Divorce And Taxes | TaxConnections

24 Jun 2022

Dividing Property In Divorce Tax Traps – Part 9 In Series

(Part 9 is continuation of series, links to all parts are provided at end of this blog post. This valuable series on Dividing Property In Divorce Tax Traps has been updated for the Tax Cuts And Jobs Act (TCJA) and the Cares Act. This series is provided by David Ellis of Ellis & Ellis CPAs in Pasadena, CA.)

d.Losses of S Corporations

Both passive and active owners of S Corporations can only deduct losses to the extent that they have basis in the stock of the S Corporation.[1] Generally, taxpayers acquire basis in S Corporation stock by receiving pass throughs of profits, making capital contributions, or making loans directly to the S Corporation.^[2]

When the owners of S Corporation stock receive pass through losses that are in excess of their basis, such losses are carried over until the stockholders re-establish enough basis in the stock to deduct the loss in whole or in part.^[3]

(1) S Corporation losses follow the stock.^[1]

For transfers of S Corporation stock incident to a divorce after 2004, any concomitant losses escheat to the spouse obtaining or keeping the stock.

(2)Carry over losses following the stock are treated as if they were incurred by the S Corporation in the subsequent year.^[1]

Written by David Ellis | Posted in Dividing Property • Divorce And Tax

17 Jun 2022

Dividing Property In Divorce Tax Traps – Part 8 In Series

(Part 8 is continuation of series, links to all parts are provided at end of this blog post. This valuable series on Dividing Property In Divorce Tax Traps has been updated for the Tax Cuts And Jobs Act (TCJA) and the Cares Act. This series is provided by David Ellis of Ellis & Ellis CPAs in Pasadena, CA.)

C. Losses And Other Carry Forwards

Tax losses and other carry forwards such as investment interest expense are easy to overlook in divorce proceedings, but often may be of extreme economic value. Remarkably, in many cases the tax law offers no specific guidance as to how such items are to be allocated between divorcing spouses. In such cases the practitioner must fall back on the general rules governing state property law, be it community property, equitable distribution, case law where available, English Common Law, or if all else fails, common sense.

1.Carry Forwards of Net Operating Losses

a) Community Property States

In community property states, the allocation of net operating loss carry forwards follows the usual rules for allocating community ^[1]

(1)Earned income is split evenly between spouses

(2)Rules for unearned income vary by state

(3)Expenses paid out of community funds are split evenly^[2]

(4)Expenses paid out of separate funds are allocated to the spouse who pays them (54)

Example:

Written by David Ellis | Posted in Divorce And Tax • TaxConnections

10 Jun 2022

Dividing Property In Divorce Tax Traps – Part 7 In Series

DAVID ELLIS - Dividing Property In Divorce Tax Traps – Part 7

(Part 7 is continuation of series, links to all parts are provided at end of this blog post. This valuable series on Dividing Property In Divorce Tax Traps has been updated for the Tax Cuts And Jobs Act (TCJA) and the Cares Act. This series is provided by David Ellis of Ellis & Ellis CPAs in Pasadena, CA.)

4. Individual Retirement Account (IRA) Transfers

Except for purposes of calculating the 10% early withdrawal penalty,[1] IRAs are not considered Qualified Plans and therefore there is no requirement that a QDRO be in place to avoid tax on their division in divorce proceedings.[2]

a) IRA transfers between spouses are tax free if pursuant to a decree of separate maintenance or divorce (or written instrument related thereto).[3]
b) A QDRO will not protect against early withdrawal penalty from nonqualified retirement plan such as an IRA, SEP or SIMPLE.[4]
c) Letter Ruling 9344027

Although IRS Letter Rulings are binding only on the parties to which they are addressed, the author is of the opinion that the aforementioned should serve as a cautionary tale to any parties dividing IRAs in a divorce.

The ruling concerns two divorcing taxpayers that had entered into written separation agreement. The taxpayers resided in a community property state.

Written by David Ellis | Posted in Divorce And Tax

02 Jun 2022

Dividing Property In Divorce Tax Traps – Part 6 In Series

DAVID ELLIS - Dividing Property In Divorce Tax Traps – Part 6

(Part 6 is continuation of series, links to all parts are provided at end of this blog post. This valuable series on Dividing Property In A Divorce Tax Traps has been updated for the Tax Cuts And Jobs Act (TCJA) and the Cares Act. This series is provided by David Ellis of Ellis & Ellis CPAs in Pasadena, CA.)

2. How QDRO (Qualified Domestic Relations Order) Distributions are Taxed

a)The alternate payee assumes the same rights and responsibilities as the plan participant. When a distribution is made to a plan participant’s spouse or former spouse, it is taxed to such spouse or former spouse.^[1]

Tax Trap Alert: When distributions are made to a dependent of a plan participant, they are not taxed to such dependent, but rather they are taxed to the plan participant.^[2]

b)Basis is allocated on a prorated formula between the participant and the participant’s spouse or former spouse according to present value formulations.^[3]

c).QDRO distributions not subject to early withdrawal penalty. Age of the alternate payee does not matter for QDRO distributions. No early withdrawal penalty ^[4]

Tax Trap Alert: Although QDRO distributions from qualified plans are not subject to the 10% penalty for early withdrawal, the same does not hold true for IRA’s, SEP’s, or SIMPLE plans regardless of any domestic relations court order.^[5]

Tax Trap Alert: In the author’s experience, it is not unusual for an alternate payee to rollover distributions under a QDRO into an IRA. Assuming the alternate payee does not meet the age (or one of the other exceptions), subsequent distributions from the IRA will be subject to the 10% early withdrawal penalty. Practitioners should take care to call this tax pitfall to the clients’ attention prior to the rollover of the QDRO distribution into an IRA.

Written by David Ellis | Posted in Divorce And Tax

18 May 2022

Dividing Property In Divorce Tax Traps – Part 4 In Series

(Part 4 is continuation of series, links to all parts are provided at end of this blog post. This valuable series on Dividing Property In A Divorce Tax Traps has been updated for the Tax Cuts And Jobs Act (TCJA) and the Cares Act. This series is provided by David Ellis of Ellis & Ellis CPAs in Pasadena, CA.)

Dividing Property In Divorce Tax Traps – Part 4

Mortgage Interest and Real Estate Taxes. An issue that practitioners frequently face in divorce situations is allocating the deduction between spouses for mortgage interest and taxes when one spouse has moved out of the residence and separate returns are being filed.
- If spouses are still legally married at year’s end and a joint return is filed, there is no need to allocate deduction, even if spouses are living apart
- If separate returns are filed and mortgage interest and/or real estate taxes paid from a joint account, half of the payment is allocated to each spouse.^[1]
- Interest and real estate taxes paid from separate accounts are deemed to be paid by the spouse who owns the account.^[2]
- In community property states, expenses paid from community property funds are generally allocated one half to each spouse.^[3] Community property rules vary from state to state. Practitioners may need to consult legal counsel as to community property rules in their state. For example, in California, the marital community for tax purposes ends when the spouses separate with the intention not to reunite.^[4] In other states, the community does not end until the date of divorce. In community property states, expenses paid from noncommunity funds are allocated to the spouse who paid them.
- Interest payments must be “qualified” in order to be deducted. Often in a divorce situation, one of the spouses will move out of the house and establish a second residence, while continuing to contribute to the mortgage payments.

The question then arises as to if non-resident spouses can deduct their share of the mortgage interest, since they are no longer using the house as their principle residence.

Written by David Ellis | Posted in Divorce And Tax