NEBRASKA SUPREME COURT HOLDS IN BOCK V. DALBEY THAT STATE TRIAL COURT LACKS DISCRETION TO ORDER THE PARTIES TO FILE A JOINT FEDERAL INCOME TAX RETURN

My two Tax Wars Blog(www.steinbergtaxlaw.wordpress.com) posts on October 6, 2011 discussed and criticized the Nebraska Court of Appeals decision (Bock v. Dalbey, 19 Neb. App. 210, 809 N.W.2d 785 (2011)), upholding a trial court’s order requiring Mathew Bock and Jennifer Dalbey, divorced in August 2010, to file joint federal income tax returns for the years 2008 and 2009. They were married in 2006 and had filed jointly for the year 2007. Dalbey did not want to file a joint return with her former spouse although the election to file jointly was available to them because they were married on December 31 of 2008 and December 31, 2009, the dates which determine marital status for those years. The lower court had ordered Bock to pay the tax on the joint return and filing jointly would have produced a lower tax liability for him than would have resulted on a Married Filing Separate Return. But Dalbey had little income and signing the joint return would have subjected her to joint and several liability for her former husband’s tax liability if he did not pay the tax due on the return or was assessed additional taxes on audit. Dalbey appealed the Court of Appeal’s ruling upholding the trial court’s order that the spouses file a joint return.

The Nebraska Supreme Court decision refers to Leftwich v. Leftwich, (442 A.2d 139 (D.C. 1982)), as the most cited case holding that a trial court in a dissolution proceeding may not compel spouses to file a joint return, stating in part:

To sanction the trial court's effectively ordering a spouse to cooperate in filing a joint return would nullify the right of election conferred upon married taxpayers by the Internal Revenue Code. Such a right is not inconsequential; its exercise affects potential criminal and/or civil liabilities of taxpayers.... Married individuals filing a joint return expose themselves to joint and several liability for any fraudulent or erroneous aspect of the return.

The Nebraska Supreme Court noted that Leffwich held critical the fact of the wife’s exposure to liability and the availability of less intrusive measures for dealing with marital tax liabilities, i.e., altering other aspects of the distribution of marital property to adjust for any perceived disadvantage to the husband from filing separately.

The Nebraska Supreme Court also discussed Bursztyn v. Bursztyn( 379 N.J. Super. 385, 879 A.2d 129 (2005)), a leading case relied on by the Court of Appeals in upholding the trial court’s discretion to order the filing of a joint return. The Bursztyn court found that the court’s statutory mandate to consider the tax consequences of its equitable distribution outweighed the “minor intrusion” upon the spouse’s right to file separately and not elect joint filing. The Nebraska Court of Appeals found that this abridgment of the right to elect under federal law (IRC Sec. 6013) did not conflict with federal law or violate the Supremacy Clause of the U.S. Constitution because marital rights are a strictly a matter of state law concern outside the scope of federal jurisdiction. The Nebraska Supreme Court noted, however, that the Bursztyn court agreed with the Leffwich court’s reasoning that “altering the equitable distribution of marital property was a less intrusive option to remedy a tax disadvantage” to one spouse from filing separately and required to lower court to consider that lesser remedy before resorting to compulsion regarding filing a joint return.

Without commenting on the applicability of the Supremacy Clause, the Nebraska Supreme Court, decided under state law that adjusting the equitable distribution is the preferred method for dealing with a tax disadvantage to one spouse from filing separately, and that a trial court lacks discretion to order the filing of a joint return, stating as its reasons for so holding:

 The U.S. Tax Court is not bound to respect the state court order and might well find under IRS regulations and its own case law that such a return was not a valid joint return because the unwilling spouse did not intend to file jointly but was compelled to do so. The Supreme Court stated, “This means that a trial court cannot know with certainty whether its equitable division of the marital estate based on consideration of a joint tax return will be given effect by federal authorities or courts.”

 The lower court’s order is a mandatory injunction, an extremely harsh remedy that should not be exercised unless damage would be irreparable and no adequate remedy at law is available. In the case at hand Nebraska’s equitable distribution law Sec. 42-365 is broad in its scope and could be employed to adjust for any tax inequity.

o The trial court may consider a party’s unreasonable refusal to file a joint return in making equitable adjustment where the other spouse is disadvantaged by filing separately. The Supreme Court stated: … “because we conclude that § 42-365 permits a court to adjust its division of the marital estate to fit the equities of the case, we agree with the Leftwich court that equity principles weigh against permitting a trial court to resort to the coercive remedy of compelling a party to file a joint tax return.”

 “A resisting spouse's exposure to liability under the federal tax code is too difficult to predict if compelled to file a joint return… Obtaining relief under the innocent spouse statute, however, is far from certain…. Summed up, for a divorcing spouse with little or no taxable income for the tax year, signing a joint tax return may pose considerable liability risk with no appreciable benefit.”

 “Because the risks frequently outweigh the benefits, in private negotiations a spouse will often not agree to a joint return without the other spouse's agreement to share in the tax savings and to promise indemnity. We believe that these decisions are best left to the parties to negotiate after considering the risks and benefits of a joint return. If a spouse unreasonably refuses to file a joint return, the other spouse can take the matter up with the court.”

 “(The) filing deadlines under the federal tax code create practical hurdles to allowing a trial court to compel the parties to file joint returns. Under § 6013(b) of the tax code, a husband and wife can only elect to file a joint return for up to 3 years after they filed separate returns. But the opposite is not true. If the husband and wife filed a joint return, they cannot revoke that decision after the filing time limits for the taxable year have expired. So, if a trial court orders a party to file a joint return, he or she will usually have to comply quickly or risk being held in contempt. Yet even if the party appeals the order, the party cannot revoke the joint return. The party's only avenue for relief from federal tax liability is the tax code's innocent spouse statute. As discussed, that option is a precarious road at best. Thus, the tax code's time limitations also weigh against permitting trial courts to order the parties to file a joint return.”

Thus, the Court of Appeals was reversed. The Nebraska Supreme Court did not find it necessary to rule on the Supremacy Clause issue because state law provided a less harsh remedy at law making equitable compulsion unnecessary and therefore improper. This is a very well reasoned opinion that should be read by every family lawyer and every tax preparer before advising clients to file a joint return.

I believe the Supremacy Clause would be apply because the state court in ordering spouses to file jointly does not merely adjust tax equities between the parties but interferes with the relationship between the taxpayer and the U.S. Treasury. The order also increases the burden on the IRS and federal court system by making it almost certain that the unwilling spouse will seek innocent spouse relief when, absent the court order, no joint return would have been filed.

Joint return and innocent spouse issues emanate from the present tax rate structure and other tax law provisions making it almost always highly disadvantageous to file under the status of Married Filing Separately. Thus, spouses and frequently divorcing spouses will file jointly only later to realize the tax savings is not a favorable trade-off for assuming joint and several liability for their spouse’s tax debt. Even non-marital assets may be subject to forced collection action by the IRS.

The innocent spouse rules are complex. As a result innocent spouse claims are among the most frequently litigated tax issues. To obtain a day in court procedural rules must be strictly followed. Some have recommended eliminating joint and several liability and enacting rules similar to Section 6015(c) (Procedures to limit liability for taxpayer’s no longer married) the general rule for all joint filers. That would still leave the complexities of allocating income and deductions between the spouses on a combined return. Why not amend the code to give spouses the option to elect to file separately using the single tax rates or elect to file jointly using the joint tax rates and other rules applying to joint returns? Income and deductions on the separate return would follow title. Estimated tax payments would be made separately or jointly and split equally. A joint return would carry joint and several liability except for fraud or duress exceptions. Changing the law in this fashion would reduce most innocent spouse litigation and remove the current law prejudice against the “Married Filing Separately” filing status. The election to file jointly, as it stands pushes spouses into joint filing for short-sighted financial benefit, but operates adversely with regard to the interests of the lower earning or non-earning spouse who at the time of electing often cannot foresee or understand these substantial detriments. That tax naivety places a great responsibility and potential malpractice strain on those advising the more vulnerable spouse.

See Special CPA Edition dated 11/29/11 discussing Theresa M. Karam v. Commissioner, 2011 TC Memo 230). http://www.ustaxcourt.gov/InOpHistoric/karammemo.TCM.WPD.pdf

In Karam, the Tax Court stated in its decision on an innocent spouse claim that the wife had brought a malpractice suit and obtained a $150,000 judgment against the CPA return-preparer for not advising her about the adverse consequences of filing a joint return.

CONCLUSION

1. Always advise your client about the advantages and disadvantages of filing a joint return. It is not just a current dollar savings issue. The ramifications of joint and several liability can result in losing the martial home.

2. It’s time for congress to reconsider the application of our tax rates to married couples and give spouses a more appealing option for filing separately without joint liability but with fairer rates and tax computation or the simpler option of filing one combined return with lowered split rates but joint and several liability.