If divorcing parties will file their income tax returns jointly, how do you allocate each party’s fair share of taxes? How do you draft an unambiguous provision that spells that out?

Such were among the questions raised by the July 18, 2018 decision of the Appellate Division, Second Department, in Cohen v. Cohen.

There, in October 2013, the parties entered into a settlement stipulation which was incorporated into their 2014 judgment of divorce. Article XIII, paragraph “1,” of the stipulation addressed the parties’ respective liability for their jointly-filed 2013 tax returns: any taxes due were to be “paid by the parties in proportion to their respective income.”

In January 2015, the husband moved to enforce the stipulation by seeking a determination of the wife’s proportionate liability for the parties’ jointly filed 2013 taxes and to direct the wife to pay that sum. In the order appealed from, Supreme Court Nassau County Justice Stacy D. Bennett granted the husband’s motion and determined that the wife was responsible for 11.3% of the parties’ tax liability for 2013, giving the parties credit for any payments already made.

On appeal, the Second Department held that the relevant provision was ambiguous as to how to calculate the parties’ respective income. The appellate court noted that whether an agreement is ambiguous is a question of law for the courts. Moreover, the Second Department held that the parties’ submissions to Justice Bennett were insufficient to resolve the ambiguity.

Accordingly, the matter was sent back for an evidentiary hearing at which extrinsic evidence could be introduced to determine the parties’ intent with regard to the relevant provision of the stipulation, and for a new determination thereafter as to the husband’s motion.

Glenn S. Koopersmith, of Garden City, represented the wife. Lee Rosenberg and Natalie A. Corriss, of Saltzman Chetkof & Rosenberg LLP, of Garden City, represented the husband.

Among the problems when drafting a settlement agreement provision for the allocation of liability for a jointly-filed tax return is that the I.R.S. Form 1040 personal tax return does not use term “income” by itself. Line 22 identifies the couple’s “total income.” After allowing for certain deductions, the parties “adjusted gross income” may be found at line 37. Then, after allowing for other itemized or the standard deduction, the couple’s “taxable income” is found at line 43.

Presumably, at the hearing now ordered, the parties will attempt to prove which of these three terms, “total income,” “adjusted gross income,” or “taxable income,” they intended when they agreed any taxes due were to be “paid by the parties in proportion to their respective income.” Or was some other measure intended?

What’s more, what did the parties intend when they agreed to allocate “any taxes due?” Was that a reference to all income taxes imposed, or were the parties only to allocate the taxes due with the return and not those previously withheld or otherwise paid?

Ideally, a tax-allocation provision should be drafted in a fashion that no one has to think. The numbers are simply to be plugged in. However, that’s not as easy as it sounds.

One suggestion: a separate tax return should be prepared for each party, with responsibility for all income taxes, due or previously paid, allocated on the percentage each party’s “total taxes” bears to the combined individually-prepared total taxes; but that raises its own questions.

  • The filing status for each party’s individual return must be considered. Should both returns be computed as “married filing separately,” or may one spouse make use of “head of household” status?
  • Who gets the dependency exemptions for the children?
  • Will both parties be required to itemize deductions or may one or both take standard deductions [the IRS does not allow the parties to differ in this area; if one itemizes, both must]?
  • Who will be entitled to take, for example, the marital residence mortgage interest and realty tax itemized deductions?
  • Who will be entitled to take advantage of any capital or operating loss carryforwards [and are such deemed marital property]?
  • Who will be entitled to take advantage of any tax credits?
  • Is only the “total tax” reported at line 63 to be used, or are the “other taxes” reflected on lines 57 through 62 to be excluded?
  • Who, and in what proportion, will use any prior year’s overpayment of taxes not refunded, but applied to this year’s estimated tax?
  • Assuming the return is being prepared for a year that includes or follows the year in which the divorce action was commenced, how should temporary maintenance be considered?

When considering the provision, the prior year’s tax returns should be reviewed to begin to anticipate the questions that will be raised. What’s more, the tax preparer should be consulted to identify any other anticipated issues.

Bottom line: the tax allocation provision may be one of the most difficult to draft; it may be one of the most difficult to work out what is fair. Drafting it should begin with looking at the prior year’s return and then identifying any new issues that may have surfaced.