Yosinsky v. Commissioner illustrates a common misconception of married taxpayer’s about joint and several liability for the tax owed on a joint tax return. Contrary to popular belief the IRS is not obligated to pursue one spouse or the other for the tax owed. IRS may collect the full tax liability from the separate assets of either spouse or from jointly owned assets. It matters not that the collection against one spouse seems unfair unless the unfairness combined with other enumerated factors entitles the spouse to relief under the so called innocent spouse provisions of Section 6015(b), (c), or (f). Yosinsky also illustrates the harsh consequences that can ensue from failing to utilize a Qualified Domestic Relations Order (QDRO) when making payments from a taxpayer’s retirement account to a spouse or former spouse.
Often tax unfairness can be averted by anticipating tax problems in a marital settlement agreement or in making appropriate requests for relief to the divorce court. Yosinsky involved spousal support and other payments that the Colorado divorce court order had anticipated would be paid from the husband’s retirement assets. It is not stated but it appears that the support was temporary support ordered to be paid during the pendency of the parties divorce proceedings because the parties were still married on December 31, 2006. They were, however, separated in 2006 and the divorce was acrimonious. That may have accounted for the lack of planning that could have anticipated the perceived tax unfairness which ultimately led the taxpayer husband to request innocent spouse relief from IRS and having been denied to seek a reversal of the denial in U.S. Tax Court.
At the time of the Colorado hearing on support, the husband had separated from his long-term employment. It was anticipated that the support and other payments would come from the taxpayer’s three 401(k) retirement accounts. He was ordered to pay support to his wife, pay marital debts and give to her $50,000 towards completing construction on the marital home. She had no assets and only nominal income of her own. The payments to her were made in 2006 and the parties filed a joint return for such year. To make the payments and to support himself, the taxpayer withdrew $442,000 from a single IRA into which he had unwisely rolled over his employer 401(k) accounts.
The divorce court order was not part of the Tax Court record and it is not stated whether the court ordered the parties to file a joint return or designated the payments as non-taxable to the wife and non-deductible to the husband. The distributions from the IRA were in part taxable to the husband and also subject to a 10% early withdrawal penalty under Code Section 72(t). The 10% penalty would not have applied had the taxpayer made the distributions directly to the wife from his 401(k) accounts under a Qualified Domestic Relations Order. It is not stated why a QDRO was not employed to transfer funds from the husband to the wife but clearly that was a costly mistake. Not only would the penalty have been averted but the funds distributed would have been taxed to the wife and not the husband.
The husband cried foul because he was forced to pay tax on funds given to the wife. The court found he did not qualify under Section 6015(b) or (c) as to the underpayment of the amount due on the return ($46,261) because there was no deficiency as to that amount; and, he did not qualify for relief under Section 6015(f) (equitable relief) for the deficiency assessed on audit ($11,198, including accuracy related penalty) because the adjustment related to his items of income (sale of employer stock and IRA distributions).
The taxpayer asserted a novel but unsuccessful argument that he faced jail time if he did not take the distributions. Therefore, in taking the IRA distributions he was, “acting as an agent to implement the orders of the (Colorado divorce) court,” which, in effect made his wife equitable owner of a portion of the IRA funds. Since taxable income follows title, income from the distributions belonged, not to him, but to his wife. The Tax Court rejected the premise, citing Lucas v. Earl, 281 U.S. 111, 114-115 (1930), and finding that the funds distributed from the IRAs were all derived from taxpayer’s employer funded retirement accounts and as such were taxable to and items attributable to the person who earned the funds. The Colorado court did not specifically order the taxpayer to rollover his 401(k) accounts into a single IRA account and make distributions from that account.
The court also refused to consider additional factors under the Rev. Proc. proposed in Notice 2012-8, 2012-4 I.R.B. 308 because the proposed revenue procedure is not final and because the comment period under the notice only recently had closed. Instead, the court, applying the factors stated in Rev. Proc. 2003-61, found that the taxpayer husband was not entitled to equitable relief.
Unfairness is not a persuasive tax argument. When obvious tax inequities are suggested in a divorce settlement or court order, the marital settlement agreement should clearly address the tax consequences aiming at fairness or the parties should argue the fairness issue before the divorce court and seek an order that addresses tax issues.
Temporary support is an often overlooked tax problem because, unless the court states it is not taxable, payments made pursuant to a court order will be taxable to the recipient spouse. In Yosinsky the parties filed a joint return thus obviating the need to characterize the payments to the wife. The Tax Court does not state whether the court ordered the parties to file a joint return. It may be that the husband would have been better off filing a separate return and claiming an alimony deduction for payments to the wife if not designated by the divorce court as non-taxable. As events transpired, the taxpayer did just about everything wrong and wound up paying tax on funds received by his wife and paying a 10% penalty for the honor.
© 2012 by Robert S. Steinberg, Esquire
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