Michigan Court of Appeals Holds Joint Tax Return Signing Compellable In Divorce
On November 18th, 2014, the Michigan Court of Appeals held in a divorce case that a trial court may in certain circumstances compel a spouse to sign joint tax returns. The Court specifically held that
compelling a party to sign a joint tax return should be limited to cases (1) where the parties do not have sufficient assets available for the court to shift in order to make up the difference in tax liability, (2) where there is no history of tax problems with the other spouse, (3) where the parties have a history of filing joint tax returns during the course of the marriage, and (4) the parties either agree, or the court orders, that the reluctant spouse be indemnified and held harmless by the other spouse for any tax liability.
In Butler v Simmons-Butler, Docket No. 321445, the Michigan Court of Appeals addressed whether it was legal error for the trial court to compel a spouse to sign joint tax returns during a divorce case.
The Court first recited the facts of the case.
It is an understatement to say that this marriage went downhill quickly. The parties “met” through an internet based dating company, and were married in October 2007. Plaintiff (father), a border patrol agent, was the main income source throughout the marriage, as defendant (mother) mostly stayed at home (with the children who were born soon after the marriage) until just prior to the divorce. Living in Arizona, just a year into the marriage the parties both allegedly engaged in domestic violence, leading defendant in 2010 to seek a personal protection order and a divorce from plaintiff in the Arizona courts. Ultimately the parties reconciled and moved to Michigan in 2011. By that time the parties had two young sons. The turmoil, unfortunately, did not end once they arrived on Michigan soil.
In fact, less than two years after moving to this state, defendant took the children without plaintiff’s knowledge, and plaintiff almost immediately filed for divorce. Defendant repeatedly accused plaintiff of inappropriate behavior with the older child, but nothing was ever verified or confirmed. With the court now involved, the parties filed numerous motions (and defendant fired a good number of her attorneys) and engaged in significant discovery and counseling. The court twice temporarily changed the children’s custody, with the last order awarding plaintiff temporary custody. Defendant was held in contempt of court for failing to comply with an order to return the children after parenting time, which ultimately led to her incarceration just prior to trial.
Trial occurred in late 2013, and after hearing all the evidence (much of which was presented by plaintiff), the court issued a very thorough, well-written and reasoned opinion granting sole legal and physical custody to plaintiff, awarding plaintiff the marital home and all of its accompanying debt, evenly splitting the marital portion of plaintiff’s main pension, and awarding two cars to plaintiff and the latest model to defendant. Spousal support was not awarded, defendant was ordered to pay child support, and miscellaneous other economic matters were decided by the court.
The final judgment of divorce was consistent with these rulings. Defendant now appeals that judgment as of right.
The Court's analysis of whether the trial court had the authority to order the mother to sign joint income tax returns.
The trial court entered an order amending its divorce judgment, requiring the parties to file amended joint tax returns for tax years 2011 and 2012, stating, in pertinent part:
[T]he parties shall file amended joint tax returns for the 2011 and 2012 tax year[s], divide any tax refunds equally, and be equally responsible for any tax deficiencies for [those] years. In the event either or both parties received a tax refund(s) as a result of filing separately, the party who received that refund shall be responsible for re-paying that refund from his or her one-half share of the total tax refund, if any, to which the parties would have otherwise have been entitled to had they filed jointly. In the event a refund a party received as a result of filing separately exceeds that party’s one-half share of the total joint refund, that party shall pay the other party the difference between the other party’s half of the total joint refund (to which the party would have been entitled had they filed jointly) and the refund that was actually received from filing an amended joint tax return. In the event either or both parties incurred and/or paid an income tax deficiency as a result of filing separately, then he or she shall first be reimbursed that deficiency from any joint tax refund(s) before they are divided. The Defendant shall cooperate in the filing and signing of the amended returns for 2011 and 2012.
Defendant argues that the trial court lacked the authority to order her to file amended joint returns, and that she should not have been compelled to sign joint returns under penalty of perjury, as in doing so she would be affirming that the facts plaintiff states on the returns were true.
In considering this issue, we first recall that “Michigan law grants the trial court in a divorce case broad discretion to do equity regarding the disposition of property,” so long as it conforms with Sparks. Licavoli v Licavoli, 292 Mich App 450, 454; 807 NW2d 914 (2011). See, also, Beckett v Beckett, 186 Mich App 151, 153; 463 NW2d 211 (1990) (“The trial court has great discretion in the adjustment of property rights upon divorce.”). One could say that when granting a divorce, a circuit court has more discretion to fashion relief than it does on any other case, particularly when addressing the division of property. See Greene v Greene, 357 Mich 196, 202; 98 NW2d 519 (1959) (recognizing the trial court’s “traditional broad discretion” in divorce cases); Smith v Smith, 113 Mich App 148, 150; 317 NW2d 324 (1982) (in divorce cases trial courts have “wide discretion” in dividing property). Indeed, the court’s guiding principle in distributing property upon divorce is—within the confines of statutory and case law—to reach the broad goal of “a fair and equitable division in light of all the circumstances.” Beckett, 186 Mich App at 153.
The parties have not cited to any Michigan law—and we have likewise found none—that addresses whether a trial court can order a party to sign and file an amended joint tax return for a tax year occurring during the marriage. There are Michigan cases highlighting the fact that trial courts often take tax consequences into consideration when fashioning the ultimate equitable distribution of marital property. See, e.g., Friend v Friend, 486 Mich 1035; 783 NW2d 122 (2010) (recognizing uniform spousal support orders take into consideration tax consequences of payments); Clarke v Clarke, 297 Mich App 172, 188; 823 NW2d 318 (2012) (trial courts can order which parent may claim the federal dependency tax exemption); Nalevayko v Nalevayko, 198 Mich App 163, 164; 497 NW2d 533 (1993) (generally recognizing that courts may consider effects of taxation in distributing assets so long as it is not speculative); Everett v Everett, 195 Mich App 50, 55; 489 NW2d 111 (1992) (“the trial court erred in valuating stock options without considering tax consequences.”). Clearly, then, circuit courts often consider the tax implications in a variety of contexts so as to ensure that it is accurately determining the value of an asset and equitably distributing the marital estate. But it is one thing to take into account the tax consequences that affect the marital estate. It is quite another to force a party to sign a tax filing that comes with potential legal ramifications.
Pursuant to the federal Internal Revenue Code, a spouse has the option to file a joint tax return. 26 USC 6013. It is generally understood that a husband and wife obtain a much more advantageous tax rate when filing a joint tax return. Bock v Dalbey, 283 Neb 994, 996-997; 815 NW2d 530 (2012). Along with potential tax benefits, however, comes potential liability for both signers. Id.; Sanders v United States, 509 F2d 162, 165 (CA 5, 1975). Because of these considerations, and oftentimes because divorcing parties will not agree on anything—let alone what tax forms to file—a court is confronted with the issue raised in this case: in order to gain a tax advantage to one or both parties on income earned during the marriage, with the result likely being additional marital assets available for distribution, does a circuit court have the power to order a party to sign a joint tax return (or an amended one) for the benefit of the marital estate?
Courts from states across the Union that have addressed this issue have come to differing conclusions. Defendant relies in large part on the Nebraska Supreme Court decision in Bock. That case involved a marriage dissolution proceeding that included the trial court’s division of marital property. At issue was the trial court’s order that the parties file joint tax returns for the years 2008 and 2009. The parties filed jointly in 2007, but had not filed any subsequent returns. Bock, 283 Neb at 995. The defendant appealed the order, arguing that the trial court did not have the “discretion to order the parties to file a joint return to preserve assets for the marital estate or to equalize its division of the estate.” Id. at 996. The court cited case law from several other states holding that a trial court cannot compel a party to file a joint tax return. Id. at 997 n 10. The Bock court particularly relied on Leftwich v Leftwich, 442 A2d 139 (DC App, 1982), one of the first courts to hold that in a divorce proceeding a trial court could not override a party’s right to select his or her filing status under the Internal Revenue Code:
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. [Id. at 998, quoting Leftwich, 442 A2d at 145 (ellipsis in original).]
To foreclose the right to be free from potential liability exposure as a joint filer was unacceptable to the Leftwich court, particularly where the trial court—instead of ordering the filing of joint returns—could have remedied any perceived tax disadvantage by altering the disposition of other marital property. See Bock, 283 Neb at 998, quoting Leftwich, 442 A2d at 146.
The Bock court set forth additional policy considerations militating against allowing a trial court to order a party to file tax returns with a specific status (joint or individual). It reasoned that because federal tax courts look at the parties’ intent in filing jointly, “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” where the parties are compelled to file jointly. Bock, 283 Neb at 1000. The Bock court also viewed the trial court’s order to file joint returns as a mandatory injunction which, under the circumstances, was too harsh a remedy in light of the ability to make up the tax difference through property adjustments. Id. Additionally, the court noted that Internal Revenue Code filing deadlines create practical hurdles to a trial court compelling the filing of joint returns, as a joint tax return is not revocable after the passing of the filing deadline. Id. at 1003. As a result, the Bock court held:
We conclude that the Court of Appeals erred in holding that a district court has discretion to compel the parties to a marital dissolution proceeding to file a joint income tax return. Because a trial court can equitably adjust its division of the marital estate to account for a spouse’s unreasonable refusal to file a joint return, resort to a coercive remedy that carries potential liability is unnecessary. [Id. at 1004.]
Several other decisions follow Leftwich without much additional analysis or rationale. See Teich v Teich, 240 AD2d 258; 658 NY2d 599 (1997) (spouse has unqualified right to decide whether to file a joint return, and court can separately address adverse consequences of decision not to file jointly); In re Marriage of Lewis, 81 Or App 22, 25; 723 P2d 1079 (1986) (following Leftwich without much discussion); Matlock v Matlock, 750 P2d 1145, 1145 (Okla App, 1988) (citing to Leftwich, court cannot compel filing of joint return, but can take consequences into account when dividing property); In re Marriage of Butler, 346 NW2d 45, 47 (Iowa App, 1984), overruled in part on other grounds, In re Marriage of Hoffman, 493 NW2d 84 (Iowa App, 1992) (same holding as Teich, Lewis, and Butler). Although Kane v Parry, 24 Conn App 307, 315- 316; 588 A2d 227 (1991), held without any discussion that a court could not order parties to file a joint tax return in the absence of a prior agreement to do so, it did not rely upon Leftwich or its progeny.
As noted earlier in this opinion, other courts have concluded that it is within a trial court’s discretion to order a party to sign and file a joint tax return. One of the more frequently cited cases coming to this conclusion is Bursztyn v Bursztyn, 379 NJ Super 385; 879 A2d 129 (2005). Though recognizing that “[t]here are good arguments on both sides of the issue,” the court ultimately concluded that “trial courts should have discretion to compel the filing of joint tax returns.” Id. at 397. Considering many of the same factors as the Nebraska Supreme Court did years later in Bock, the Bursztyn court recognized that because compelling a party to sign and file a joint tax return had some potential adverse tax implications, courts should consider the tax consequences to the marital estate between filing a joint or individual return and, where appropriate, first attempt to “compensate the parties for the adverse tax consequences of filing separately.” Id. at 398. But, if that is not feasible, the court ultimately held that the power to compel exists to “preserve the marital estate by compelling joint returns.” Id. at 397.
Other courts have held that divorce courts do have the discretion to order parties to sign a return, or to amend a return. For instance, in In re Marriage of Lafaye, 89 P3d 455, 461 (Colo App, 2003), the court held that the federal tax code does not “deprive the dissolution court of jurisdiction to enter orders as between the parties,” and consequently the trial court could preclude the wife from amending joint returns. The Ohio Court of Appeals similarly held that, because a trial court is required by Ohio law to consider the tax consequences of a division of property, a divorce court has the jurisdiction and authority to order a spouse to amend a tax return as part of a property division. Bowen v Bowen, 132 Ohio App 3d 616, 636-637; 725 NE2d 1165 (1999). In dicta, the Arkansas Court of Appeals stated that because a trial court in divorce proceedings “may mould any remedy that is justified by the proof,” it was within a trial court’s discretion to order a party to sign a joint tax return. Cox v Cox, 17 Ark App 93, 95; 704 SW2d 171 (1986). And, without too much elaboration, the New Hampshire Supreme Court held that whether to compel the signing of a joint tax return is within a divorce court’s discretion. Wheaton-Dunberger v Dunberger, 137 NH 504, 511; 629 A2d 812 (1993). Kentucky courts have likewise held it to be a discretionary decision, Schmitz v Schmitz, 801 SW2d 333, 336 (Ky App, 1990), while the Minnesota Court of Appeals held that a divorce court has the discretion to order the parties to file joint tax returns to avoid the depletion of funds available for distribution. Theroux v Boehmler, 410 NW2d 354, 356 (Minn App, 1987).
The articulated reasons in support of not affording a trial court the discretion of ordering parties to sign a joint tax return are reasoned and worthy of serious consideration. As we read those cases, none of the courts has concluded that 26 USC 6013 by itself precludes a state trial court from taking away the discretion normally given to a married taxpayer by ordering the filing of a joint tax return. Instead, those courts have recognized the federal policy in that statute, and the potential liability consequences attendant to both joint filers. In deference to those concerns, and recognizing that typically a divorce court can make up any detrimental tax consequences resulting from an individual filing through redistribution of the parties’ property, those courts held that it is preferable not to allow a court the discretion to order a reluctant spouse to file a joint tax return.
We believe that the Bursztyn approach is most consistent with Michigan law and the broad discretion historically afforded to trial judges disposing of marital (and at times, separate) property. As noted, there are no restrictions placed on trial courts by the Michigan Legislature or Michigan courts relative to compelling joint tax returns. And circuit courts in divorce actions, through the exercise of their broad equitable powers, routinely issue orders compelling the parties to do, or refrain from doing, certain actions regarding their personal property. See, e.g., Kasben v Hoffman, 278 Mich App 466, 474-475; 751 NW2d 520 (2008) (court can order the transfer of personal property between the parties); Korth v Korth, 256 Mich App 286, 293-294; 662 NW2d 111 (2005) (court has equitable power to order the sale or abandonment of dilapidated property); Yeo v Yeo, 214 Mich App 598, 602; 543 NW2d 62 (1995) (court has equitable power to compel sale of marital home). Nor, as we just mentioned, have any courts concluded that federal law precludes such an order. Absent any such prohibition, and because tax consequences are routinely considered by Michigan courts when exercising their broad discretion in resolving property issues, we hold that it is within the broad discretion of a trial court to compel a party to sign a joint tax return when, under all the circumstances, it is in the best interests of the marital estate and, as discussed below, there is (1) no ability for the court to make up the difference in tax liability through an allocation of property, (2) there is no history of tax problems with the requesting spouse, (3) the parties have a history of filing joint tax returns during the marriage, and (4) the court orders the spouse (absent an agreement to do so) to indemnify and hold harmless the reluctant spouse for any resulting tax liability. There are several reasons for this holding.
First, like the Bursztyn court, we too recognize that there is some potential risk involved to a spouse who signs a joint return. As we have said, the statute itself provides for joint and several liability on any tax deficiencies and other liabilities. Callaway v Comm’r of Internal Revenue, 231 F3d 106, 111 (CA 2, 2000) (if a joint return is made, liability with respect to the tax shall be joint and several), citing 26 USC 6013(d)(3). But, somewhat tempering this potential liability is that a spouse compelled to sign a joint return during the course of a divorce proceeding may very well obtain the benefit of the “innocent spouse rule,” should any issues arise from the other spouse’s filing information. See 26 USC 6015; Friedman v Comm’r of Internal Revenue, 53 F3d 523, 528-529 (CA 2, 1995) (recognizing that because innocent spouse rule is remedial in nature, “it is construed and applied liberally in favor of the person claiming its benefits”); Purcell v Comm’r of Internal Revenue, 826 F2d 470, 475 (CA 6, 1987) (“The purpose of the innocent spouse rule is to protect one spouse from the overreaching or dishonesty of the other”); see also Manella v Comm’r of Internal Revenue, 631 F3d 115, 117-118 (CA 3, 2011); Henson v Comm’r of Internal Revenue, unpublished memorandum opinion of the United States Tax Court, issued October 10, 2012 (Docket No. 14304-10) (explaining the threshold requirements a spouse must prove to obtain relief under the innocent spouse rule). However, at the time divorce proceedings occur it is generally unlikely that either the parties or the trial court will know if the IRS has determined there to be any tax deficiencies, additional liabilities, etc., with any recent tax filing. So, whether the reluctant spouse would obtain the benefit of the innocent spouse rule could be unclear at the time of entry of the judgment of divorce. But the existence of the rule does in some measure counter the risks of being ordered to sign a joint tax return with a former—or soon to be former—spouse.
Second, in order to protect a reluctant spouse from exposure on any tax deficiencies resulting from the other spouse’s information, a trial court should order (absent an agreement between the parties) that the reluctant spouse be indemnified and held harmless by the other spouse. See, e.g., In re Marriage of Lafaye, 89 P3d at 461. In this way the reluctant spouse can know with certainly that no additional funds will be required to satisfy the other spouse’s desire to file jointly.
Finally, as almost all the courts addressing this issue have noted, and it is just as true here in Michigan, trial courts adjudicating a divorce are already empowered to shift marital (and in some cases, separate) property and debt between the parties in order to reach a fair and equitable result. In many cases where there is property available to address potential tax deficiencies resulting from an individual filing, it will be more practical5 to make up the tax difference by providing additional property to the spouse who has to make up the tax liability difference resulting from filing an individual return. Bursztyn, 379 NJ Super at 398.
As a result, and in light of all the foregoing considerations, the general default rule is for a court to redistribute the property at its disposal to make up any additional tax liability incurred as a result of an individual filing. But, if that is not possible because of insufficient property available for the court to make up for the additional taxes or because of some other exceptional circumstance, as a last resort a trial court has the discretion to order the signing of a joint tax return. In other words, compelling a party to sign a joint tax return should be limited to cases (1) where the parties do not have sufficient assets available for the court to shift in order to make up the difference in tax liability, (2) where there is no history of tax problems with the other spouse, (3) where the parties have a history of filing joint tax returns during the course of the marriage, and (4) the parties either agree, or the court orders, that the reluctant spouse be indemnified and held harmless by the other spouse for any tax liability. Id. at 398-399.
Turning now to the decision in this case, we conclude a remand is necessary for the trial court to reconsider its decision ordering defendant to sign amended joint tax returns. Defendant has argued that she should not have been compelled to sign the amended joint returns because of the risk of future liability. Although some level of risk exists until such time as a return is accepted by the IRS, the limited record does not contain evidence that plaintiff had prior tax problems, that he has or had any intention to engage in tax fraud, or that he otherwise exhibited an inability to have a proper tax return prepared. Additionally, there appears to be little marital property to divide between the parties, so the trial court may be limited in its ability to make up any tax deficiency without taking it directly from defendant. But the record is not sufficient for us to make any conclusions, and this decision is in the first instance one relegated to the trial court’s discretion. Accordingly, we vacate that portion of the judgment ordering defendant to sign amended joint tax returns, and remand this issue to the trial court for reconsideration in light of the factors outlined in this opinion.