Originally published on Forbes.com Mar 12th, 2014
One of the aggravations of tax season is the surprise 1099 or K-1 that shows up after you think the return is done. Of course, tax software has made it much easier to rerun returns, so it is not nearly as painful as it used to be. Having the surprise K-1, for a really material number crop up years later is another matter entirely. That is what had Ann S. Carrino in Tax Court.
Ms. Carrino received a K-1 from CR LP with income of over $750,000. The K-1 was for the year 2003 and she received it sometime in 2007. It was the result of an amended return filed by CR LP on April 15, 2007. Ms. Carrino chose not to amend her own return.
How Do You Get A Surprise K-1 Three Years Late?
In this case, the late K-1 was a salvo in a messy divorce exchange. Ms. Carrino’s then-husband, Vince Carrino petitioned to end their marriage in June 2002. They separated four days later. It took over four years to sort things out from there. During that period of time, they were still married. There were two factors that made things fiendishly complicated. One was that Mr. Carrino ran hedge funds. The other was that the couple lived in California, a community property state.
Around the same time as the separation, Vince (the Tax Court used first names) got a new hedge fund running. He did not mention the new fund to Ann. In his mind, he was not using community property to get the fund going. In retrospect, it was determined by the court involved in the state court, that CR LP was, in fact, funded mostly (72.5%) with community property. In November 2006, Vince paid Ann $6.5 million for her community interest in CR LP.
What About Taxes?
Vince was concerned that he had paid all the taxes on the earnings that had built up CR LP. Apparently, they had been filing separately. Cate Blanchette’s character in Blue Jasmine would have, in retrospect, applauded that decision.
Ann’s position was that the extras taxes Vince had paid would be taken care of when they did a final true-up. Vince got impatient with that approach. Hence the last-minute amended partnership return for 2003, that gave Vince the ammunition to file a refund claim by shifting about $750,000 in income to Ann.
Was The Amended Return A Good Idea?
The judge handling the divorce certainly did not think so. The Tax Court quotes a state court order in a footnote:
It is clear that hasty and unilateral action in this regard has caused needless fees and costs. While court has no jurisdiction over the IRS, it does have jurisdiction over the parties and their dealings with each other. The court agrees with and finds actions with respect to their 2003 tax returns to be unnecessary and contrary to the fiduciary duties to . As a result, he shall pay when due and indemnify and hold free and harmless of and from all penalties, interest, fees and costs incurred by her over and above the actual taxes (Federal and State) due on her returns as ultimately determined by the IRS and the Franchise Tax Board.
Apparently his refund claim was disallowed.
While Ann contends that the Commissioner–due to confidentiality rules–has declined to reveal to her how the IRS treated Vince’s claim for a refund on his 2003 amended return, we take judicial notice that the IRS disallowed it. Vince filed a Tax Court petition in August 2011 seeking redetermination of the IRS’s decision to disallow his refund claim of $278,880 for 2003.
I looked that ruling up and was not at all surprised to find that Vince was “pro se”. It was really kind of a bonehead move. You don’t take refund claims to Tax Court. You need a notice of deficiency in order to get into Tax Court.
Is The IRS Being A Chazar?
Given that they turned down Vince’s refund claim, it doesn’t seem right that they are chasing Ann, but that’s what they decided to do. One approach was based on the amended partnership return which prompts a journey down the TEFRA rabbit hole. The Tax Court ruled in Ann’s favor as far as that went:
We therefore find that this part of the Commissioner’s determination is not moot, but that it is wrong because Ann’s interest in CR LP was not that of a partner, but of a holder of a community-property interest in Vince’s partnership. We thus rule in Ann’s favor in the partnership case.
That did not do her any good, since even though she was not a partner she still had a community property claim on her then spouse’s interest in the partnership.
Therefore–regardless of whether Ann was a partner in CR LP (or a member in CR LLC) in 2003–we conclude that the general rule of federal income-tax law–that a married person filing separately must report half of the community income –applies in her case to the income that CR LLC earned.
Joint Returns?
I have a general against the grain belief that joint returns are a bad idea (or at least not that good an idea) for couples who are in the process of splitting. It is possible that I might modify that a bit for people in community property states. They end up getting stuck with a split of much of the property. Apparently, but for the ill-considered amended partnership return, the whole matter would have slid by, but the Tax Court’s ruling is that Ann was supposed to pick up that income even though she was not a partner.
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