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Thursday, October 20, 2016

Tax challenges for divorced parents - why?

We get used to certain rules in the tax system and then think they HAVE to be there. But, often, that is not the case. I think the rules related to divorce are good examples.

Alimony is deductible by the payer and taxable to the recipient. This violates the "fruit of the tree" doctrine from the famous 1930 US Supreme Court case, Lucas v Earl. Basically, income is to be taxed to the person who earns it. Our income tax law violates this by letting the alimony payer's income get taxed as if really originally generated by the recipient. If the alimony rules were not in the law, the tax law would be more equitable and simpler. And, the tax consequences can be worked out in the divorce proceedings. The tax law doesn't exist to solve everyone's issues, but to raise revenue for government operations. Former Congressman Camp's Tax Reform Act of 2014 plan (H.R. 1 of 113rd Congress) removed alimony from the income tax rules.

Another oddity and complication is the exception for claiming dependency for divorced parents. The general rule is that children are claimed as dependents by the custodial parent - the one the children live with most of the year. But the tax law, trying to solve issues of divorced parents, adds a rule to allow the custodial parent to file Form 8332 to waive his/her right to the exemption and give it to the non-custodial parent. Again, this issue can be worked out via the amount of alimony and child support the parents agree to.

Every year there are court cases where alimony or Form 8332 are handled incorrectly. I've got a short article in this week's AICPA Tax Insider on a few rulings involving Form 8332 problems that helps illustrate the added complication of trying to help out the divorced parents. [Form 8332 Challenges for Divorced Couples]

What do you think?

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