Getting Married And ObamaCare Subsidies

I am reading a case that reminds me of a return from last year’s filing season. I had an accountant who became upset, arguing that the result was unfair.

I agree, but this is tax.

I started practice in the eighties, and a significant portion of my tax education was at a law school.  Tax accounting classes tended to be staccato-like:  issue-driven, procedural and reliably arithmetic. Tax law classes were case and doctrine-focused: what is income, for example, and we would study the concept of income as it evolved over the decades.

It seemed to me that tax law early in my career followed – as a generalization - more of that law school feel: corporate liquidations and the General Utilities doctrine; the claim of right doctrine and North American Oil; business purpose and Helvering v Gregory. There were strong Ways and Means and Finance Committee chairs with some understanding of the issues (and precedent) their committees were addressing.  

But those were different politicians. Both they and taxes have gotten progressively weirder.

Congress went on to introduce something called uniform capitalization, arguing that accountants did not know how to absorb costs into inventory; tax items – personal exemptions or itemized deductions, for example – that would evaporate like a Thanos movie moment; an alternative minimum tax that would tax something that ultimately went down in value; the increasing refundability of tax credits, meaning that those at the low end of the income scale had as much if not more opportunity to game the system than any big-baddy McMoneybags did.

Let’s look at the Fisher case.

Christina Fisher began the year as a single mom. She married Timothy in November. Christina was struggling, and she received Obamacare subsidies.

You may recall that there are two relevant aspects to Obamacare that will come into play in this case:

(1)  If you are below a certain income level, you might be entitled to some – or even full – subsidy of your health insurance premiums.

(2)  You can use that subsidy to pay your premiums immediately rather than wait to the end of the year and receive the subsidy via a tax refund.

There was no question that Christina was entitled to a subsidy for more than 10 months. Her circumstances changed when she married; she no longer qualified.

Time to prepare her taxes.

One is supposed to attach a reconciliation of projected income when receiving the subsidy to actual income ultimately reported on the tax return. The Fishers did not.

The IRS did it for them. They also wanted approximately $4,500, saying she was not entitled to the subsidy.

A rational mind would expect that the tax law would go to a month-by-month calculation. There was no doubt that she qualified for 10 months. Let’s allow for some doubt in the month of marriage. Let’s also disqualify the last month of the year because of Timothy’s income.

At worst she would have to pay back 2 months, right?

Nah.

She has to use her household income for the year – including Timothy’s income.

Then she takes half of that amount for her monthly testing.

Not her OWN income, mind you, but one-half of combined income for the year.

Who came up with this?

Not the best and brightest exercising due deliberation, clearly.

Well, using even one-half of the combined household income, Christina failed all 10 months one would have expected her to pass. She owed almost $4,500 to the IRS.

And that is why my accountant lost his mind last year. He could not believe that what he was reading is really what was meant. It made no sense! Surely there is an alternative calculation? Does the tax Code allow a facts and circumstances …?

Ahh, he is still young. He will learn.

Spouses Owning Businesses, Divorce And Taxes

A fundamental concept in taxation is that an “accession to wealth” represents taxable income, unless the Code says otherwise.

There are limits on this, of course, otherwise you would be immediately taxed when your mutual fund or house went up in value. The Code will (usually) want to see a triggering event, such as a sale, exchange or disposition by other means. You don’t pay tax on your stock gain, for example, until you sell the stock.

But the concept also creates problems. For example, consider the recent development of crowdfunding. You have an idea for the next great breakfast sandwich, and you reach out on the internet for money to get the idea going. You have accession to wealth, but is the money taxable to you? The tax consequence can get very murky very quickly. For example:

·        If you provide investors with breakfast sandwiches, there is an argument that you sold sandwiches.

·        If investors instead receive ownership (say shares of stock), we would sidestep that sale-of-sandwiches thing, but you might have an issue with securities laws.

·        If investors receive nothing, one could argue that the monies were a gift. The closer you get to detached generosity without expectation of economic gain, the better the argument.

Let's next consider accession to wealth in a divorce context. Here is Code Section 1041:

(a) General rule. No gain or loss shall be recognized on a transfer of property from an individual to (or in trust for the benefit of)—

(1) a spouse, or

(2) a former spouse, but only if the transfer is incident to the divorce.

(c) Incident to divorce. For purposes of subsection (a)(2), a transfer of property is incident to the divorce if such transfer— 

(1) occurs within 1 year after the date on which the marriage ceases, or

(2) is related to the cessation of the marriage.

Believe it or not, the general definition of income could trigger when marital assets are divided upon divorce. That makes little sense, of course, so Section 1041 provides an escape clause.

Question: how much time do you have to separate the marital assets?

The first answer provided in (c)(1) is one year. It is immediately followed by (c)(2) which (appears to) expand the answer to any period as long as the asset transfer is related to the cessation of marriage. That is a bit open-ended, so the tax Regulations interpret (c)(2) as up to six years.

The Belots started a dance school in New Jersey in 1989. The wife was the dancer and creative force, while the husband attended to the business side. Eventually they had several dance studios, a corporation to manage them and a partnership to own the real estate. They did well. While owned 100% by the spouses, the husband and wife were not necessarily 50:50 owners in each entity.

They started divorce action in 2006,and adjusted their ownership in each entity to 50:50. The divorce was finalized in January, 2007.

There is a reason they got divorced. Tired of her ex-husband's participation, Ms. Belot bought-out his share in 2008 for $1,580,000.

Mr. Belot took the position that this was not taxable under Section 1041. The IRS took the opposite position and billed him almost $240,000 in tax and penalties.

Off to Tax Court they went.

The IRS argued that each and every transaction had to come under the umbrella of Section 1041. There was no question that the first transaction qualified, but the second transaction – cashing-out Mr. Belot entirely – did not because it represented an event arising after the divorce. The second settlement represented a business contingency and was not related to the divorce decree.

The IRS was following a hyper-technical interpretation of its Regulations.

The problem is that the Code does not say "pursuant to the divorce decree." It instead says "related to the cessation of marriage." The divorce decree is arguably the most vivid expression of such cessation, but it is not the only one. The Belots were clearly still dividing marital assets owned at the time of divorce.

The Court decided in favor of the Belots.

Why did the IRS even pursue this?

The IRS was enforcing the everything-is-taxable position, unless excluded by the Code somewhere.