IRS issues final regs. on marital-related stock redemptions.

• Author: Packard, Pamela

The IRS issued Kegs. Sec. 1.1041-2, which applies the Sec. 1041 provisions only to marital-related stock redemptions. It has not withdrawn Temp. Kegs. Sec. 1.1041-1T(c), Q&A-9, which continues to apply to transfers of property other than stock redemptions, by a spouse or a former spouse.

Background

Under Sec. 1041, gains or losses on property transfers between spouses or former spouses incident to a divorce are generally not recognized. However, if the particular "transfer" involves the redemption of stock by a corporation, the tax-free consequences become mom complex.

The final regulations were preceded by Prop. Regs. Sec. 1.1041-2, issued in August 2001. In the preamble to the proposed regulations, the IRS noted the need for regulatory guidance, given the uncertainty created by the courts on marital-retted stock redemptions. (For a thorough discussion of the Tax Court's divided decision in Read, 114 TC 14 (2000), a case that added further uncertainty, see Barton,Tax Clinic, "The Tax Court Applies Sec. 1041 Nonrecognition Provisions to Stock Redemptions" TTA, June 2000, p. 400.)

Discussion

The final regulations address marital-related stock redemptions, in general, and contain a special rule that allows spouses or former spouses to agree as to which party will be taxed on the stock redemption. The addition of this rule was a direct result of the need for such a provision, as expressed by commentators. According to the final regulations, stock redemptions will be taxed in one of two ways. Essentially, a marital-related stock redemption is either respected as a stock redemption to one spouse or, conversely, deemed a constructive distribution to the other.

Regs. Sec. 1.1041-2 (a)(1) provides that if the stock of a spouse or former spouse (transferor spouse) is redeemed by a corporation and the redemption is not treated under "applicable tax law" as a constructive distribution to the other (nontransferor) spouse, the transaction will be respected as a stock redemption. Further, Sec. 1041 will not apply, because the transfer is not a transfer of property between spouses. The transferor spouse's proceeds are then tested under Sec. 302 as a sale or exchange or dividend equivalent (Regs. Sec. 1.1041-2(b)(1)). For example, if an ex-husband and--wife equally owned all the stock of a corporation, and the corporation redeemed all the stock of the ex-wife (or transferor spouse) for cash, she will receive sale or exchange treatment under Sec. 302(b)(3)...