Assignment of income and divorce.

• Author: Hoffman, Michael J.R.

In Balding, 98 TC No. 27 (1992), the Tax Court explored the relationship between Sec. 1041 and the assignment of income doctrine. California residents Hazel and Joe Balding were divorced in 1981. At that time, Mr. Balding's military retirement benefits were held to be his separate property and, therefore, not part of their property settlement. A revision in California law retroactively changed the status of the military benefits to community property. Accordingly, Mrs. Balding petitioned the divorce court to amend its judgment and award her a community property share of these retirement benefits. Before the court could act on the petition, the Baldings agreed to a settlement under which Mrs. Balding relinquished any claim against the military retirement benefits and agreed not to bring any further claims regarding marital property in exchange for Mr. Balding's promise to make three fixed payments to her.

Consistent with Letter Ruling 8813023 (issued to Mrs. Balding in 1987), the Service argued that Mrs. Balding's surrender of her community property interest in the retirement benefits was an anticipatory assignment of income and, therefore, the consideration received should be included in gross income. The court disagreed, holding instead that Sec. 1041 takes precedence over the doctrine of anticipatory assignment of income. Under Sec. 1041, gain or loss realized on transfer of property between spouses or former spouses incident to a divorce is not recognized; rather, the transfers generally are treated as gifts, resulting in the transferee taking a basis equal to the transferor's adjusted basis. The court held that the exchange between Hazel and Joe Balding should be so viewed. Accordingly, the three payments to Mrs. Balding from her former husband were held to be excluded from gross income. However, the court explicitly left open the question of whether Mrs. Balding would have to include one-half of the retirement benefits as they were paid to Mr. Balding.

For the following reasons, the authors believe that Sec. 1041 overrides not only the anticipatory assignment of income doctrine (as held by the Tax Court in Balding), but the assignment of income doctrine as well. First, Congress intended that uniform Federal income tax treatment apply to transfer between former spouses incident to a divorce (and between current spouses), regardless of state property laws. (See the General Explanation of the Deficit Reduction, Act of 1984, hereinafter...