Tips on Allocation of Income Tax Credits and Refunds Between Spouses
Which spouse is entitled to the credits for income taxes withheld from wages and estimated tax payments? Which spouse is entitled to any refund that may result from a joint return or an amended return? These are questions that frequently arise during a divorce. With an understanding of the income tax rules regarding income tax credits and refunds, you may be able to identify tax credits that represent assets for your client.
Income Tax Withholding
Income tax withheld from wages is allowed as a credit to the spouse who received the wages. This rule is provided by Internal Revenue Regulation Section 1.31-1. This includes withholding from pensions which are treated like wages for withholding purposes under Internal Revenue Regulation Section 35.3405-1.
Estimated Tax Payments
If married spouses file joint estimated tax vouchers but subsequently decide to file separate returns, the estimated payments can be apportioned between the spouses in any manner they decide. Internal Revenue Regulation Section 1.6654-2(e) provides this rule. The apportionment of these credits can be part of the divorce settlement. If the spouses cannot agree on how to split the payments, the estimated tax payments are allocated based on the ratio of the taxes shown on the separate returns to the combined separate taxes. Each spouse calculates his or her share of the estimated tax payments based on the following formula:
Spouses Separate Tax Liability
Estimated Tax Payments Combined Separate Tax Liabilities of Both Spouses
If married spouses file separate estimated tax vouchers and file separate returns, each spouse can only take credit for his or her payments.
Revenue Ruling 80-7 provides guidance to the amount of any refund to which each spouse is entitled if a joint return is filed. Each spouses tax liability must be computed as if separate returns were filed. The ratio of the separate taxes to the combined separate taxes is applied to the joint liability indicated on the return in order to determine each spouses share of the joint liability. The formula for computing each spouses share of the joint liability is as follows:
Spouses Separate Tax Liability
Tax Liability Combined Separate Tax Liabilities of Both Spouses
Each spouses share of the joint liability is subtracted form his or her withholding and estimated tax credits, which were determined following the rules previously discussed, in order to determine the amount of his or her refund. In a community property state, the IRS may apply the overpayment due the non-liable spouse against amounts owed by the other spouse per Revenue Ruling 85-70.
Earned Income Credit
The Earned Income Credit (EIC) is a refundable credit available to low-income wage earners. The EIC is refundable to the extent of the amount allowed under the law, regardless of whether the taxpayer had any withholding on wages. This would enable a taxpayer with no tax liability for the year to still obtain a refund equal to the credit. Allocation of the EIC is computed in a manner similar to that for refunds. The formula, per Revenue Ruling 87-52, for this is as follows:
Spouses Separate EIC
Combined Separate EICs of Both Spouses
Each former spouse is entitled to file an amended return for a previous year in which a joint return was filed. Revenue Ruling 80-8 provides that only the spouse filing the amended return is required to sign it. Furthermore, the Internal Revenue Service will issue a refund check in the name of the spouse who filed the amended return. The amount of the refund on such a return is based on the ratio of the separate amended tax liabilities to the combined amended tax liabilities applied to the amended joint tax liability. The formula is as follows:
Spouses Amended Separate Tax Liability Amended
x Joint Tax
Combined Amended Separate Tax Liabilities of Both Spouses Liability
The spouses share of the amended joint liability is subtracted from the spouses withholding and estimated tax credits in the joint return year to determine the amount of the refund.