Keeping up to date with the tax law is more than waiting for actual law changes. The numerous court cases issued each week often include reminders about due diligence, reminders for clients, and planning considerations. Of course, some of the court cases, such as regular Tax Court decisions, have new interpretations of the law. One recent case includes a reminder about the need for spouses to coordinate filing to optimize the combined tax result.
In Bruce, TC Summary Opinion 2014-46 (5/12/14), husband (H) and wife (W) were married in 2008. They had two children (including a child of W from a prior relationship). H worked for the Navy and sometimes worked away from home. In 2009, the couple mostly lived in Navy housing. W moved out in 2010, as did H and they sometimes lived with one of their parents. Divorce proceedings began in early 2010 and were complete in February 2011. H moved out of home where he lived with W in December 2010. H e-filed their MFJ 2010 return in February 2011 and told W he’d split the $4,581 refund with her. W provided H with her bank account information. W also told H she would talk to a friend of hers who did tax work. Before 4/15/11, W filed a return as head-of-household, claiming the children as dependents. H did not know.
The IRS sent a deficiency notice to H changing his filing status to MFS and denying him the child credit, dependency exemption and EITC. The Tax Court agreed with IRS. Per §1.6013-1(a)(1), it is permissible to change from joint to separate filing status if done before the due date of the return. W filed her HH return in March 2011.
The court held that W was entitled to the dependency exemptions because the children lived longer with her because H moved out in December 2010. The court also noted that the time H was away for military service does not affect this residency test. Once it was determined that W was entitled to claim the children, H did not qualify for the child credit, dependency exemption or EITC. The court did not uphold accuracy-related penalties against him though because it seemed reasonable for H to assume W was fine with the MFJ return and W even gave H her bank account information so he could give half of the refund to her.
Lesson learned – Most likely, the couple would have had a combined benefit from joint filing status… Joint income was low enough to qualify for the EITC. Also, since it does not appear that H lived out of the home for the last six months of 2010, W should have filed as MFS, not as HH (see IRC 7703(b)). With both H and W using MFS, no one can claim the EITC. Of course, divorcing spouses have additional factors to consider and to avoid joint liability, separate filing is sometimes warranted.
This and other updates of summer will be covered in the Quarterly Tax Update scheduled for August 26.