Since the 1970s, divorces have been much more common in the United States than they were previously. Divorces raise legal issues such as possession of assets, custody of children, claims to income, and countless others. One issue that is often overlooked is the allocation of estimated tax payments to the taxpayer's and spouse's income tax returns, when they file separate returns in the year of the divorce.
When a couple have filed joint returns in the past and file separate returns in the current year due to a divorce, estimated tax payments for the current year are typically credited to the first person listed on the previous year's joint tax return. The first person listed is the "taxpayer," which is usually the husband. Issues arise when the "spouse," usually the wife, earns most of the income in the relationship. Consider the following:
Example 1: J and K filed a joint tax return for the 2013 tax year with J listed as the "taxpayer" and K listed as the "spouse." J's income in 2013 was $100,000 while K's income was $900,000, for a combined $1,000,000 of taxable income on their joint tax return. In 2014, the couple expect to have more income than in 2013 so they use the safe-harbor method of making estimated tax payments and pay a total of $435,000 in estimated tax. By the end of 2014 the two are divorced. When J files his 2014 tax return, he will have a large overpayment of tax since the $435,000 in estimated tax payments are credited to his return, which has minimal income. K's return will have a large balance due since she has substantially all of the income with no estimated tax payments to her name.
Currently, there is no reliable way to communicate to the IRS and state taxing authorities that the estimated tax payments belong to the spouse, even though they are under the taxpayer's Social Security number since the taxpayer is listed first.
According to IRS Publication 505, Tax Withholding and Estimated Tax, couples who have filed joint returns in the past and will be filing separate returns in the current year due to a divorce can divide estimated tax payments in any way they can agree upon. If an agreement cannot be made, estimated tax payments for the current year should be divided in proportion to each spouse's tax as shown on their current year's separate returns. Consider the following:
Example 2: J and K are filing separate tax returns in 2014. They have paid a total of $435,000 in estimated tax for the 2014 tax year. J's tax on his 2014 tax return is $30,000, and K's tax on her return is $450,000, for a combined total tax of $480,000. Since J's tax is 6.25% of the total tax ($30,000 ÷ $480,000), his allocation of the estimated tax payments is $27,188 (6.25% × $435,000). The balance of estimated tax payments is allocated toK.
While in theory this is a reasonable solution, in practice it seems to be difficult. Often, during a divorce, communication between the spouses is minimal, at best, due to the high emotions and stress from legal proceedings. The lack of communication makes it difficult to calculate the portion of estimated tax payments that should be assigned to each spouse. In some cases, one spouse may file his or her tax return early in the tax season, since it has minimal activity, and have a large refund already credited before the ex-spouse files his or her tax return.
Overpayments on Past Jointly Filed Returns
The treatment of overpayments on past jointly filed tax returns is similar to the IRS's guidance for estimated tax payments. Sec. 6402(a) provides that overpayments should be credited against the tax liability from the person who gave rise to the overpayment. In other words, an overpayment cannot be credited to the person who did not pay tax to generate the overpayment. If both spouses contributed to the overpayment on a prior jointly filed return, the overpayment needs to be apportioned to each spouse proportionate to his or her tax obligations in the current year. This calculation would be similar to that of the estimated tax payment calculation described above from IRS Publication 505.
A problem identified in numerous cases is that the IRS will ignore these calculations and simply allocate the entire overpayment to the first taxpayer without allocating any of the overpayment to the spouse, which seems unfair. This can be the case even if a suitable calculation was done and documented on the taxpayer's and spouse's separate returns. A potential solution to this problem might be to treat the overpayment as a marital asset or as part of the community property. Treating it in this manner would allow one spouse to claim it and have it be offset against other assets being divided in the divorce. This approach would prove simpler than providing a calculation to the IRS, which may overlook it anyway.
Since divorces are so common, the IRS and state taxing authorities need a better and simpler approach to assigning estimated tax payments and crediting overpayments from previous jointly filed tax returns. Perhaps there could be some kind of checkbox on Form 1040, U.S. Individual Income Tax Return, indicating to whom to apply overpayments or a separate form for the calculation. In any case, estimated tax payments should not automatically be assigned to the taxpayer who is listed first on the tax return. There needs to be a way to communicate with the IRS and state taxing authorities on this matter.
Valrie Chambers is an associate professor of accounting at Stetson University in Celebration, Fla. Jason Borkes is a senior accountant in the tax department at SingerLewak LLP in Irvine, Calif. For more information about this column, contact Prof. Chambers at email@example.com.