Divorce

Mar 2022 : ROBACH VS. ROBACH

Posted by Joseph W. Cunningham, JD, CPA

View / Download March 2022 Article – PDF File

Tax Trends and Developments Column – Michigan Family Law Journal

This Month’s Column: Court of Appeals distinguishes McNamara vs. Horner in ruling that allocation of appreciation between a pre-marital employee benefit account balance and contributions during marriage is acceptable where information to do so is available. Robach vs. Robach, Mich App Docket No. 352077 (12/16/21) – Unpublished.

Facts

  • H & W were married in 2011 and divorced in 2019.
  • H had various stock options, stock grants, and additional shares of stock in the company at which he worked.
  • Most of these stock interests were acquired before the marriage though some did not vest until after.
  • H claimed that his stock options and grants were not received “on account of service credit accrued during marriage” (emphasis added) and, accordingly, were not part of the marital estate under MCL 552.181(1).
  • Further, he hired an expert to allocate the appreciation on his retirement account between growth attributable to (1) their pre-marital balances and (2) contributions during marriage.
  • The expert was able to do so because H had Fidelity account statements for the entire period of the marriage.
  • The trial court agreed with H and his expert, and, correspondingly, awarded his company stock and appreciation allocated to his pre-marital retirement account balances to him as his separate property.
  • W appealed.

Court of Appeals Decision

  • W claimed that because the expert relied on statements provided by H the expert’s analysis was unreliable.
  • She further claimed that, pursuant to the published case of McNamara vs Horner, 249 Mich App 177 (2002), contributions during marriage were commingled with premarital funds in the retirement account and, hence, could not be separately identified for the allocation.
  • The Court ruled, essentially, that it had not been demonstrated that the account statements used by the expert were unreliable.
  • It also upheld the expert’s allocation of appreciation during marriage because the expert was able to specify preand post-marital funds in the Fidelity statements.

Comments on the Case

  • As readers of this column may recall, the decision in McNamara vs. Horner has been criticized as arbitrarily narrow with its strict application often resulting in gross unfairness.
  • Where sufficient documentation is available – as in the Robach case – it is quite possible to allocate appreciation during marriage between a pre-marital retirement account balance and (2) contributions during marriage.
  • Having all the statements for the subject period is certainly ideal. But, if a few are missing, interpolating between statements is sometimes possible.
  • While the published McNamara vs. Horner case remains the law in Michigan, the unpublished Robach decision indicates that a common-sense result may be attained where sufficient information is available.
  • As a matter of full disclosure, the author hereof was the expert in Robach.

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… “ROBACH VS. ROBACH”
View / Download March 2022 Article – PDF File

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

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Feb 2022 : Sale of Marital Residence in a Divorce Context – Taxation of Gain

Posted by Joseph W. Cunningham, JD, CPA

View / Download February 2022 Article – PDF File

Tax Trends and Developments Column – Michigan Family Law Journal

As is generally known, prices of homes in Michigan have increased substantially in the last couple years. Sellers are frequently receiving multiple offers above their asking price.

So, most homes sold in these conditions will result in considerable gains over what the seller paid for the house.

Because of the recent surge in home sale prices, the following summarizes how the gains on residential sales are treated for tax purposes in a divorce context.

General Rules of Taxation on Principal Residence Sale

There is an exclusion for tax purposes of gain on the sale of a principal residence – up to $250,000 for qualifying single taxpayers and $500,000 for qualifying married taxpayers who file a joint tax return.

To qualify for the exclusion, a single taxpayer must own and live in the home as a principal residence for two of the five years preceding the sale.

A taxpayer who fails to satisfy the use requirement due to a change of employment, health problems, or other unforeseen circumstances is allowed a percentage of the exclusion equal to the percentage that the two years ownership and use requirements are met.

For a married couple, one spouse must satisfy the two out of five years ownership requirement, but both must have lived there for two of the five years preceding the sale.

A taxpayer may use the exclusion each time a home is sold, provided two years have elapsed since the last sale.

As a practical matter, even with the recent increase in home prices, the lion’s share of gains will not exceed the exclusion. However, particularly for houses held for many years in upscale areas, gains might be higher than the exclusion.

Sale In A Divorce Context

Home Sold While Married

The marital status on the date of sale determines whether the parties are married for purposes of the exclusion.

If parties are married on the date of sale, the $500,000
gain exclusion is available provided:

  • The parties file a joint return for the year of sale. This means that the divorce does not occur in the year of the sale.
  • One of the spouses satisfies the two out of five years ownership requirement
  • Both satisfy the two out of five years use requirement.
  • Neither has used the exclusion within two years preceding the sale.

Special Rules Applicable to Divorce-Related Sales

  • Attribution of Ownership – When an interest (e.g., fifty percent) in the marital residence is transferred from one spouse to the other pursuant to the divorce, the transferor’s period of ownership passes with the property to the transferee.
    Example:

    • H and W agree that she will transfer her 50% interest in their home to him.
    • H decides to sell the house 2.5 years after the divorce.
    • W’s period of ownership is transferred to H with respect to the 50% interest she transferred to him.
    • Thus, he satisfies the two out of five years ownership requirement and, hence, qualifies for the $250,000 exclusion on the entire gain, not just the 50%.
  • Attribution of Use – If it is expressly provided in the divorce settlement that one spouse is entitled to remain in the home until it is sold (often when the youngest child is emancipated), that spouse’s use is attributed to the other (who is usually out of the house and would not otherwise qualify).
    Example: In their settlement, H and W agree that:

    • They will continue to jointly own the house;
    • W will live there with their child; and,
    • The home will be sold and proceeds divided in four years when their child graduates from high school.

Provided that the divorce settlement expressly provides for W’s right to remain in the home until it is sold, then her occupancy is attributed to H for purposes of the two years use requirement. Thus, the $500,000 exclusion is available.

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… “Sale of Marital Residence in a Divorce Context – Taxation of Gain”
View / Download February 2022 Article – PDF File

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

Read More “Feb 2022 : Sale of Marital Residence in a Divorce Context – Taxation of Gain”

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

Posted by Joseph W. Cunningham, JD, CPA

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)

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

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

Posted by Joseph W. Cunningham, JD, CPA

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)

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

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

Posted by Joseph W. Cunningham, JD, CPA

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)

Read More “Aug/Sep 2021 : Thoughts on Start-Up Companies in Divorce Settlements”