Tax Issues in Custody and Divorce

As we come to the end of the year, I am often asked about different tax issues applicable to my clients’ situations.

If my client’s divorce will not become final before the end of the year, the parties can still file a joint tax return. Once the judgment of divorce has been filed, an ex-spouse can file the return as a head of household, if he or she has paid for over half the maintenance of the household, and has a dependent living at his or her home for over half the year.

When the parties are divorced, only one of them can claim the $3,500 child dependency exemption on their tax returns for 2008. The parent claiming the dependency exemption is also allowed a $1,000-per-child tax credit for children younger than 17, as long as his or her income is not above the following cut-offs. For a married couple filing jointly, it is $110,000, for a married couple filing separately, it is $55,000 per spouse, and for all others, it is $75,000. If the applicable income exceeds the above thresholds, the amount of the child tax credit is reduced proportionately.

Usually, it is the person named as the custodial parent in the child custody portion of the divorce decree that is allowed to claim the child as a dependent. If the divorce decree does not name a custodial parent, then the parent with whom the child has lived with the longest throughout the year is the custodial parent.

A non-custodial parent, however, can claim the child dependency exemption, as long as the custodial parent signs a waiver promising not to claim the exemption. This is typically accomplished by the use of IRS Form 8332. However, the recent amendments of the IRS regulations dealing with this issue have complicated this issue. The final regulations provide that a release not on a Form 8332 must be a document executed for the sole purpose of releasing the claim. A court order or decree or a separation agreement cannot serve as the written declaration. If a release of a claim to a child is for more than one year, the noncustodial parent must attach a copy of the written declaration to the parent’s return for the first tax year for which the release is effective. Copies must also be attached to returns for later years. Under the final regulations, a custodial parent who released the right to claim a child, can revoke the release for future tax years by providing written notice of the revocation to the other parent. The final regulations require that the parent revoking the release notify, or make reasonable attempts to notify, in writing, the other parent of the revocation. What is a reasonable attempt is determined under the facts and circumstances, but mailing a copy of the written revocation to the noncustodial parent at the last known address or at an address reasonably calculated to ensure receipt satisfies this requirement. A revocation can be made on Form 8332, or successor form designated by IRS. A revocation not on the designated form must conform to the substance of the form, and be in a document executed for the sole purpose of revoking a release. A taxpayer revoking a release may attach a copy rather than an original to the taxpayer’s return for the first tax year the revocation is effective, as well as for later years.

Yet another related issue is who can claim the child as dependent under the group health plan coverage and health savings account (“HSA”) distributions. Under the final regulations, for purposes of group health plan coverage and health savings account (HSA) distributions, both parents can claim the child as a dependent if: (1) the child qualifies as a dependent of one of the parents; (2) the parents (both parents together) provide more than ½ of the child’s support for the calendar year; (3) the child is in the custody of one or both parents for more than ½ of the calendar year; and
(4) the parents are divorced, legally separated under a decree of separate maintenance, separated under a written separation agreement, or live apart at all times during the last six (6) months of the calendar year.

If a non-custodial parent claims the child exemption first, and without the custodial parent’s permission, he or she is likely to receive the exemption temporarily. However, once the custodial parent files his or her tax return including the exemption, and IRS notices that a child’s social security number has been included on two different tax returns, then both parties would be notified by IRS that only one party is entitled to the exemption, and the tie-breaker rule would be used to resolve this situation. This rule says that if two parents claim that a child as a dependent, the parent with whom that the child lived with the longest during the year, receives the exemption. If the child had spent the same amount of time with both parents, then the parent that had the higher adjusted gross income would get the exemption. The parent who was not entitled to the exemption would have to repay the tax, plus penalties and interest.

Regardless of who the custodial parent is, if the non-custodial parent pays for any of the child’s medical bills, these costs can be a deduction, subject to appropriate income limits. Child-care credit for work-related expenses can be claimed for children younger than 13.

The spouse who pays maintenance or spousal support can also receive a tax deduction for these payments, even if they aren’t itemized—as long as the payment amounts are stated in the divorce agreement or the judgment of divorce, and actually paid. The spouse who receives maintenance must pay taxes on it. For child support, however, there is no deduction for paying it and no taxes are paid by the parent receiving it. Assets transferred from one spouse to another during a divorce are not generally taxed.

Please note that the above discussion is not a tax advice and these issues should be discussed with your tax professional.

Non-custodial Parent’s Right to Particpate in Child Rearing Decisions

In 1996, Mathew’s parents, Jesus Fuentes and Karen Fuentes, were divorced. On August 1, 1996, “Order Directing Custody” was entered, granting Mathew’s mother exclusive custody of Mathew. Mathew attended New York City public schools, where he received special education services to accommodate his disability.

In 2000, because Mr. Fuentes believed that the education accommodations Mathew received were inadequate, he requested that Mathew be reevaluated for additional services. After the Committee on Special Education for the Hearing, Handicapped, and Visually Impaired determined that Mathew’s current services were adequate, Mr. Fuentes requested a hearing to review the committee’s determination. On January 8, 2001, the Impartial Hearing Office denied Fuentes’s request for a hearing. Its Chief Administrator based her denial on Mr. Fuentes’s custodial status. Because Mr. Fuentes was the non-custodial parent of Mathew, Chief Administrator determined that he was not the “person in parental relation” as defined in N.Y. Educ. Law § 3212 and concluded that Mr. Fuentes did not have the right to participate in educational decisions affecting Mathew and refused to process his father’s requests.

Mr. Fuentes, the non-custodial biological father, brought an action in the Federal Court for the Eastern District of New York against the Board of Education of the City of New York, under 42 USC §1983 and 20 USC §1415(f)(1) [IDEA], to review the City’s assessment of his son’s special educational needs and to be granted an impartial hearing for reconsideration of the City’s determination that his son did not need more special education than what he was receiving. After determining that, under New York law, a non-custodial biological parent has no right to make special education decisions, absent a court order or agreement between the parties affording such rights to the non-custodial parent, the Federal Court for the Eastern District of New York dismissed the complaint for lack of standing [FRCP 12(b) and (c)].

The Second Circuit held that although the First and Second Departments of the Appellate Division have held that a non-custodial parent, absent an order or agreement to the contrary, has no right to make educational decisions, the Second Circuit chose to have New York’s Court of Appeals definitively state the law of New York and, thus, certified the following question: “Whether, under New York law, the biological and non-custodial parent of a child retains the right to participate in decisions pertaining to the education of the child where (1) the custodial parent is granted exclusive custody of the child and (2) the divorce decree and custody order are silent as to the right to control such decisions.” Fuentes v. Bd. of Ed. of City of New York.

I have previously written about the custodial arrangements and the right of decision-making associated with each type of custody, and while there are many decisions on this issues from the Appellate Division, the Court of Appeals so far has not issued a definitive ruling on this issue. When the Court of Appeals decides this case, this is likely to be the controlling statement of New York law on the rights of non-custodial parents with respect to their right to be involved in educational and other decisions effecting their children. The Court of Appeals is likely to issue its decision in the next few months.

“Cohabitation” and Interpretation of Separation Agreement’s Provisions Applicable to Maintenance

A typical separation agreement that provides for post-divorce maintenance will have a number of provisions describing circumstances under which such maintenance can be terminated. One of the more common clauses speaks of the spousal maintenance being terminated where the former spouse is cohabitating with another adult of opposite sex for a period of time. Most separation agreements do not define cohabitation, but the courts have held that in order for cohabitation to take place, there must be a sexual relationship, as well as a degree of economic partnership between the former spouse and the unrelated adult of the opposite sex. In Graev v. Graev, __ N.Y.3d __ (October 21, 2008) the Court of Appeals had to decide whether the term “cohabitation” as included in the parties’ separation agreement was unambiguous, and whether the prior standard utilized by the courts was still valid. In a 4-3 opinion, a divided Court of Appeals ruled yesterday that “cohabitation” is an ambiguous term whose definition for purposes of potential violations of separation and divorce agreements depends on what the parties understood it to mean when making their settlements. While all of the judges agreed that a couple need not share household expenses or function as a single economic unit to be cohabitating, the Court was divided over how to resolve the dispute between Linda and Lawrence Graev and the $11,000 in monthly maintenance fees he contends she forfeited by living with a boyfriend for at least 60 straight days in violation of their separation agreement. Since the Court of Appeals held that the term “cohabitation” as contained in the parties’ separation agreement was ambiguous, it remanded the case back to the trial court to hold a fact-finding hearing to determine what the parties’ understanding of this term was at the time the separation agreement was executed. As the Court of Appeals pointed in the footnote, “[t]he wisest rule, of course, is for parties in the future to make their intentions clear by careful drafting.”

Change in Health Condition and Maintenance

In order to obtain a reduction of maintenance, the party seeking the reduction bears the burden of establishing a substantial change of circumstances. Lipow v. Lipow, 110 A.D.2d 756 (2d Dep’t 1985); Patell v. Patell, 91 A.D.2d 1028 (2d Dep’t 1983); Hickland v. Hickland, 56 A.D.2d 978 (3d Dep’t 1977). Some courts have held that an unanticipated medical condition which befalls a party after a judgment of divorce was entered, may be a basis for modifying that party’s maintenance obligation. Bischoff v. Bischoff, 159 A.D.2d 404 (1st Dep’t 1990); Wantuch v. Wantuch, 56 A.D.2d 866 (2d Dep’t 1977).

In Praeger v. Praeger, 162 A.D.2d 671 (2d Dep’t 1990), a husband agreed to certain maintenance obligations with knowledge that he had a history of heart disease, heart surgeries and several heart attacks. Thereafter, he suffered a stroke which he claimed rendered him permanently disabled and unable to perform his profession. The husband pointed to that stroke as a basis for modifying his maintenance obligation. In light of his condition at the time of the divorce, the court refused even to grant a hearing, absent additional medical and financial evidence that a substantial change of circumstances had occurred.

If after the judgment of divorce is entered, the party paying maintenance develops a health condition that impairs his/her ability to pay maintenance, any application seeking modification of maintenance must be supported with admissible medical evidence and an evidentiary showing must be made that the health condition has impaired that party’s financial situation.

Family Court Lacks Power to Modify Maintenance Provision in Separation Agreement

In a recent decision, Johna M.S. v. Russell E.S., the Court of Appeals held that the Family Court lacks power to modify maintenance provisions contained in the parties’ separation agreement. The separation agreement that the wife and the husband both signed, explicitly stated that the wife is “completely disabled” and will be in need of maintenance “for the remainder of her life”. The agreement provided for current maintenance payments of $100.00 per week payable to the wife and recited that this being only a determination of her “present” need and his “present” economic circumstances. It further stated that the wife could if need be seek a “modification” of those sums in a “de novo” proceeding in a court of “appropriate jurisdiction”. A divided Court of Appeals held that the Family Court is not such an “appropriate” court and that in respect of spousal (as opposed to child) maintenance, family court lacks subject matter jurisdiction of a “modification”.

The Court pointed out that there was no risk that the wife would become a public charge. According to the Court of Appeals, the danger of a spouse becoming a public charge is the only circumstance in which, under Family Court Act § 463, the Family Court can modify a separation agreement when the matrimonial action has not been brought as of yet.

A key factor in Johna M.S. was that Family Court lacks “equity” jurisdiction. As Judge Smith points out in his dissent, the prior cases held that Family Court’s attempt to “modify” such a separation agreement amounts to a kind of “reformation or rescission”, which are equitable remedies: they seek to alter the parties’ agreement and there was no effort by the wife to do that here. On the contrary, the agreement itself contemplated modification, wholly negating the “equity” analogy. As a result, the disabled wife’s only choice is to either accept maintenance of $100.00 per week as permanent, or to sue in supreme court for a divorce or separation, where she will be able to seek a greater amount of maintenance.

Parent’s Obligation to Pay College Expenses Does Not Always Terminate at the Age of 21

In New York State, a parent’s obligation to pay child support terminates when the child reaches the age of 21. However, in situations where a parent is charged with the financial responsibility of paying for the child’s college education, this support obligation may extend well beyond the age of 21. In the case of Lamb v. Amigone, 12 A.D.3d 1165 (4th Dept. 2004), the Appellate Division, Fourth Department, held that unless the parties’ Separation Agreement made a specific reference to parental contribution toward college expenses terminating at the age of majority, the parental college expense contribution continued beyond the age of 21.

That result was also reached by the Appellate Division, Fourth Department, in Schonour v. Johnson, 27 A.D.3d 1059 (4th Dept. 2006), where the Court held that where “[i]n their stipulation, the parties did not place any age limitation on their mutual promises to contribute to the costs of their daughters’ undergraduate college educations”, the appellant was obligated to pay for his daughters’ four years of college education regardless of their age.

Similarly, the court can order payment of college expenses even where the child reaches the age of majority if special circumstances exist. See Domestic Relations Law § 240 [1-b] [c] [7]; also, Krouner v. Urbach, 267 A.D.2d 575 (3rd Dept. 1999); Smith v Smith, 174 AD2d 818, 819 (3rd Dept. 1991).

Thus, both stipulations of settlement and settlement agreements must be carefully prepared and reviewed to make sure that they conform with the parties’ intent. Otherwise, the parties may find themselves in court, relitigating provisions of their settlement many years later.