Changes Affecting the Taxation of Alimony and Property Settlements
| Publication year | 1987 |
| Pages | 636 |
1987, April, Pg. 636. Changes Affecting the Taxation of Alimony and Property Settlements
As part of the Tax Reform Act of 1984 ("1984 Act"),(fn1) Congress substantially changed the Internal Revenue Code ("Code") provisions that pertain to the taxation of alimony. The Tax Reform Act of 1986 ("1986 Act"),(fn2) which recently was signed into law, made some modifications to the 1984 rules. This article highlights these recent changes.
The 1984 Act provided an objective definition of alimony or separate maintenance payments. One of the elements of this definition was the requirement that the divorce or separation agreement specifically state that the payments ceased with the death of the payee spouse. This requirement caused a great deal of hardship.(fn3) Many non-tax attorneys failed to insert this language in the agreement because they believed that state law would operate to discharge the payor spouse from further alimony payments.
Recognizing the hardship that such a rigid definition imposed, Congress amended the definition of alimony as part of the revisions made by the 1986 Act.(fn4) Specifically, the 1986 Act deleted the requirement that the divorce or separation agreement must specifically require the payments to cease upon the death of the payee spouse. The Code now provides that a payment will not be disqualified as alimony solely because the decree does not specifically state the payments will terminate upon the death of the payee spouse, as long as such termination would occur by operation of state law.(fn5)
As part of the 1984 Act, Congress enacted Code § 1041. This section provided that transfers of property to a spouse incident to a divorce would be treated generally in the same manner as a gift for income tax purposes. Gain or loss would not be recognized to the transferer spouse, and the transferee spouse would receive the property at the transferer's tax cost. When the transferee subsequently disposed of the property, the transferee would then recognize the gain or loss that was inherent in that property. This new non-recognition rule applied in all instances. In enacting this provision, Congress believed that all parties in a divorce situation should have the same income tax treatment regardless of differing state property laws.(fn6)
The 1986 Act made some subtle changes to this nonrecognition rule.(fn7) These changes involve two specific situations. First, non-recognition of gain will not apply where property is transferred into trust and the amount of liabilities assumed by the trust (or the amount of liabilities to which the property transferred in trust is subject) exceeds the tax cost of the property.(fn8) This is not a novel concept. Under general principles of income tax law, whenever there is an assumption of liabilities in excess of tax cost in connection with a disposition of property, the selling party recognizes gain equal to the...
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