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The final joint tax return before a divorce finalizes will often raise the issue of how carryforward tax items, NOLs, and other items should be allocated between the spouses following a divorce. Specific regulations apply to how some tax carryforward items are to be allocated between the parties in a divorce. Where an allocation method is not specifically required by the regulations a practical method of allocation is warranted.
It is very common for marital settlement agreements negotiated between the parties through divorce attorneys to dictate how joint NOLs incurred over the marriage are to be allocated between the spouses upon dissolution. Many family law attorneys would be surprised to learn that the agreed apportionment of the couple’s NOLs negotiated between the parties will not be respected by the federal courts or the IRS should it come to light. There is no provision in the IRC that allows the allocation of NOLs between the parties either by contract or by state court decree. The proper allocation of NOL’s between the parties that would be respected by the federal courts and the IRS is found under Regulation 1.172-7(d) and in IRS Publication 536.
The party that gets to benefit from a carryforward NOL flowing forward from a joint return to one of the party’s separate tax return following a divorce depends on which party generated the NOL. If the NOL was generated by one of the spouses separately, the carryover is allocated to the spouse that generated it. If both H and W generated the NOL, Under Reg. 1.172-7(d) the NOL carryforward is required to be apportioned between the spouses in the same manner as if each spouse’s separate NOL carryforwards would have been calculated had each spouse filed married filing separate returns in the tax years that generated the NOL.
Consider the Following Example where Bob and Samantha filed joint returns for 2013 and 2014. They sustained a joint NOL of $2,000 for 2013 and a joint NOL of $4,000 for 2014. For 2014, Bob’s total business deductions exceeded his gross business income by $1500, and Samantha’s business deductions exceeded her gross income by $500. Therefore, $1500 of the $2,000 joint NOL for 2013 is considered to be Bob’s and $500 is considered to be Samantha’s. For 2014, Bob’s gross business income exceeded his business deductions by $2,500, and Samantha’s business deductions exceeded her gross business income by $1,500 Therefore, $2,500 of the $4,000 2015 joint NOL is considered to be Bob’s separate NOL and $1500 is considered to be Samantha’s.
There is currently no official published authority on how to go about allocating a minimum tax credit (MTC) carryforward between the parties to a divorce that were accumulated on married filing joint income tax returns before dissolution. The recommend approach per Ltr. Rul. 8828032, is to allocate MTC carryforwards is with reference to the properties or businesses that created the timing differences and allocating the MTC in the ratio that each property or business created the total timing difference. Once each property or business that created the MTC receives an allocation of the total MTC the parties would get to benefit by the MTC that follows the property or business each spouse is awarded in the marital property settlement agreement or order.
At present, no primary authority or judicial precedent exists that provides guidance as to how invest interest carryforwards are to be allocated among divorcing spouses. It seems reasonable then that investment interest carryforwards can be allocated in any reasonable manner including based on the property and activity that generated the expenses as long as the allocation is consistent for both regular tax and AMT purposes.
Under Reg. 1.1212-1(c)(1)(iv), Capital loss carryforwards are required to be allocated by analyzing each spouse’s separate capital losses that gave rise to the carryforward. Where the properties that generated the capital losses ae jointly owned, or the equivalent in a community property state, any loss carryforwards are equally split between the divorcing spouses.
Under Reg. 1.170A-10(d)(4)(i)(b), any charitable contribution carryforwards that were generated on married filing joint returns are apportioned between the divorcing spouses in the ratio that would have resulted had if the spouses had filed married separate returns for the year the excess charitable contributions arose. A problem with this requirement is once the two spouses file “married filing separately” many of the tax rules change and so do the resulting charitable loss carryforwards when separately stated.