Many folks in Illinois have questions regarding Community Property and sometimes travel under the false assumption that Illinois has Community Property. First and foremost let me clarify that ILLINOIS IS NOT a community property state, but here are some clarifications for those of you who do live in such a state.

A number of states are “community property” states, meaning that they recognize the concept of community property law. Community property law is dependent on state law and will, therefore, vary somewhat from state to state, but generally, 50% of community property and community income is considered owned by each spouse. State laws usually identify whether income or assets are considered community or separate property; separate property is owned exclusively by one of the spouses.

Community Property

Community property and income may include:

  • Property acquired by the couple during the marriage while domiciled in a community property state, unless purchased with separate property assets.
  • Property that the spouses have agreed to convert from separate to community property.
  • Property that cannot be identified as separate (by default it is considered community).
  • In certain states, income from community property assets (but not separate property assets), is community income. In other community property states (e.g., Texas, Idaho, Louisiana, and Wisconsin), even income from separate property is community income.
  • Salaries, wages, or pay for the services of either or both spouses while married and living in a community property state; money earned while living in a non-community property state can be separate income to the spouse who earned it. In some community property states, money earned after a marital separation is separate income.
  • Income from real estate that is community property under the laws where the real property is located.

Separate property and income may include:

  • Property owned by a spouse prior to the marriage.
  • Property received as a gift or inherited by one of the spouses, even while married.
  • Property purchased with separate property assets, even during the marriage.
  • Any property that the couple agrees to convert from community to separate property under a valid state law agreement.
  • Money earned while domiciled in a non-community property state.
  • Income from separate property, which is income to the owner/spouse.
  • Federal Tax Treatment of Community and Separate Income

Whether a couple has community property and/or income depends on the laws of the state where they are “domiciled.” Domicile is not necessarily the same as residence. Domicile is the couple’s permanent, legal home, intended for use for an indefinite or unlimited time. It is a question of the intent of the couple, but the IRS looks to a variety of factors to verify domicile, including where the spouses pay tax, vote, own property, and have social and business ties to the community.

For federal tax purposes, couples who have community assets and income (as determined under state law) may have to calculate their federal income tax differently. However, it is only if they are married and file separate tax returns that the disparate treatment arises. Just as community property is considered owned 50/50 by spouses, community income is also considered attributable 50/50 to each spouse.

When filing separately, each spouse must report one-half of the community income as their own income, regardless of who actually earned the money. Usually, all community income from the sources set forth above is added together, divided by two, and each spouse must list that amount as income on a separate tax return. In addition, each spouse must report in full whatever separate income was earned in the tax year from the sources described above. It sounds simple, but in practice figuring the amount or portion of income that may be community or separate can become complicated.

Income Tax Deductions and Exemptions

When filing separately, spouses claim an exemption for themselves. When there are dependents, (entitling the couple to further exemptions), the exemptions must be divided between the spouses by number, not the value amount of the deductions from income. Thus, if the couple has three children, all eligible to be taken as exemptions, the spouses must divide up this number (two for one spouse, one for the other spouse, etc.), not allocate the total exemption amount for all the dependents.

If one spouse itemizes deductions on the return, the other spouse must also itemize deductions. Deductions may be allocated as follows:

  • Expenses incurred to earn or produce community business or investment income are generally divided equally among the spouses; each spouse is entitled to deduct one-half.
  • Expenses incurred to earn or produce separate business or investment income are deductible by the spouse owning the business or investment, provided the expenses were paid with separate funds.
  • Expenses that are not attributable to any specific income, such as medical expenses, are usually deductible by the spouse who pays them. If they are paid with community funds, the amount of the deduction is divided equally between the spouses.

Equitable Relief

This division of community income can lead to inequitable results. For example, if one spouse deserts the other, the deserted spouse may have to file a separate tax return listing income earned and received by the other spouse, without having the resources to pay the resulting taxes. U.S. tax laws provide equitable relief for this under certain circumstances specified in the Internal Revenue Code and its regulations.

Work with a Chicagoland Attorney and Mediator

Getting a Divorce is a difficult time of life, choosing the right attorney should not be! For over 4 decades Alan Pearlman, Ltd. has been serving Chicagoland and the surrounding Suburbs in obtaining solutions to these difficult matters. Contact my office at 847-205-4383 for your free 1/2 hour telephone consultation and see how we can be of service to you.

All 50 states have laws authorizing certain nonparent parties, typically grandparents, to seek child visitation rights. These statutes are controversial, and parents often argue that the laws interfere with their fundamental constitutional right to rear their children, which includes the right to determine who may educate and socialize with their children. However, as parens patriae, states are required to protect all citizens who are unable to protect themselves. Accordingly, state legislatures and courts are vested with the power to consider the best interest of their child citizens in enacting and enforcing grandparent visitation laws, provided certain guidelines are followed.

Troxel v. Granville

In 2000, the U.S. Supreme Court issued a severely fractured opinion on the constitutionality of a Washington visitation statute. The law permitted “any person [to] petition…for visitation rights at any time” and authorized courts to grant visitation whenever it would “serve the best interest of the child.” Under the statute, the Troxels were seeking visitation rights of their granddaughters from their mother, after the Troxel’s son (the children’s father) committed suicide. The mother sought to limit the visitation between the Troxels and their granddaughters. The statute, however, was ruled as being “breathtakingly broad.” The Court held that, as applied, the law unconstitutionally infringed on the mother’s fundamental right to make child care, custody and control decisions.

The Troxel Court found that the excessive judicial discretion authorized by the statute was problematic. The Court seemed to suggest the need for state grandparent visitation laws to reflect a child’s needs while simultaneously affording more deference to the parents’ rearing decisions. Thus, Troxel left open the probability that grandparent visitation statutes can be constitutional even with the existence of fundamental protected rights of parents.

Aftermath of Troxel – Effect on Grandparent Visitation Rights

Immediately after Troxel, several lawsuits forced other courts to review their own state visitation laws. Some states’ courts, such as New Jersey, held their statutes to be facially valid, but unconstitutional as applied to the facts of the particular case. Other states, such as Florida and Illinois, held their statutes to be unconstitutional on their face. Still other states, such as Texas, distinguished Troxel, holding their own statutes to be constitutional.

Restrictive Visitation Statutes

Approximately 15 states have “restrictive” nonparental visitation laws which allow only the grandparents to petition for a visitation order. These laws also generally apply only in cases where parents are getting divorced, where one or both parents have died, or where the child was born out of wedlock.

Permissive Visitation Statutes

Most states have more “permissive” visitation laws which allow grandparents to seek visitation in any case where it would be in the best interest of the child. These states view grandparent visitation rights as only a small infringement on parents’ rights.

Some states have even more permissive visitation laws which authorize courts to consider visitation requests from other third parties such as stepparents or other family relatives. States with such highly permissive visitation laws may also permit grandparents to petition for visitation even where the family is still intact (i.e., no divorce or death has occurred).

Future of Grandparent Visitation Laws

Both the language in Troxel and the overall trend appear to allow that grandparent visitation statutes will be constitutional, provided that they direct courts to “presume” that a fit parent’s decisions regarding visitation are within the child’s best interest. In other words, at least some special weight must be given to a parent’s decision to deny visitation to the grandparents.

California’s statute provides an example of a constitutional permissive visitation law. The California Supreme Court upheld the law which specifically codifies the “fit parent presumption” recommended by Troxel. The court awarded visitation rights to the grandparents of a child whose parents were divorced. This decision is consistent with the trend upholding those statutes which allow grandparents to petition for visitation when the family is no longer together, focusing on the child’s best interest. However, it still appears to be more difficult for grandparents to seek visitation when the family unit is intact.

Work with a Chicagoland Attorney and Mediator

Getting a Divorce is a difficult time of life, choosing the right attorney should not be! For over 4 decades Alan Pearlman, Ltd. has been serving Chicagoland and the surrounding Suburbs in obtaining solutions to these difficult matters. Contact my office at 847-205-4383 for your free 1/2 hour telephone consultation and see how we can be of service to you.

Couples that seek to dissolve their marriages without the challenges of litigation often turn to alternative dispute resolution. Non-litigation settlement strategies are particularly effective for couples committed to maintaining respectful relationships with their spouses after the divorce, and may also minimize negative consequences facing the children. The following issues, among others, are typically amenable to such settlement strategies:

  • Property divisions
  • Spousal support
  • Interim living arrangements
  • Child support
  • Custody and visitation

Divorce Mediation and Collaborative Divorce, Generally

Two kinds of alternative dispute resolution models, often used by divorcing couples, include collaborative divorce and divorce mediation. In divorce mediation, the parties hire an independent neutral third party who brings the spouses together (with their attorneys if any were hired) to assist them to reach a satisfactory divorce settlement. In a collaborative divorce, a relatively new form of dispute resolution, each spouse hires their own attorney, and the two attorneys and their clients negotiate directly with each other without resorting to litigation.

Although divorce mediation has become a popular alternative to litigation, collaborative divorce, available in most states, is also beginning to establish itself as a successful form of divorce dispute resolution. Further, just as the practice of mediation is common in numerous other areas of law, collaborative law is starting to be used for numerous non-family law disputes, such as employment and business disputes.

Same Goals, Different Approaches

The underlying goal of both divorce mediation and collaborative divorce is to allow couples to reach mutually satisfactory divorce settlements in lieu of facing the unpredictable results of judge-imposed decisions. While both resolution models have proved to be generally effective, numerous differences may affect a couple’s decision when deciding which would be most appropriate.

Fees and Experts

Although few comparison studies have been conducted with respect to the costs of collaborative divorce, the general consensus is that litigation, on average, is more expensive. One study indicates that collaborative divorce fees generally reach about 1/3 the cost of the typical litigated divorce. Expenses will increase when there is a need to hire outside professionals. For instance, if the attorneys reach an impasse or lack the expertise to address a particular issue such as the value of one of the spouse’s businesses, a financial expert may be retained for assistance. In a collaborative divorce, the parties generally split all costs and fees.

Similar to collaborative divorce, in mediation, the parties generally split the mediator fees. However, unlike collaborative divorce, the parties are not required to hire attorneys (although the option generally remains open). Mediator fees can range widely, being as low as $100 to $200 per hour and sometimes exceeding $400 per hour, often depending upon the type of law involved or the complexity of the issues. Many mediators have separate fee scales for couples who choose to schedule the whole day.

Motivation to Settle Inherent in Collaborative Divorce

One feature unique to collaborative divorce is the built-in motivation to settle. Specifically, if the parties are unable to reach a settlement, and the dispute proceeds to litigation, the attorneys must withdraw from representation. When this occurs, the parties are required to hire new counsel and pay the additional fees.

Additionally, participants to collaborative divorce generally sign agreements that include provisions against bad faith negotiations. Although similar agreements are sometimes signed prior to mediation sessions, in collaborative divorce, such agreements have a slightly different impact on the negotiation. This is due, in part, to the fact that attorneys participating in collaborative divorce have abandoned, to an extent, much of their adversarial duties in exchange for a more resolution-driven focus. In contrast, in mediation, the attorneys do not rely as heavily on the conciliatory nature of the negotiation and may choose to withhold potentially materially relevant information.

Power Imbalances

Disputants frequently rely on mediators to offset power imbalances between parties. Such issues may be present in instances where one party has difficulties communicating with the other for various reasons, such as when a wife is divorcing an abusive husband. Given the nature of such a relationship, it may be difficult for the wife to effectively verbalize some of her concerns or desires. Where an attorney is present at a mediation to represent the wife in this type of situation, such imbalances will be minimized. Nevertheless, mediators often ask the parties, at some point, to speak directly with each other, often as a means of venting or “to get it all out.” Even without attorneys present, mediators who employ proper techniques will still be able to neutralize such imbalances. In a collaborative divorce, however, this concern is arguably less pronounced since the attorneys are communicating directly with each other and act as buffers between difficult personalities.

Balances of power may also be affected by attorney representation or the lack thereof. Mediators are generally not permitted to provide legal advice, but may provide legal information. Thus, unrepresented parties may be at a disadvantage in mediation. However, this is never an issue in collaborative divorce.

Work with a Chicagoland Attorney and Mediator

Getting a Divorce is a difficult time of life, choosing the right attorney should not be! For over 4 decades Alan Pearlman, Ltd. has been serving Chicagoland and the surrounding Suburbs in obtaining solutions to these difficult matters. Contact my office at 847-205-4383 for your free 1/2 hour telephone consultation and see how we can be of service to you.

Decisions regarding the division of marital assets upon divorce may be made either by the divorcing spouses themselves or by a judge. State law governs how marital and separate property is divided in the property distribution. Typically, each spouse will receive a percentage of the total value of their joint property. Although it is illegal to do so, one spouse may try to hide their assets in an effort to protect the assets from property division. There are numerous tactics that an individual might try to use to veil their assets. However, it is possible to find hidden assets to make them available for a fair distribution in a divorce.

Two Schemes to Divide Property

Appropriate division of property between divorcing spouses varies by state. Generally, a court will divide assets under one of two schemes, depending on the jurisdiction. In an “equitable distribution” or “separate property” state, any assets and earnings that were accumulated during the marriage are distributed equitably, or fairly. That does not mean that the assets are divided equally. In fact, as applied, two-thirds of the property is typically awarded to the spouse with the higher income, with the remaining one-third going to the other spouse.

In contrast, in one of the nine “community property” states (AZ, CA, ID, LA, NV, NM, TX, WA, WI; AK is opt-in), property is first characterized as community or separate property before it is divided. Generally, community property is any property that was acquired during the marriage, and it is owned equally by both spouses. Community property is divided fifty-fifty regardless of which spouse acquired it or earns a higher income. Separate property is typically all property acquired by only one spouse before marriage, or through a gift, inheritance or a personal injury award. As such, separate property is awarded entirely to the spouse to whom it belongs.

Preventing Hidden Asset Harm

Hiding assets to shield them from equitable or equal division upon divorce is both financially harmful to the innocent spouse as well as illegal. One way spouses may protect themselves is by being aware of all financial information before the divorce proceedings begin by making copies of financial documents such as tax returns, bank statements, and pay stubs. Another way to protect assets is to set up individual accounts that can only be accessed by the person named on that account.

Common Ways to Undervalue or Disguise Marital Assets

There are numerous ways in which a spouse may attempt to hide some assets to prevent their inclusion in the divorce property distribution. Tactics used to hide assets of a business include:

  • Money from the business is paid to a family member or close friend for phony services, then returned to the spouse after the divorce
  • Salary checks are written to non-existent employees
  • Collusion with the spouse’s employer to delay business contracts, raises, or bonuses until after the divorce
  • Skimming cash from a business owned by one spouse
  • Cash converted into traveler’s checks
  • Payment of a non-existent debt to a family member or friend that will be repaid to the spouse after the divorce
  • Unreported income on tax returns and financial statements
  • Investing in certificate “bearer” bonds and/or Series EE Savings Bonds
  • Artwork, antiques or other property whose value is undervalued or overlooked
  • Rent, college tuition or gifts given to a girlfriend/boyfriend
  • An account set up under a child’s Social Security number
  • Retirement account that the other spouse never knew about

Locating Hidden Assets

Hidden assets are sometimes difficult to locate, and their existence may be difficult to prove. Typically, formal discovery procedures in divorce litigation can assist in finding assets that have been hidden by one spouse. For example, the court can order certain financial records to be disclosed, which may reveal the hidden assets. Further, forensic accountants may aid in locating hidden assets since they are trained to assess the value of investments or businesses, interpret and evaluate various financial records, and can testify on their findings in court. Finally, a private investigator might be necessary to help discover such assets.

Work with a Chicagoland Attorney and Mediator

Getting a Divorce is a difficult time of life, choosing the right attorney should not be! For over 4 decades Alan Pearlman, Ltd. has been serving Chicagoland and the surrounding Suburbs in obtaining solutions to these difficult matters. Contact my office at 847-205-4383 for your free 1/2 hour consultation and see how we can be of service to you.

 

This past January 1st over 250 new laws took effect for Illinois, including several sweeping changes to Illinois’ divorce laws. Here are some of the major changes to the Illinois Marriage and Dissolution of Marriage Act that have taken effect this year:

I. Maintenance (750 ILCS 5/504)

As of January 1, 2019, maintenance is no longer tax-deductible to the payor spouse, and no longer includable in the gross income of the recipient spouse. In light of this new federal tax reform, numerous changes were made to Illinois’ maintenance statute effective January 1, 2019, and are summarized below:

  1. Maintenance Barred if Award is Not Appropriate (750 ILCS 5/504(b-1))
    Unless the court finds that a maintenance award is appropriate, the court shall bar maintenance as to the party seeking maintenance regardless of the length of the marriage at the time the divorce action was commenced.
  2. Guideline or Non-guideline Maintenance Awards (750 ILCS 5/504(b-1))
    Only if the court finds that a maintenance award is appropriate, shall the court order guideline maintenance or non-guideline maintenance. However, if the application of guideline maintenance results in a combined maintenance and child support obligation that exceeds 50% of the payor’s net income, the court may determine non-guideline maintenance, non-guideline child support, or both.
  3. Guideline Maintenance Awards (750 ILCS 5/504(b-1)(1)(A))
    If the parties’ combined gross annual income is less than $500,000, and the payor has no obligation to pay child support or maintenance or both from a prior relationship, the amount of maintenance shall be calculated by taking:33 1/3% of the payor’s net annual income, minus 25% of the payee’s net annual income. The amount calculated as maintenance, however, when added to the net income of the payee, shall not result in the payee receiving an amount that is in excess of 40% of the combined net income of the parties.
  4. Modification of Maintenance Orders Entered Before 1/1/19 (750 ILCS 5/504(b-1)(1)(B)) and (750 ILCS 5/504(b-4))
    Modification of maintenance orders entered prior to 1/1/19 that are and continue to be eligible for inclusion in the gross income of the payee for federal income tax purposes and deductible by the payor shall be calculated by taking:

    30% of the payor’s gross annual income minus 20% of the payee’s gross annual income, unless both parties expressly provide otherwise in the modification order. The amount calculated as maintenance, however, when added to the gross income of the payee, may not result in the payee receiving an amount that is in excess of 40% of the combined gross income of the parties.
    For any order for maintenance or unallocated maintenance and child support entered before 1/1/19 that is modified after 12/31/18, payments thereunder shall continue to retain the same tax treatment for federal income tax purposes unless both parties expressly agree otherwise and the agreement is included in the modification order.
  5. Maintenance Findings (750 ILCS 5/504(b-2)(3))
    The court shall state whether the maintenance award is fixed-term, indefinite, reviewable, or reserved by the court.

  6. Gross income for Maintenance Purposes (750 ILCS 5/504(b-3))
    Gross income means all income from all sources, except maintenance payments in the pending proceedings shall not be included.
  7. Net income for Maintenance Purposes (750 ILCS 5/504(b-3.5))
    Net income has the meaning provided in Section 505 of the Act (i.e., Child Support), except maintenance payments in the pending proceedings shall not be included.
  8. Maintenance Designation (750 ILCS 5/504(b-4.5))
    1. Fixed-term maintenance (750 ILCS 5/504(b-4.5)(1)) – If a court grants maintenance for a fixed term, the court shall designate the termination of the period during which this maintenance is to be paid. Maintenance is barred after the end of the period during which fixed-term maintenance is to be paid.
    2. Indefinite maintenance (750 ILCS 5/504(b-4.5)(2)) – If a court grants maintenance for an indefinite term, the court shall not designate a termination date. Indefinite maintenance shall continue until modification or termination under Section 510.
    3. Reviewable maintenance (750 ILCS 5/504(b-4.5)(3)) – If a court grants maintenance for a specific term with a review, the court shall designate the period of the specific term and state that the maintenance is reviewable. Upon review, the court shall make a finding in accordance with 504(b-8), unless the maintenance is modified or terminated under Section 510.

II. Child Support (750 ILCS 5/505)

The Illinois child support statute was amended to align with the federal tax law changes concerning maintenance, and to create uniformity with the new Illinois maintenance statute outlined above.

  1. Gross income for Child Support Purposes (750 ILCS 5/505(a)(3)(A))
    Gross income includes maintenance treated as taxable income for federal income tax purposes to the payee and received pursuant to a court orer in the pending proceedings or any other proceedings and shall be included in the payee’s gross income for purposes of calculating the parent’s child support obligation.
  2. Net Income for Child Support Purposes (750 ILCS 5/505(a)(3)(B))
    Net income includes maintenance not includable in the gross taxable income of the payee for federal income tax purposes under a court order in the pending proceedings or any other proceedings and shall be included in the payee’s net income for purposes of calculating the parent’s child support obligation.
  3. Spousal Maintenance Adjustment (750 ILCS 5/505(a)(3)(F)(2)
    Obligations pursuant to a court order for spousal maintenance in the pending proceeding actually paid or payable to the same party to whom child support is to be payable or actually paid to a former spouse pursuant to a court order shall be deducted from the parent’s after-tax income, unless the maintenance obligation is tax deductible to the payor for federal income tax purposes, in which case it shall be deducted from the payor’s gross income for purposes of calculating the parent’s child support obligation.

III. Modification and termination of provisions for maintenance, support, educational expenses, and property disposition (750 ILCS 5/510)

An order for maintenance may be modified or terminated only upon a showing of a substantial change in circumstances. The court may grant a petition for modification that seeks to apply the changes made to Section 504 by these amendments to an order entered before the effective date of these amendments only upon a finding of a substantial change in circumstances that warrants application of the changes. The enactment of the amendment itself, does not constitute a substantial change in circumstances warranting a modification. 750 ILCS 5/510(a-5).

IV. Disposition of Property and Debts – Designation of Life Insurance Beneficiary (750 ILCS 5/503)

A large aspect of divorce is the division of property and debts, including life insurance policies and proceeds. Newly enacted Section 503(b-5)(2) addresses treatment of a life insurance beneficiary designation upon entry of a divorce judgment, and is summarized below:

If a divorce judgment is entered after an insured has designated the insured’s spouse as a beneficiary under a life insurance policy in force at the time of entry, the designation of the insured’s former spouse as beneficiary is not effective unless:

  • The divorce judgment designates the insured’s former spouse as the beneficiary;
  • The insured re-designates the former spouse as the beneficiary after judgment entry; or
  • The former spouse is designated to receive the proceeds in trust for, or on behalf or, or for the benefit or a child or a dependent of either former spouse.

If a designation is not effective under one of the foregoing examples, the proceeds of the policy are payable to the named alternative beneficiary, or if there is not a named alternative beneficiary, to the estate of the insured.

An insurer who pays the proceeds of a life insurance policy to the beneficiary under a designation that is not effective under the above examples is liable for payment of the proceeds to the person or estate, only if:

  • Before payment of the proceeds to the designated beneficiary, the insurer receives written notice at the home office of the insurer from an interested person that the designation is not effective under the statute; and
  • The insurer has not filed an interpleader (i.e., a lawsuit to compel two parties to litigate a dispute).

Note:  the provisions of the new statute do not apply to life insurance policies subject to regulation under ERISA, the Federal Employee Group Life Insurance Act, or any other federal law that preempts application.

V. Visitation by Certain Non-Parents (750 ILCS 5/602.9)

With certain exceptions, certain non-parents may bring an action requesting visitation with a child.

The list of “appropriate persons” includes grandparents, great-grandparents, step-parents, and siblings of a minor child age 1 or older. These individuals may bring a petition for visitation and electronic communication if there has been an unreasonable denial of visitation by a parent and that denial has caused the child undue mental, physical, or emotional harm, and one of the following qualifying conditions exists:

  • The child’s other parent is deceased or has been missing at least 90 days;
  • A parent of the child is incompetent as a matter of law;
  • A parent has been incarcerated in jail or prison for more than 90 days immediately prior to filing the petition;
  • The child’s parents have been granted a divorce or legal separation, or there is a pending dissolution proceeding or other action involving parental responsibilities or visitation of the child and at least 1 parent does not object to the grandparent, great-grandparent, step-parent, or sibling having vitiation with the child; or
  • The child is born to parents who are not married to each other, the parents are not living together, the petitioner is a grandparent, great-grandparent, step-parent, or sibling of the child and the parent-child relationship has been legally established.

The newly amended Section 602.9(c)(E)(iv)-(v) clarifies that if the petitioner is a grandparent or great-grandparent, the parent-child relationship need be legally established only with respect to the parent who is related to the grandparent or great-grandparent. If the petitioner is a step-parent, the parent-child relationship need be legally established only with respect to the parent who is married to the petitioner or was married to the petitioner immediately before the parent’s death.

Work with a Chicagoland Attorney and Mediator

Getting a Divorce is a difficult time of life, choosing the right attorney should not be! For over 4 decades Alan Pearlman, Ltd. has been serving Chicagoland and the surrounding Suburbs in obtaining solutions to these difficult matters. Contact my office at 847-205-4383 for your free 1/2 hour consultation and see how we can be of service to you.

Many married couples file joint tax returns to take advantage of certain benefits offered by this filing status. This may result in the unfortunate and unintended consequence of one spouse being held responsible for the underreporting of income by the other spouse. Even when there is a divorce decree stating that one spouse will be solely responsible for any amounts due on prior tax returns, the IRS may withhold a tax refund of the other spouse to satisfy the former spouse’s tax obligation.

When a married couple files a joint tax return and penalties arise as a result of an underreporting of taxable income, the IRS will relieve one spouse from liability if that spouse can prove that he or she is “innocent” of any wrongdoing. In order for the individual to obtain relief as an “innocent spouse,” the following criteria must be met:

  • The return filed must be a joint return, or, if the return was filed while living in a community property state, the return filed may be a “married filing separately” return
  • At the time the return was filed, the individual believed the correct amount of tax was, or would be, paid
  • The individual’s spouse failed to report or underreported his or her income
  • The individual did not have knowledge of the unreported income or erroneous items at the time the return was filed
  • It would be unfair to hold the individual liable for the tax deficiency
  • The individual applies for relief no later than two years after the IRS’s first attempt to collect the deficiency

If an individual meets the criteria for innocent spouse relief, the individual will be relieved of responsibility for the tax due on the return or any penalties or interest. Depending on the facts and circumstances, the innocent spouse may be eligible for relief of all taxes due on the return, including penalties and interest, or only partial relief.

A QDOT is a specific type of marital deduction trust that is designed to ensure that non-citizen spouses will eventually pay any taxes that may be due upon distribution of the principal from the trust, even if the surviving spouse resides outside of the United States. Without a QDOT, an estate would be immediately taxable. More specifically, the marital deduction typically allows the assets of an estate to be passed to a spouse without tax consequences.

The marital deduction for property passing to a non-citizen spouse is generally not allowed without the existence of a Qualified Domestic Trust (QDOT).

Special Requirements

To ensure the taxes are eventually paid, there are certain required provisions:

  • The trustee of the trust, or one of the co-trustees, must be a U.S. citizen or a domestic corporation of the U.S.
  • The trust must contain a restriction that no principal will be distributed from the trust unless the U.S. citizen or domestic corporation trustee has the right to withhold any tax due from the distribution.
  • The trust must comply with Treasury Regulations to ensure the collection of any tax.
  • The trust must satisfy the applicable rules for marital trusts for U.S. citizen surviving spouses.
  • A QDOT election must be made on the decedent’s estate tax return.

If a trust fails to qualify as a QDOT, under certain circumstances a QDOT can be created by the use of a reformation (correction or change of an existing trust document). Some foreign countries prohibit trusts or prohibit a trust from having a U.S. trustee. In recognition of these situations, the Secretary of the Treasury has the authority to prescribe regulations allowing exceptions to the above requirements for qualifying as a QDOT. However, such regulations may only allow a marital deduction for nontrust arrangements or for trusts without a U.S. trustee under circumstances where the U.S. would retain jurisdiction and where there is adequate security to impose a tax on transfers by the surviving spouse of the property transferred by the deceased spouse.

Estates of $2 Million or Less

For estates of $2 million or less, the trust must either require that real property located outside of the U.S. accounts for no more than 35% of the fair market value of the trust property or meet the requirements for an estate that exceeds $2 million in assets.

Estates Exceeding $2 Million

For estates that exceed $2 million in assets, the QDOT must provide one of the following:

  • Require that at least one trustee is a U.S. bank
  • Post a surety bond in favor of the Internal Revenue Service (IRS) in an amount equal to 65% of the fair market value of the trust assets
  • Provide a letter of credit from a domestic bank or U.S. branch of a foreign bank, or issued by a foreign bank and confirmed by a domestic bank, in an amount equal to 65% of the fair market value of the trust assets

QDOT Property May be Subject to Estate Tax if:

  • Any principal distributions (except distributions made on account of hardship) to the surviving spouse will be subject to estate tax
  • The surviving spouse’s death prior to December 31, 2009 will cause the remaining property in the QDOT to be subject to estate tax as if it were included in the estate of the first spouse to die
  • If the QDOT ceases to meet the requirements under the regulations, an estate tax is imposed as if the surviving spouse had died on the date when the trust failed to qualify as a QDOT

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Getting a Divorce is a difficult time of life, choosing the right attorney should not be! For over 4 decades Alan Pearlman, Ltd. has been serving Chicagoland and the surrounding Suburbs in obtaining solutions to these difficult matters. Contact my office at 847-205-4383 for your free 1/2 hour consultation and see how we can be of service to you.

Prior to filing for divorce, various federal tax considerations should be reviewed due to their potentially profound implications. Among the major issues commonly covered in a divorce decree or agreement are: alimony, sometimes referred to as “spousal” or “separate maintenance” support; division of property; and child support. Each has its own tax treatment and implications.

Division of Property

Most divorces involve a division of the property owned by the couple. Such a division of property is not usually a taxable event, i.e., neither owes taxes nor gets a deduction from income because he or she receives certain property as a result of the divorce.

There are, however, tax implications following divorce that affect future taxes. More specifically, selling personal and real property in the future may require spouses who received such property (pursuant to a divorce) to pay taxes in connection to that property.

Personal and real property have a “basis” for federal tax purposes. The basis is usually the purchase price of the property. When the property is sold later, the amount by which the sales price exceeds the basis is called “capital gain.” Capital gain is usually taxable at special rates. Thus, when property distributed pursuant to a divorce decree is subsequently sold by the receiving spouse, the receiving spouse may be required to pay taxes on the proceeds of the sale.

For example, in a divorce, the wife may receive the family home while the husband might receive stock or other investments equal in value to the house. If the house has a lower basis than the stock, when both are sold, the husband could end up with significantly more money, because he owes less capital gains tax.

On the other hand, under tax law applicable at the beginning of 2004, the first $250,000 (for individuals) or $500,000 (for couples) of the taxable gain on the sale of a qualifying personal residence is exempt from tax. In light of these tax issues, selling the house before the divorce, then dividing the proceeds, might make more sense.

Child Support

The parent who is granted custody of the child or children from the marriage, usually receives a set amount of money per month as “child support.” Child support payments are not includable in the taxable income of the receiving spouse and are not tax deductible by the spouse making the payments.

If the written agreement or divorce decree orders both child support and alimony and the spouse making the payments pays less than the required total amount, for tax purposes, the child support obligation is deemed paid in full first. Only money exceeding the amount of the child support obligation is treated as alimony.

Alimony or “Spousal Support”

In general, for federal income tax purposes, alimony and “separate maintenance payments” are “deductible” from the income of the spouse paying and includable in income for the recipient. Keep in mind that ALL THIS changes on January 1, 2019 according to the new tax laws signed into law this past December when Alimony i.e. Maintenance will no longer be deductible by the payor nor includable in the income of the recipient for Federal Tax Purposes. A word to the wise is simply if you are contemplating and/or are presently in the process of Divorce and you are going to be paying Alimony/Maintenance then if at all possible try to complete your matters prior to 1/1/2019. In that way you will be able to claim the deduction in all future years and you will not lose this benifit to you. “Deductible” for federal income tax purposes means it is subtracted from a taxpayer’s gross income before taxes are calculated, resulting in lower taxes. Taxpayers with a threshold amount of deductions must file a particular form with the IRS when paying income taxes and list such deductions.

Between the time a couple separates and a divorce decree is granted, one spouse may pay money for the support of the other spouse. These payments are deductible as long as they are made pursuant to a decree, court order or a “written separation agreement.” In order for alimony payments to be deductible, federal tax laws and regulations require the following:

  • The payments are made in cash, check or money order (no promissory notes, transfers or use of property, transfer of services, etc.) to the spouse, or to a third party in lieu of alimony at the written request of the recipient spouse, stating the payments are intended as alimony, and the request is received before the tax return is filed
  • The divorce decree, order or the written agreement of the parties does not identify the payments as something other than alimony
  • The spouses do not file a joint return with each other
  • The spouses are not members of the same household when the payments are made, if they are legally separated under a decree of divorce or separate maintenance – separation within the family home is not sufficient
  • There is no liability to make the alimony payments after the death of the recipient spouse – if part of the payment amount continues after death, that portion is not deemed alimony, and if all of the payment continues, none of it is alimony
  • The alimony payments are not treated as child support

Three major issues commonly resolved in a divorce decree or agreement are: alimony, or spousal support; division of property; and child support. Each has its own tax treatment and implications. In general, for federal income tax purposes, alimony is “deductible” from the income of the spouse paying it and considered taxable income to the spouse receiving it.

If the payor spouse has a significantly higher income, there is an incentive to maximize the amount of payments that are considered alimony to the ex-spouse, as opposed to nondeductible payments such as property distributions and child support payments. The recipient (ex-spouse) may be in a much lower income tax bracket and agree to the plan.

It is important to note, however, that the IRS objects to attempts to mischaracterize child support or property divisions as alimony, because of the tax effects.

Child Support Disguised as Alimony

Child support payments are not deductible from the income of the payor spouse for federal income tax purposes. Payments that are specifically designated as child support in the divorce decree or written agreement between the spouses cannot be treated as alimony for income tax purposes.

Moreover, if the spouse making alimony and child support payments pays less than the required total for both, the child support obligation is deemed paid in full first for tax purposes. Only money exceeding the amount of the child support obligation may be treated as alimony.

When Alimony May Be Deemed Child Support

Payments characterized as alimony may be treated as child support if, and to the extent that, the payments are reduced on the happening of a contingency related to the child, such as if the child:

  • Becomes employed
  • Dies
  • Leaves the home
  • Leaves school
  • Marries
  • Reaches a specified age or income level

Contingencies Associated with a Child-Related Event

In addition, alimony payments may not be reduced based upon an event “associated with a contingency” related to the child. This is the same concept in a sense, but refers to more indirect methods. If the divorce decree or agreement does not reference a child, but merely sets a date when the amount of alimony is reduced, it may still indicate the alimony is child support if, upon investigation, either of the following is discovered:

  • That the alimony is reduced within six months, before or after, the birthday on which the child becomes an adult under local law (typically 18 or 21 years old)
  • If there are two or more children of the marriage and at least two reduction dates for the “alimony,” and the reductions all occur within one year (before or after) the date on which one of the children reaches a certain age between 18 and 24 years old

If the alimony provisions satisfy either of the above “tests,” there is a rebuttable presumption that the payments are really child support to the extent of the reduction. Thus, if the alimony amount is reduced one or more times on dates related to a child’s birthday, the amounts by which the alimony is reduced are considered “child support” and are not deductible by the payor spouse for federal income tax purposes.

Rebutting the Presumption

The above are not the only times the IRS may seek to recharacterize alimony as child support. The IRS may scrutinize any major reductions of alimony after a period of years.

Reductions which are made at a specified date on or near the birthday(s) of a child or children, as described above, however, create a “presumption” that the payments were really child support. The taxpayer may “rebut” this presumption. One way to do this might be to show that there is another rationale for the reduction date, such as it coincides with one half the duration of the marriage and/or is a common time for reduction or elimination of alimony under local law and practice.

In a rare 8-0 decision, the Supreme Court recently overturned a ruling by the highest court of Arizona regarding the division of military retirement pay under a divorce decree. Howell v. Howell, decided May 15, held that any waived portion of military retirement pay cannot be treated as divisible community property in the case of divorce (197 L. Ed. 2d 781).

The ruling reaffirmed the Court’s decision in Mansell v. Mansell, clarifying that waived pay is exempt from division, regardless of whether the waiver was made before or after the issuance of the divorce decree (490 U.S. 581).

When John and Sandra Howell divorced, Sandra was awarded 50 percent of any military retirement pay John would receive. John subsequently retired and Sandra received her share for about 13 years.

Thirteen years after the issuance of the decree, John was found to be partially disabled and eligible to receive disability pay, a non-taxable benefit. In order to receive this disability pay, John was required to waive a corresponding amount of his retirement pay, which he did. This waiver decreased Sandra’s monthly payment pursuant to the division established in the decree by $125.

 She petitioned the Arizona family court to enforce the original decree, requiring John to indemnify Sandra in the amount of his disability pay—$125. The court ruled that Sandra had a “vested” interest in an amount equal to 50 percent of John’s retired pay at the time of the decree and granted Sandra’s petition. The Arizona Supreme Court affirmed, ordering John to “reimburse” Sandra for the decrease in her share of the military retirement pay (238 Ariz. 407).

John appealed and the Supreme Court reversed the decision of the Arizona Supreme Court. In 1982 Congress passed the Uniformed Services Former Spouses’ Protection Act. 10 U.S.C. §1408. This law made military retirement pay divisible by state courts as community property in the case of divorce. The law specifically excluded amounts deducted from retired pay.

The Supreme Court subsequently held in Mansell that state courts could not divide “military retirement pay that has been waived to receive veterans’ disability benefits” (490 U.S. 581 at 595).

Arizona’s Supreme Court attempted to distinguish Mansell on the basis that the waiver in Mansell was made pre-decree, whereas John Howell waived a portion of his retired pay many years post-decree. The Supreme Court was not persuaded that Mansell was distinguishable.

The court held that a waiver of retirement pay, regardless of when it was made, exempted that amount from division in a divorce decree. The Court also held that Sandra did not have a vested interest because “state courts cannot ‘vest’ that which (under governing federal law) they lack the authority to give. (Howell, 197 L. Ed. 2d. 781 at 788).

The Arizona Supreme Court’s phrasing of the decision as requiring “indemnification” likewise did not change the protection of the waived retirement pay, because “such reimbursement and indemnification orders displace the federal rule and stand as an obstacle to the accomplishment and execution of the purposes and objectives of Congress” in enacting the Uniformed Services Former Spouses’ Protection Act (Id. at 789).

The Supreme Court’s decision in Howell addresses a complex question about military disability pay and indemnification. As the Court says, “the question is complicated, but the answer is not.”

Our cases and the statute make clear that the answer to the indemnification question is ‘no’” (Id. at 785).

A court may take into account the possibility of a future change to the retirement pay when deciding award amounts at the time of a divorce decree, but waived retirement pay is off limits for division.