March 1999 Volune 12 No3 - Utah State Bar

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I" I. 14 by David S. Dolowitz INTODUCTION Tax law impacting divorce was substantialy changed in 1984 and 1986. Modifcations to the changes were enacted in 1997 and 1998. Decisions under the revised provisions are now reachig the Tax Court and the appellate courts so the effect of the changes can be evaluated. This is a brief update on three areas: Alony, Section 1041 Exchange, and Assignment of Income. ALIMONY Section 71 (b) (1) (D) requires that liabilty to make almony payments must end on the death of the payee spouse. Three recent decisions make it clear that this must be in the decree. In 1997, the Tax Court found that faiure to provide in the decree that the obligation to pay mortgage payments on behal of the payee would end on her death made the payments non- deductible. Pettet v. United States, 97-2 USTC §50,948 (ED NC, 1997). A lump sum almony payment under a modied divorce decree lost its ta deductible status because of a faiure to include this provision. Barrett v. United States, 96-1 USTC §50,084 (CA-5, 1996). This faiure was found to apply to equal- ization payments for uneven division of community property and a negligence penalty was imposed on the tapayer because the faiure was so obvious. Croteau, TC Memo 1998-9 (1998). In an interesting side-light, delinquent alony payments col- lected by the mother's estate and passed on to the chidren were found to be taable income to the chidren. Kitch v. Commis- sioner, 97-1 U.S.T.C. §50,124 (CA-lO, 1996). In a very recent decision, Thomas R Nelson v. DonnaJ Zullo Nelson, TCM 1998-268, where payments ordered made by the decree from the husband to the wie were held non-modifable propert payments by the Ohio courts,' the effort of the Internal Revenue Servce to disalow them as tax deductible § 71 payments by the husband was rejected by the Tax Court because the decree provisions requiring the payments met every test of § 71. Under the provisions of § 71 (c), payments which terminate around attag of majority of a chid or other contingency described in § 71 ( c) made otherwse deductible alony payments into non-deductible chid support. Consequently, the alony tax transfer of § 215 was lost when the payments were found to be in the nature of chid support, as defined in § 71 (c) . Hammond, T.C. Memo 1998-53 (1998). On the other hand, where the payor agreed to pay attorneys fees and auto loan payments on behal of the ex-spouse, pursuant to a marital settlement agreement, and it was prOYided that these would terminate in the event of her death, they were considered deductible as almony payments. (The legal termiation of these payments on death occurred under Ohio law, not because of the specifc provisions of the decree). Burkes, T.C. Memo 1998-61 (1998). SECTION 1041 EXCHAGES The issue of whether or not interest payments on §1041 propert transfers effected by a note would or would not be considered as taxable income, is now being resolved.john L. Seymour, 109 T.C. No. 279 (1997). John deducted al interest he paid to his former wife as residential and investment interest. The Internal Revenue Servce chalenged the deductions assert- ing they were §1041 payments. The Tax Court ruled that when the wife received a settement of approximately 4900,000.00 (one-third (1/3) in cash, two-thirds (213) in a note with interest due on the unpaid balance) and the husband received stock, real estate (business), the marita home, an automobile and household furnishigs, §1041 did not require interest on the indebtedness of one spouse to another under § 1041 to be non- deductible personal interest and that the interest of the notes L1aDid ST,
T must be apportioned among the assets transferred. The court said that the debt must first be alocated to the acquisition of the residence, then among passive assets (investments and business assets) and, fialy, the personal assets. The case was then remanded for a determination by the Internal Revenue Servce, if it wished to continue to pursue its chalenge, as to what assets were paid for in cash as opposed to the notes. As a result, if notes are given pursuant to § 1041, alocation should be made as to whether or not it is for a residence (§163(h) (3)), business (§ 163 (d) (3)), business real estate (§ 163(d) (3)) or personal propert. Personal property would be non-deductible personal interest (§ 163 (h) (1) ). However, al of the other would be interest deductible to the payor and taable income to the payee. The worst possible result for both partes is the interest to be considered to be personal interest. It would then not be deductible to the payor, but would be taxable income to the payee. This decision was followed by Ronald R. Armacost and Cathy L. Armacost v. Commissioner, TCM 1998-150 (April 27, 1998), where Ronald, who had agreed to equalze his property division with his former wife, Lida, with a note for $240,000.00 payable over 20 years at 10% interest secured by the propert awarded to him, deducted the interest he paid on the note. The Internal Revenue Servce chalenged the deduc- tion. The Tax Court followed its rug in Seymour, examined the division of property and alocated the asset percentages as to investment, residential and personal, then upheld the investment and qualed residential interest deductions whie rejecting the personal interest deductions. ASSIGNMENT OF INCOME A question arising under § 1041 with a higWy negative impact, is that of assignment of income. In a case close to us, Kochan- sky v. Commissioner, IR.S., 92 Fed. 3d. 957 (9th Cir. 1996), an attorney who, as part of his divorce settement, agreed to split with his wie a contingent fee that was to be earned in a pending medical malpractice case, was required to pay income tax on the entire amount of the fee. The Ninth Circuit ruled ths was controlled by the "ancient precedent" of Lucas 1). Earl, 281 U.S. 111 (1930), which held that income is taxable to the per- son who ears it. It is suggested that if you deal with a situation I j\Asi- wt'\\t-e~ t-ö Bet- ö\\ t-~e Net-. AV'ösNei- ~elpe~ \Ae ~ö it-. ArosNet, Inc. 28 South 400 East Satt Lake City, UT 84111 (801) 532-2767 fax, (801) 531-9966 e-mail: info aros.oet www.aros.net ~ia~ ~ar 15
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March 1999 Volune 12 No3 - Utah State Bar

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