Tax Consequences of Divorce and Intra-Family Transactions

• Author: William Kratzke
• Pages: 474-543

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Chapter 8: Tax Consequences of Divorce and Intra-Family

Transactions

I. Introduction

The tax consequences of marriage, support of a family, and divorce reflect how we

choose to apply the basic principles that we tax income once and only once and that

expenditures for personal consumption are not deductible. Taxpayer chooses

whether to have a spouse or a child, so expenditures for the support of a spouse or

a child presumably are not deductible. The Supreme Court’s decision in Poe v.

Seaborn assured that the legal ownership of income within a family unit would be

an important issue. We consider now the extent to which we recognize the family

as a taxpaying unit.

We already know that the filing status

“married filing jointly” implies that

married persons are in fact one taxpaying

unit, whether one or both contribute to its

taxable income. The fact that a taxpayer

provides financial support to another

person may give that other person the tax

status of “dependent” and entitle taxpayer

to a dependent deduction. We learn shortly

that whether taxpayer may claim another as

a dependent usually turns on the existence

of a family relationship.

The definition of “marriage” is a matter of

state law; state law determines who is and

who is not married.171 State law also

defines the rights that spouses have with

respect to their property and income before, within, and after the marriage. State

171 States may not deny same-sex couples of the right to marry . See Obergefell v. Hodges, ___ U.S. ___,

___, 135 S. Ct. 2584, 2604-05 (2015) (fundamental liberty as well as right under Due Process, and Equal

Protection clauses).

The Tax Formula:

(gross income)

MINUS § 62 deductions

EQUALS (adjusted gross income

(AGI))

MINUS (standard deduction or

itemized deductions)

M IN U S (personal exem ptions)

EQUALS (taxable income)

Compute income tax liability from

tables in § 1 (indexed for inflation)

MINUS (credits against tax)

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law governs adoptions and so is determinative of who is a “child” of the taxpayer.

State (or local) law also governs the placement of foster children. State law defines

the obligations that family members have towards each other – notably that parents

have obligations of support for their children up to a certain age. This may affect

whether one person is a dependent of a taxpayer.

We consider here the tax ramifications of marriage and famil y – before, during, and

after.

II. Before Marriage

The Code treats a married couple as a single taxpayer – although spouses may elect

to be taxed separately. Until they are married, they remain separate taxpayers –

although one might be a dependent of the other. Taxpayers may enter certain

transactions with each other in contemplation of marriage, but presumptively such

transactions are arm’s-length transactions.

Farid-es-Sultaneh v. Commissioner, 160 F.2d 812 (2d Cir. 1947)

CHASE, Circuit Judge.

The problem presented by this petition is to fix the cost basis to be used by the

petitioner in determining the taxable gain on a sale she made in 1938 of shares of

corporate stock. She contends that it is the adjusted value of the shares at the date

she acquired them because her acquisition was by purchase. The Commissioner’s

position is that she must use the adjusted cost basis of her transferor because her

acquisition was by gift. The Tax Court agreed with the Commissioner and

redetermined the deficiency accordingly.

....

The petitioner is an American citizen who filed her income tax return for the

calendar year 1938 ... and ... reported sales during that year of 12,000 shares of the

common stock of the S.S. Kresge Company at varying prices per share, for the total

sum of $230,802.36 which admittedly was in excess of their cost to her. ...

In December 1923 when the petitioner, then unmarried, and S.S. Kresge, then

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married, were contemplating their future marriage, he delivered to her 700 shares

of the common stock of the S.S. Kresge Company which then had a fair market

value of $290 per share. The shares ... were to be held by the petitioner “for her

benefit and protection in the event that the said Kresge should die prior to the

contemplated marriage between the petitioner and said Kresge.” The latter was

divorced from his wife on January 9, 1924, and on or about January 23, 1924 he

delivered to the petitioner 1800 additional common shares of S.S. Kresge Company

which were also ... to be held by the petitioner for the same purposes as were the

first 700 shares he had delivered to her. On April 24, 1924, and when the petitioner

still retained the possession of the stock so delivered to her, she and Mr. Kresge

executed a written ante-nupt ial agreement wherein she acknowledged the receipt of

the shares “as a gift made by the said Sebastian S. Kresge, pursuant to this

indenture, and as an ante-nuptial settlement, and in consideration of said gift and

said ante-nuptial settlement, in consideration of the promise of said Sebastian S.

Kresge to marry her, and in further consideration of the consummation of said

promised marriage” she released all dower and other marital rights, including the

right to her support to which she otherwise would have been entitled as a matter of

law when she became his wife. They were married in New York immediately after

the ante-nuptial agreement was executed and continued to be husband and wife

until the petitioner obtained a final decree of absolute divorce from him on, or

about, May 18, 1928. No alimony was claimed by, or awarded to, her.

The stock so obtained by the petitioner from Mr. Kresge had a fair market value of

$315 per share on April 24, 1924, and of $330 per share on, or about May 6, 1924,

when it was transferred to her on the books of the corporation. She held all of it for

about three years, but how much she continued to hold thereafter is not disclosed

except as that may be shown by her sales in 1938. Meanwhile her holdings had

been increased by a stock dividend of 50%, declared on April 1, 1925; one of 10 to

1 declared on January 19, 1926; and one of 50%, declared on March 1, 1929. Her

adjusted basis for the stock she sold in 1938 was $10.66 per share computed on

the basis of the fair market value of the shares which she obtained from Mr. Kresge

at the time of her acquisition. His adjusted basis for the shares she sold in 1938

would have been $0.159091.

When the petitioner and Mr. Kresge were married he was 57 years old with a life

expectancy of 16½ years. She was then 32 years of age with a life expectancy of

33¾ years. He was then worth approximately $375,000,000 and owned real estate

of the approximate value of $100,000,000.