Income
Tax I
Bogdanski
Fall 2016
Sample Answers to Question 1
1. Willa and Darla
In the begining, Willa and Darla are Hugh's dependents, but after the divorce they ceased to be. Also any amounts spent on Darla by Willa would not be deductible because they are S262 personal expenses. It doesn't matter that Willa doesn't live in a community property state. The law considers transfers between husband and wife to be non recongized transactions with no tax
2.
Property Settlement
The agreement between Hugh and Willa that states that Hugh transfers a vacation home with a FMV of $300,000 and a strock with a FMV of $20,000 is a property settlment and cannot be deducted under 1041(a)(2). while the transaction is a realizing event, it is not a recognized event. This section applies so long as Willa's marriage is recognized under federal law, is related to the cessation of the marriage, and takes place within 1 year of the date when the marriage ceased. Here, because there is an agreement in a divorce settlement from a marriage that is valid under state and federal law. Therefore the elements are met and although there is a realizing transfer event, the amount is not recognized.
Willa's basis in the house and stock is carryover basis of Hugh's which is $250,000 in the house, and $30,000 in the stock. Although the transfer of the home is delayed by unforseen circumstances, I believe that the transfer is still a non-recgonized event under 1041. Even though it was transfered 3 years laterm, and the transfer took place while Willa and Hugh were not married, the tranfer was due to an even that was related to the cessation of marriage, so even within 3 years, the transfer still is a nonrecognized event for Willa. I think the limit is up to 6 years.
This transfer is not an alimony payment because it is not cash, and usually alimony is paid in monthly payments. See Infra #3.
3.
Alimony Payment
The decree from the court to pay Willa $1,000 cash each month and pay for Willa and Darla's landlord the rent on their apartment (up to $1,800 a mont) for three years is Alimony under IRC 215. In order to qualify for alimony, 1) the payment must be in cash ($1,000 cash per month and rent payment in cash), 2) pursuant to a written instrument (the divorce decree), 3) with no election to have the payments not be for alimony purposes (nothing in the facts state the paymens are not alimony), 4) with the payee and payor living apart and not part of the same household (Willa and Darla moved into an apartment in late 2016, presumably not with Husband), 5) no obligaion to pay after the payee dies (payments end when willa dies or remaries), and 6) for the benefit of the ex spouse (Willa is benefited). Although the rent is arguably both for willa and darla, I don't think it is a child support payment in disguise because the payments remain steady and end while Darla is 12.
The result of Alimony is that it is an above the line deduction for the spouse, and Gross ordinary income to Willa in the year that she receieves the money.
4.
Custody of Dependent and Child support, Child Credit, Deduction as dependnent,
Head of Household
Hugh's payment to Darla of $800 per month and $1,000 a month after Darla reaches the age of 14 is child support under IRC 71(c)(2). Child support is not gross income to Darla (and not a deduction to Hugh). No Tax Consequences for either.
Darla would qualify as Willa's qualifying child under IRC 152. In order to qualify, Darla would have to be a child, sibling, niece, or newphew (Darla is child), and lives with the Willa for more than 1/2 year (Darla lives with Willa full time), Darla is younger than Willa (although we don't know how old, woman needs to be at least teens to give birth), Child is under 19 (Darla is 8 at the time), and doesn't provide more than one-half od her own support (Hugh does this and it doesn't matter that he does. All that matters is that Darla isnt paying for her own support). Since all the elements are met, Darla is Willa's qualifying child.
Although it could be argued that Hugh could contest Willa's claim and Darla would become his qualifying child, Hugh would lose the argument. The tie-breaker rules state that ties between parents go to the one with the greater custodym, and under the agreement, Darla is in Willa's custody. Even though Hugh makes more than Willa, that is secondary to custodial rights. While Darla may qualify to be Hugh's "qualifying relative," he would lose out on that claim because one of the elements of being a qualifying relative is that the person is not someone else's "qualifying child," which, in this case Darla is Willa's qualifying child.
Having a dependant makes Willa head of household under section 1 and she will have a favorable rate schedule compared to filing as just an individual, and a standard deduction of $9,300. Furhtermore, although Willa is also allowed to take a personal exemption of $4,050 and one for Darla. These exemptions are may be subject to a IRC 151 phasehout, but since willa makes very little money now, she will be able to take advantage of all of it.
Furthermore, since Willa has a qualifying child under the age of 17, she may also be able to take a child tax credit of $1,000 for each qualifying child under IRC 24. This child credit too is subject to phase out, and is reduced by $50 for each $1,000 over $75,0000 for single, but Willa is far from that kind of income and can take full advantage of it. Tax credits are superior to tax deductions because Credits reduce your tax liability dollar for dollar, where the max that a tax deduction can reduce your tax liability is 39.6%. For Willa, a deduction would be worse, might not save anything or maybe just 10%.
5.
Professional Fees to lawyers
Willa will be able to deduct her lawyer's fees under IRC 212 because the fees was related to getting Alimony. While usually if the source of litigation is personal, the cost might not be deductible, but when it comes to Alimony collection, the part of the attorney's fee which is attrituable to collecting income under 71 alimonyis deductible by Willa. Reg 1.262-1(b)(7). Also the income tax aspect of the legal services is also deductible under 212(3). Since the child support and property settlement were also going after income, they too should be deductible for Willa.
These deductions are Miscelaneous Itemized deduction that is below the line, and the aggregate of the deductions over 2% of Willa's AGI are deductible. Since Willa has such a high standard deduction for her income, she might be better off taking the standard deduction.
6. Stock
Sale of XYZ
This is a realizing event for Willa. Willa's basis was her carry over basis from Hugh, which was $30,000. Since Willa held on to the stock for over a year, this is a long term capital gain/loss transaction with favorable rates (for gain). The amouont realized is the consideratio, which is $25,000. The loss realized is $5,000 of long term capital loss. Unfortuantely Willa can only take offset $3,000 of capital loss to Ordinary income per year, so she will need 2 years to offest the $5,000, 3k in the first year, and 2k in the next. Willa could alternatively, if she had any capital gains, could offset the full amount towards that gain.
Vacation home + Stock in XYZ
The transfer of the cash and the stock do not recognize any income for Willa b/c it is received incident to a marital settlement, per §1041. Since Willa was a former spouse of Hugh and the transfer was made within 1 year in which the marriage ceased, the requirement for the property to be once incident to a settlement is satisfied. see 1041(a); (c). Willa will have a basis of 30K in the stock b/c the transfer is treated like a gift under 1041(b) and she gets a carryover basis. Willa will have a harder time with the transfer of the home b/c that was delayed by unforeseen circumstances and wasn't transfered until 3 years after the separation. Under 1041(c), Willa could still argue that the transfer of the home is related to the cessation and could use the "agreement" as proof that it was related to the separation. As such she would have a carryover basis of 250,000 in the vacation home.
Cash each month + rent
The 1,000 cash payment each month satisfy the definition of alimony under §71(b)(1), and as such would be ordinary income to Willa to the tune of 1,000 a month. They are cash payments, to or for the benefit of an ex-spouse, pursuant to a written agreement, with no election for them not be alimony, and the payor/payee live apart. There is also no obligation under the agreement that the payments must continue after Willa dies. With regard to the rent payments though, under §71(f), there is further inquiry if there is suspicion that the taxpayers are disguising property settlements as alimony. After the first 3 years, the payments stop plus the payments are contingent on certain conditions. If this is found not to be alimony, it will be a property settlement and Willa will not have the 1K a month of ordinary income.
Darla
Darla is a qualiying child to Willa, under §152, which could qualify Willa to deduct the exemption amount for her dependent. See 151(c). Darla is Willa's child, she lives with Willa for more than 1/2 the year, she is younger, and she is under 19 b/c she will be 14 in 2022. Also, she doesn't provide more than half of her own support. There might be a problem with the fact that Hugh provides most of the support for Darla but, based on these facts, it doesn't seem like she lives with Hugh for more than a year. Also, Willa can rely on the tie-breaker rules of 152(c)(4)(b), which give ties to the parent with greater custody. If Darla is a qualifying child, Willa can also take a child credit in an amount equal to $1,000 under §24. Depending on Willa's income, the credit might be subject to the phaseout under 24(b), which reduces by $50 for each 1000 that the taxpayer's modified adjusted gross income exceeds the threshold amount; for Willa it would be 75k, per 24(b)(2).
The child support payments to Willa are not gross income, per §71(c). Since there are contigencies upon the child support, under 72(c)(2), there will be a reduced deduction. Darla does not receive any gross income from these payments or the payments of rent.
Lawyer
Willa could deduct the part of the attorney's fees which were attributable to collecting gross income under §71(alimony). See Reg. 1.262-1(b)(7). This would be a 212 expense for production of income, an itemized deduction. Since it is not listed in 67(b), it is a miscellaneous deduction subject to a 2% floor. The tax advise is deductible under 212(c), but it is also a miscellaneous deduction subject to the 2% floor.
Selling the stock
Since Willa had a carryover basis of 25K from the transfer, her sale of the stock for $25K would give her a loss. It is also a capital loss since it is the sale or exchange of a capital asset, which includes corporate stock. She will be able to deduct this from her capital gains (if any) but can also deduct from her ordinary income up to 3K.
Exam No. 6482
Divorce Settlement
Willa (W) and Hugh (H) divorce becomes finalized in October 2017. As part of W & H's divorce settlement, H transers to W (1) "a substantial sum of cash", (2) the vacation home, and (3) stock in corporation XYZ. Under IRC § 1041, any transfer of property that occurs within 1 year of divorce or is at all related to the divorce is not recognized; it's treated as a gift (overrides Duberstein defintion of a "gift"). The (1) "a substantial sum of cash" and (2) the stock in corporation XYZ were both transfered in October 2017, so they are non-recognizable events. W realizes no gain and H has no deduction.
The vacation home is slightly more problematic because it wasnt transfered until January 2019 (more hhan a year after the divorce was finalized). However, because the transfer of the home is related to the cessation of the marriage, it still gets looped into this scheme of non-recognition [§1041(c)(2)].
It's worth noting that if W & H lived in a "community property" state, this issue would not be a problem because they both would have technically owned the property all along.
Vacation Home
After the transfer (xfer) of the vacation home, W gets a carryover basis ($250k). W has no income and H gets no deduction because the xfer is not recognized.
Stock in XYZ
Corp
After the transfer (xfer) of the stock in XYZ, W gets
a carryover basis ($30k). W has no income and H gets no deduction because the
xfer is not recognized.
Allimony
Also part of the settlment agreement is the requirement that H pay W $1,000 cash each month for 3 years until W remarries or dies. This is an allimony payment under § 71 because ("b/c") W & H no longer reside in the same household, H is not required to continue payments after W remarries or dies, and the payment is recieved under a divorce settlement. Because this is an allimony payment and H made all the monthly payments for all 3 years, W realizes $12,000/year in gross income for 3 years and H gets a $12,000 above-the-line deduction for 3 years under §215, §62(a)(10).
Willa &
Darla Rent
Also part of the settlment agreement is the requirement that H pay W & Darla's (D) Rent ($1,800) each month for 3 years until W remarries or dies. These rent payments could also be considered allimony payments under § 71 because ("b/c") W & H no longer reside in the same household, H is not required to continue payments after W remarries or dies, and the payment is recieved under a divorce settlement. Because this is an allimony payment, W realizes $21,600 per year for 3 years in gross income and H gets a $21,600 per year above-the-line deduction for 3 years under §215, §62(a)(10).
Attorney Fees
W's attorney fees relating to the advice the attorney rendered regarding tax consequences of the divorce settlement are always deductible under IRC § 212(3). However, the attorneys fees are a below the line misc itemized deduction subject to the 2% of AGI floor.
W might also be able to deduct her attorney fees regarding the divorce agreement because the allimony portion was highly contentious. W can recover her attorneys fees for the allimony discussion because it was for the production of income [REG §1.262-1(b)(7)].
H will not be able to deduct any of his attorney's fees b/c the orgin of the claim is divorce which is an inherently person dispute. (Gilmore v Commissioner)
Darla
Child Support
Also part of the settlment agreement is the requirement that H pay W $800 each month for the support of D until D turns 14 years old, in which case H will be required to pay $1,100/ month until D turns 21 years old or dies. This is a child support payment under § 71(c) because the payment is conditioned that it is for the support of D. Under § 71(c), H is not entitled to a deduction for these child support payments and W does not realize any income upon receipt of the child support payments.
Dependent
Under § 152, a dependent may be a qualifying child so long as (1) the child has not turned 19, (2) the parents provide more than half the child's support, and (3) because W & H are divorced, the taxpayer is the child's custodian unless custodian signs a written declaration.
Here, Darla has not turned 19, and the facts provide that H provides more than half of D's support, but the facts state that W got custody of D. With that being said, the only way H could claim D as a dependent and recieve the the exemption amount under §152 in addition to his own personal exemption under § 151 (subject to phaseout), W would have to sign a written declaration that she would not claim D as a dependent. Otherwise, W gets to claim D as a dependant and recieve the § 152 exemption in addition to her own personal exemption under § 151 (subject to phaseout).
2019 Sale of Stock
Because W recieved a carryover basis of $30k in the XYZ stock, W realizes a loss of $5k as a result over the sale [amount realized ($25K) minus adjusted basis ($30k)]. §1001. The sale of sock was a sale of capital assets b/ stock isnt in the list of property that isn't capital assets under § 1221(a). W can only deduct the the $5k loss from any capital gains in 2019 [§163(d)]. To the extent W is entitled to a deduction, it will be treated as a below the line, itemized ,non-misc deduction under §67(b)(1).
H has no tax consequences from this sale.