June 20, 2016

Tax Court Rejects Widow’s Claim of Deceased Spouse’s Unused Tax Credit

By Kelly Harris, Senior, Tax & Business Services

Tax Court Rejects Widow’s Claim of Deceased Spouse’s Unused Tax Credit Tax & Business

The Tax Court recently ruled that a widow could not use her deceased husband’s alternative minimum tax (AMT) credit which arose from his exercise of employee stock options prior to their marriage. The ruling was based on the fact that she could not claim eligibility for the credit and that the credit expired upon her husband’s death.

In 1998 the taxpayer’s husband, now deceased, exercised incentive stock options that were granted to him by his employer. The exercise of incentive stock options gives rise to an adjustment to alternative minimum tax if

  1. The fair market value on the date of exercise exceeds the exercise price, and
  2. If the taxpayer holds onto these options for the remainder of the calendar year before selling.

Due to the exercise of his stock options, the husband was subject to alternative minimum tax on his 1998 tax return, which, at the time, he filed with his ex-wife. As a result of being subject to AMT in 1998, this generated an alternative minimum tax credit that could be used in future years when he was no longer subject to AMT.

The taxpayer’s husband, after his divorce from wife # 1) married the taxpayer in 2002, who was the petitioner in this court case, and they filed joint tax returns each year until his death in 2004. The AMT credit that was generated was never used and was not claimed on their final married filing joint return or on her husband’s estate return for the 2004 tax year. The taxpayer tried numerous attempts to use a significant portion of her deceased husband’s AMT credit in future tax years on her own personal return including several amended returns. However, her requests were denied by the IRS and the Tax Court.

The taxpayer’s attempt to use her husband’s AMT credit was denied for the following reasons:

  1. The AMT tax and resulting credit was generated from the exercise of stock options by her husband before they were married. These stock options were not the taxpayer’s.
  2. The taxpayer failed to prove that she was entitled to the credit upon her husband’s death.
  3. The tax code treats married filing joint taxpayers as one taxable unit but does not convert two spouses into one single taxpayer.
  4. Married filing joint returns does not permit either spouse to inherit or retain any tax benefits that was generated from the other spouse once the marriage ends.
  5. The taxpayer failed to use the credit on the final married filing joint tax return or her husband’s estate return for the 2004 tax year.

In general, a deceased taxpayer’s unused deductions must be used on the last tax return of the decedent or they are forever lost. It is important to consider the following actions to help reduce the risk of unused tax credits and deductions from expiring:

  1. Contact your tax advisor regarding any credit carryovers that you may have from prior year tax returns.
  2. Determine who is entitled to these credits if filing jointly with your spouse as these credits usually follow the individual who generated them once the marriage ends.
  3. Work with your tax advisor to generate ways to use any deductions or credits.
  4. If possible, claim any unused credits on the last return of the decedent before they expire upon death.

For more information on available personal tax credits, and taking advantage of these credits on your personal return before they expire, please contact your Marcum tax advisor.

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