Credit Carryover of Deceased Spouse Cannot Be Used by Survivor in Later Tax Years

Should a surviving spouse be able to make use of an unused credit carryforward of her former spouse?  That question was posed in the case of Vichich v. Commissioner, 146 TC No. 12—and, as the Court noted, this wasn’t a question the Court had considered before.

The credit in this was the minimum tax credit under §53.  The minimum tax credit generally relates to a minimum tax paid in a prior year that is related to differences between the regular tax and the alternative minimum tax (AMT) that will reverse in later.  In this case William Vichich has exercised incentive stock options (ISOs) granted to him by his employer in 1998.

For regular tax purposes the difference between the fair value of the ISO shares received by the exercise of the options and the price paid under the option is not treated as income.  If the taxpayer holds the shares until the later of two years after the grant of the option by the taxpayer’s employer or the taxpayer’s exercise of the option, a later sale will treat any excess of the sales price over the exercise price paid as long term capital gains.

However, under the alternative minimum tax that special exclusion on exercise does not apply.  Rather such options are treated in the same manner as nonqualified options are normally treated—the excess of the value on the date of exercise over the exercise price is treated as income in computing alternative minimum taxable income.  However, when the shares are later sold, the taxpayer will be able to use the higher fair value basis in computing the recognized gain or loss in computing alternative minimum taxable income—so the difference does reverse.

William and his then spouse (who was not Nadine, the taxpayer in this case) paid alternative minimum tax in the year in question which gave rise to a minimum tax credit.  However, like many taxpayers in the late 1990s, William discovered that he was never able to actually use that credit.  William divorced Marla Vichich in January 2002 and then married Nadine later that year.  On their joint 2002 return they reported a minimum tax credit of zero and a carryforward of $304,442. 

William died in 2004, still married to Nadine.  However, following the 2002 return no minimum tax credit form was attached to their return, nor did Nadine attach such a form to her returns from 2005-2008.  But she later amended her 2007 and 2008 returns to claim the credit, as well as claiming it on her 2009 return.  You may recall that during that period Congress had changed the law to allow for the refund of “old” minimum tax credit carryovers, which resulted in six figure refunds being claimed for 2008 and 2009 by Nadine.

While the IRS paid her 2007 refund claim, they denied her claim for 2008 and then later issued a notice of deficiency on the 2009 return after initially paying out the refund.  The IRS claim was that she had not established her right to any carryover of the minimum tax credit from her former husband.

The opinion starts out by noting that neither party questioned whether, in fact, the entire minimum tax credit had passed to William upon his divorce in 2002.  While the Court did not look into that fact, its mention of this issue is a caution that some or all of the credit might be reduced at that event depending on whether a portion of that credit is properly allocable to the former spouse, something that seems likely to be true in a community property jurisdiction.  However, this particular case involved Ohio, not a community property jurisdiction, so it seems reasonable to accept that William received all of the carryover following the divorce.

As the Court points out, generally deduction carryovers that are allocable to the deceased spouse “die” to the extent they cannot be used on the final joint return.

In Rose v. Commissioner, T.C. Memo. 1973-207, the Court held that a taxpayer may carry forward one-half of the net operating losses reported on joint returns during her marriage and offset them against separate income earned after her husband’s death. The determining factor in Rose was the extent to which the taxpayer participated in the risk when the loss occurred; the taxpayer was essentially an equal partner with her husband and was therefore entitled to half of the net operating losses, whereas the losses attributable to her husband’s participation in the business were not available for her to use in subsequent years. Id. The analysis in Rose, accords with the treatment of net operating losses under Rev. Rul. 74-175, 1974-1 C.B. 52, which limits the deductibility of capital and net operating losses sustained by a decedent during his last taxable year to the final return (whether separate or joint) filed on his behalf; the estate is not eligible to deduct such losses. Similarly, under section 1.170A-10(d)(4)(iii), Income Tax Regs., a taxpayer may not deduct the excess charitable contributions of his or her deceased spouse.

Nadine points out, though, that this was not a deduction, but rather a credit—and one specifically enacted (and then made refundable by Congress) to deal with a basic inequity in the tax law.

The Court, though, did not conclude that this would lead to a different treatment.

While we recognize that the purposes of the AMT credit and the NOL carryover are not identical, we nonetheless find informative the authorities limiting the transfer of NOL carryovers between spouses. Petitioner offers us no reason not to extend those authorities to this case. She grounds her claim to the credit in issue entirely in the remedial purposes she alleges underlie section 53(e) and (f). Those subsections, however, have no bearing on her ability to take into account, for purposes of section 53(b)(1), the adjusted net minimum tax imposed on her husband before their marriage. Therefore, because petitioner could not deduct for a postmarital year an NOL incurred by her husband even during their marriage, much less before it, we conclude, on the basis of the record and the arguments before us, that, she was not entitled to take into account under section 53(b)(1) her husband’s premarital adjusted net minimum tax liability in computing her own minimum tax credit for tax year 2009.

One other item is useful to note—when Nadine filed her original claim for refund she included a Form 8275, Disclosure Statement, with the amended return.  Although the IRS initially argued she should be subject to an accuracy related penalty on the tax due, they IRS conceded that issue before trial.  Most likely the IRS recognized that, since Nadine had fully disclosed her position on the initial amended return that the IRS paid a refund for, the taxpayer was likely going to carry a “reasonable cause” defense for her positions taken in the following two years.