11th Circuit clarifies claim-of-right doctrine in divorce case

Tax Hot Topics newsletterThe 11th Circuit Court of Appeals held in Mihelick v. United States (No. 17-14975) that a divorced woman was entitled to a tax refund under the claim-of-right doctrine after income earned by her ex-husband while they were married had to be returned pursuant to a company lawsuit. The court’s ruling reverses an earlier decision by the U.S. District Court for the Middle District of Florida.

The claim-of-right doctrine provides that when property or funds are received due to a mistake of fact or law, the amount received is included in the recipient’s gross income regardless of whether the recipient is obligated to return the item to the payer when the error is discovered. For a taxpayer who acquires income that is taxable pursuant to the claim of right doctrine, and if in a subsequent year it is determined that he or she is not entitled to some or all of that income, the taxpayer can recover the taxes previously paid under Section 1341 if the following four requirements are satisfied:

  1. The income must have been included in a prior year’s gross income because it appeared that the taxpayer had an unrestricted right to such item
  2. The taxpayer must have later learned that he or she actually did not have an unrestricted right to that income
  3. The amount that the taxpayer did not have an unrestricted right to must exceed $3,000
  4. The amount that the taxpayer did not have an unrestricted right to must be deductible under another provision of the tax code

If a taxpayer satisfies these four requirements, the taxpayer has a choice between two options: 1) the taxpayer can deduct the claim of right income from the current year’s taxes, or 2) the taxpayer can claim a tax credit for the amount the taxpayer’s taxes were increased in the prior year by including that income.

From 1999 to 2004, Michael Bluso and his wife Nora Mihelick, worked at Gotham Staple Company, a closely held Ohio corporation owned by Bluso’s family. During this time, Bluso served as the company’s CEO and Mihelick performed various administrative tasks for the company. In 2004, Mihelick filed for divorce. During the divorce proceedings, Bluso became a party to a lawsuit initiated by his sister, who claimed that Bluso had breached his fiduciary duties by excessively compensating himself at the company’s expense during his employment as CEO. Mihelick was not a party to the lawsuit, but because Mihelick had reaped the benefits of Bluso’s compensation while they were married, she agreed to share the litigation liability equally with him.

The couple finalized their divorce in 2005, and in 2007, Bluso settled the lawsuit with his sister by paying $600,000 to settle her excess compensation claims. For his share of the liability, Bluso subsequently took a tax deduction under the claim of right doctrine for $300,000 on his personal return, which the IRS honored. In 2009, Mihelick reimbursed Bluso $300,000 for her share of the lawsuit settlement. Viewing herself as in the same position as Bluso, Mihelick also took a tax deduction for $300,000 and pursued a refund for her 2009 tax return.

Unlike with Bluso, the IRS denied Mihelick’s claim for a refund on the grounds that she had no presumptive right to her former husband’s income and therefore was not entitled to a refund under the claim-of-right doctrine. The district court agreed with the IRS’s position. On appeal, the Circuit Court reversed the district court’s decision and held that Bluso’s income was marital property to which Mihelick had a presumptive right, relying on Ohio state law on property rights of married couples. In light of this position, the court then analyzed each factor under the claim-of-right doctrine and held that Mihelick had satisfied each requirement and was therefore entitled to a refund.

Jeff Martin
Washington National Tax Office 
T +1 202 521 1526

Keith Mong
Managing Director
Washington National Tax Office 
T +1 202 521 1554

James Sanchez
Senior Associate
Washington National Tax Office 
T +1 202 861 4107

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