was entitled to all components associated with W’s pension.
  • To this the Hudson Court stated the question was whether the right to select a particular payment option was a “component” of the plan subject to the statute. The Court ruled that it was not such a component and held against H’s claim.
  • The Court in Gray held that W’s assertion that the survivor benefit – specifically referred to as a “component” in MCL 552.101(4) – was “foreclosed for the reasons this Court articulated in Hudson.”
  • In a persuasive dissent, Judge Ronayne Krause essentially stated that (1) Hudson did not apply to the Gray circumstances and (2) under the plain meaning of MCL 552.101(4), a survivor benefit is a component of a plan.

Comments on the Case

  • The facts in the Gray case are complicated, including that:
    • The plan involved was federal pension about which less is generally understood than with the more common commercial company plans.
    • It was noted in the trial transcript that it had been agreed at mediation that W’s lawyer was to prepare a letter with questions about the government plan. Apparently this letter, if sent, did not ask about survivor benefits.
    • And, according to H’s counsel, survivor benefits were not part of the plan but rather were “separate
      and distinct.”
  • Takeaway – It is virtually always preferable to specify in the Judgment or Settlement Agreement, as the case may be, what benefits are included with the transfer of a retirement benefit.

Otherwise, issues such as those in Gray and Hudson may arise.


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 Affirms Trial Court Holding that the Award to W of a Portion of H’s Federal Pension Did Not Include a Survivorship Benefit Gray v Gray, Mich App No. 344636 (June 25, 2020) Unpublished”
View / Download June/July 2021 Article – PDF File

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

Apr 2021 : Court of Appeals Upholds Trial Court Ruling of a Zero Value for a Medical Practice Woolever v Woolever, Mich App No. 351007 (January 28, 2021)

View / Download April 2021 Article – PDF File

Tax Trends and Developments Column – Michigan Family Law Journal


Facts

  • H, an orthopedic surgeon, had operated his practice out of a building he leased for most of the marriage. He had many employees.
    • But, in 2016, he sold his equipment to a hospital at which he began working on a contractual basis. He retained one employee, his secretary.
  • At the trial, H said the change was prompted by billing and insurance company issues.
  • H said his practice had no value because he was essentially an employee of the hospital, and, further, that he owned no equipment and had no accounts receivable.
  • He also said that he was easily replaceable and could not assign or sell his contractual position.
  • W’s valuation expert valued H’s practice at $600,000. However, he admitted that he did not have complete information based on which to calculate a value and testified that the $600,000 was in considerable part his “extrapolation.”
  • Further, the expert acknowledged that H was, as he claimed, essentially an employee of the hospital.
  • The trial court ruled that H was an independent contractor with the hospital and no longer operated a practice.
    Hence, there was nothing to value.
  • W appealed.

Court of Appeals Decision

  • The Court upheld the trial court’s ruling.
  • In doing so, the Court noted the concessions that W’s expert made noted above and stated “the evidence supported the trial court’s decision.”

Comments on the Case

  • As was noted in the case, there is a trend in the medical practice arena for doctors to form contractual relationships with a hospital instead of operating an independent practice.
  • Many groups of doctors have done this. It is often mutually beneficial in that:
    1. The hospital has the certainty of access to the doctors’ medical services and has control over the cost thereof.
    2. The doctors, in addition to significant relief from administrative matters now performed by the hospital, have a steady source of need for their services.
  • However, it can be a blurry line between a “practice” as such and being essentially “an employee of hospital.”
  • For example:
    • Assume a medical practice group consists of four doctors who make, on average, $400,000 each annually.
    • Depending on the nature of the practice, there may be a holder’s interest value to each doctor’s practice within the group.
    • For the most part, albeit, not exclusively, the group of doctors performs services for patients of one hospital.
    • The group and the hospital agree to enter a contractual arrangement which, essentially, formalizes the mode in which they had been operating.
    • The agreement provides that the doctors will each make $350,000 annually while being relieved of various administrative responsibilities.
    • So, from a de facto standpoint, are the doctors essentially in a very similar economic position as before entering the agreement with the hospital? Or, perhaps, a better position? If there was a holder’s interest value to their practice, has it disappeared?
  • Some relevant questions to consider in similar situations, under subject agreement, are:
    • Are the doctors in fact employees of the hospital or have they retained independent contractor status?
    • Are the doctors restricted from performing services for non-hospital patients?
    • To what degree are the doctors at the “beck and call” of the hospital?
    • Are the doctors on fixed salaries or is their compensation tied to the amount of services they provide?
    • To what degree does the hospital control the doctors’ schedules?
  • As with so many issues in divorce, the “practice” issue in circumstances where there is a contractual relationship with a medical institution is fact specific.

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 Upholds Trial Court Ruling of a Zero Value for a Medical Practice Woolever v Woolever, Mich App No. 351007 (January 28, 2021)”
View / Download April 2021 Article – PDF File

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