Chapter Sixteen Taxation

• Library: Marital Litigation in South Carolina (SCBar) (2020 Ed.)

Chapter Sixteen TAXATION¹

A. In General

The purpose of this chapter is to present the essential and basic federal income tax rules that directly relate to divorce, separation, child support, property and other concerns in the divorce context. It is not an exhaustive compilation. During the initial drafting of this chapter, over 1,700 pages of code provisions, regulations and statutes relating to taxes were generated. This summary description of tax law is intended to help the practicing lawyer recognize the need for further research or for the employment of an expert.

Lawyers practicing in this area will often say, "I'll rely on the CPA to advise me and my client on tax matters." However, the lawyer needs to understand the tax laws well enough to know when to refer matters to a CPA. In many cases, of course, there is not enough money to justify using a CPA. Very few accountants or family court lawyers are well-versed in the tax laws relating to divorce. However, all practitioners need some basic understanding of tax law to function appropriately in advising their clients.

The format of this chapter presents the tax rules related to each area which were in effect before the Domestic Relations Tax Reform Act of 1984 (DRTRA (1984)), followed by the rules presently in effect. The "old law" is presented for an important reason: these rules remain in effect for orders and agreements issued or entered into prior to 1984/1985. Current actions involving cases with orders in effect before the effective dates for the new rules will be governed by prior tax law. Examples of such actions include contempt, change of economic circumstances, child support changes and proceedings for enforcement. In dealing with such prior orders, the practitioner should consider whether to "elect into" the new rules or whether it would be beneficial to the parties to continue the applicability of the "old rules" to the situation.

B. Children

1. Child Support

Child support payments are nondeductible to the payor and not taxed as income to the person receiving the payments if (1) they are fixed by a "decree," instrument or agreement in effect at the time the payments are made and (2) the payments are for the support of the children of the payor. I.R.C. §§ 71(a), (b)(2), (c); § 262.

2. Dependency Exemptions

a. Dependency Exemptions Prior to DRTRA (1984)

Generally, a divorced or separated parent who had custody of a child for a greater part of the year was entitled to claim the exemption for the child, if the parents together had custody of the child for more than one-half of the year and provided more than one-half of the child's support. A special rule provided that the noncustodial parent could claim the dependency exemption if (1) a decree or written agreement allocated the exemption to the noncustodial parent and such parent paid at least $600 for the support of the child during the calendar year and (2) the noncustodial parent provided at least $1,200 for the support of the child during the year and the custodial parent did not clearly establish proof of providing a greater portion of support than the noncustodial parent. Special "multiple support" agreements between divorced spouses overrode all of the above rules.

b. Dependency Exemptions under DRTRA (1984)

The Domestic Relations Tax Reform Act of 1984 (DRTRA (1984)) established new dependency exemption rules which apply to tax years beginning after December 31, 1984. The rules apply to parents living apart at all times during the last six months of the calendar year. Parents living apart for the last six months of the year may qualify under the more favorable head-of-household filing status if other eligibility tests are met (see below). A child is treated as a dependent of both parents for purposes of medical expenses.

Under the DRTRA (1984), the custodial parent (divorced or separated) is entitled to the dependency exemption so long as both parents contribute at least half the child's support. However, the custodial parent may assign his or her right to the dependency exemption as custodial parent, provided he or she completes IRS Form 8332, "Release of Claim to Exemption for Child of Divorced or Separated Parents." Once the waiver is signed, it cannot be revoked unilaterally. The form must be attached to the noncustodial parent's tax return each and every year for which the exemption is assigned. I.R.C. § 152(e)(2).

A decree of divorce or separation instrument executed before January 1, 1985, which provides that the noncustodial parent is entitled to the dependency exemption will be honored, provided that at least $600 in support is provided for the child during the year by such parent. A pre-1985 instrument may be modified to adopt the new rules. The modification must expressly state that the provisions of the Domestic Relations Tax Reform Act of 1984 will apply. See I.R.C. § 152(a), (e).

Family court judges have the authority to allocate the right to claim the dependency exemption to either parent pursuant to the Internal Revenue Code and corresponding state tax provisions and to require the execution and delivery of all necessary documents and tax filings in connection with the exemption. See S.C. Code Ann. § 20-3-130(F) (Supp.).

If the family court awards the dependent tax exemption to the noncustodial parent, it should not provide that the exemption will automatically shift to the custodial parent after a certain period of years. Such a provision would ignore the speculative nature of predicting the future financial situations of the parties. The family court should not change the allocation absent evidence of actual changed circumstances. Hudson v. Hudson, 340 S.C. 198, 530 S.E.2d 400 (Ct. App. 2000) (affirming an award of dependent tax exemption to noncustodial parent who contributed 81% of child support and reversing family court's order that the exemption automatically shift to the custodial parent in six years based upon her expected matriculation from school, anticipated income upon graduation, and expected increase in childcare expenses). See also Engle v. Engle, 343 S.C. 444, 539 S.E.2d 712 (Ct. App. 2000) (affirming an award of tax exemption to father who earned the greater income and would therefore benefit most from the exemption and disregarding as premature the mother's argument that the tax exemption would help her finance the child's college education).

A state court order awarding the dependent tax exemption to a noncustodial parent cannot substitute for a signed release (Form 8332) from the custodial parent. Miller v. Commissioner of Internal Revenue, 114 T.C. No.13, 114 T.C. 184, Tax Ct. Rep. Dec. (RIA) 114.13 (U.S. Tax Ct. 2000). If the custodial parent refuses to sign the waiver, the family court must resort to its contempt authority to enforce execution of the waiver.

The family court does not have authority to allocate the dependent tax exemption unless this relief is requested in the pleadings or the issue is tried without objection. Abbott v. Gore, 304 S.C. 116, 403 S.E.2d 154 (Ct. App. 1991) (holding that the allocation of the dependent tax exemption is a separate issue from child support and that due process considerations prevent the family court from awarding it to a noncustodial parent who neither requests such relief in the pleadings nor raises the issue of entitlement to the tax exemption at the family court hearing); Hudson v. Hudson, 340 S.C. 198, 530 S.E.2d 400 (Ct. App. 2000) (relying on Rule 15(b), SCRCP to hold that the mother could not complain on appeal about the family court's decision to award the dependent tax exemption to the father where the issue was tried without objection).

If the parties wish to restrict the court's ability to allocate the dependency exemption, "any provision in the settlement agreement denying the court jurisdiction must be 'explicit, clear, and plain.'" Robinson v. Tyson, 319 S.C. 360, 365, 461 S.E.2d 397, 400 (Ct. App. 1995), quoting Moseley v. Mosier, 279 S.C. 348, 353, 306 S.E.2d 624, 627 (1983). Although the former husband argued that the family court did not have subject matter jurisdiction to modify the tax exemption status of the parties because the court order was based on the agreement of the parties, the Court of Appeals could find no provision in the parties' agreement that excluded the family court's jurisdiction to modify the tax deduction status of the parties. Thus, it upheld the trial court's decision to modify the decree and to grant the dependent tax deduction to the mother.

A curious aspect of Robinson is that it leaves open the question of whether the tax deduction status award is an incident of spousal support or equitable division. The Court of Appeals specifically finds that it is not an issue directly related to the best interests of the children and the family court was not authorized to modify it on that basis. Therefore, one might infer that the family court's power to modify the tax status arises from its character as spousal support (although the opinion does not say so) because property divisions are not modifiable. However, there was no finding of changed circumstances to justify a modification of spousal support, and the Court of Appeals refused to address the question of whether the trial judge abused his discretion in modifying the tax deduction award because it was not asked to decide that issue.

It appears most likely that the appellate courts consider the tax deduction award to be an independent tool that should be given to the parent who will benefit the most from it. In Hudson v. Hudson, 340 S.C. 198, 530 S.E.2d 400 (Ct. App. 2000), the family court awarded the tax deduction to the father, the noncustodial parent, while the mother was completing her education and not fully employed. On appeal, the mother argued that the family court only has authority to allocate the tax deduction pursuant to an order of child support. The Court of Appeals held that the legislature did not...