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Ex-Spouse Property Transfers Incident to Divorce | Tax Lawyer & Attorney

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This article introduces a series of articles on 26 U.S.C. §1041 and specifically the issue of tax treatment of ex-spouse property transfers incident to divorce. As a result of a divorce, it is very common for ex-spouses to transfer properties to each other as part of their settlement agreement. A question arises: are these ex-spouse property transfers taxable?

Note that this article covers a situation only when both spouses are US citizens and only direct transfers between ex-spouses (i.e. the transfers on behalf of an ex-spouse are not covered here).

General Rule for Ex-Spouse Property Transfers under 26 U.S.C. §1041

A property transfer between spouses is generally not subject to federal income tax. 26 U.S.C. §1041(a)(1). Transfers of property between former spouses are also not taxable as long as they are “incident to divorce”. 26 U.S.C. §1041(a)(2). For income tax purposes, the law treats the transferee spouse as having acquired the transferred property by gift. 26 U.S.C. §1041(b)(1). This means that “the basis of the transferee in the property shall be the adjusted basis of the transferor”. 26 U.S.C. §1041(b)(2).

It is important to emphasize that only transfers of property (real, personal, tangible and/or intangible) are governed by 26 U.S.C. §1041; transfers of services are not subject to the rules of this section. Treas Reg §1.1041-1T(a), Q&A-4.

Ex-Spouse Property Transfers Incident to Divorce

The key issue for the ex-spouse property transfers is whether they are “incident to divorce”. The statute and the temporary Treasury regulations describe two situations when a transfer between ex-spouses will be considered “incident to divorce”: “(1) The transfer occurs not more than one year after the date on which the marriage ceases, or (2) the transfer is related to the cessation of the marriage.” Treas Reg §1.1041-1T(b), Q&A-6; 26 U.S.C. §1041(c).

Ex-Spouse Property Transfers Not More Than One Year After the Cessation of a Marriage

Any transfers of property between former spouses that occur not more than one year after the date on which the marriage ceases are subject to the nonrecognition rules of 26 U.S.C. §1041(a). This is case even if a transfer of property is not really related to the cessation of the marriage. Treas Reg § 1.1041-1T(b), Q&A-6.

Ex-Spouse Property Transfers Related to the Cessation of the Marriage

26 U.S.C. §1041 does not actually define the meaning of “transfers related to the cessation of the marriage”. Rather, the temporary Treasury regulations explain this term.

The temporary regulations establish a two-prong test that states that a transfer of property is treated as related to the cessation of the marriage if: (1) “the transfer is pursuant to a divorce or separation instrument, as defined in section 71(b)(2)”, and (2) “the transfer occurs not more than 6 years after the date on which the marriage ceases”. Treas Reg §1.1041-1T(b), Q&A-7. The definition of divorce or separation instrument in the first prong also includes a modification or amendment to such decree or instrument.

If either or both of the prongs of this test are not satisfied (for example, the transfer occurred more than six years after the cessation of the marriage), then a transfer “is presumed to be not related to the cessation of the marriage.” Id. This is a rebuttable presumption and, in a future article, I will discuss how a taxpayer may rebut this presumption.

Contact Sherayzen Law Office for Professional Help Concerning Tax Consequences of a Property Transfer to an Ex-Spouse

If you are engaged in a divorce or you are an attorney representing a person who is engaged in a divorce, contact Sherayzen Law Office for experienced help with respect to taxation of transfers of property to an ex-spouse as well as other tax consequences of a divorce proceeding.

2014 First Quarter Underpayment and Overpayment Interest Rates

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On December 9, 2013, the IRS announced that the underpayment and overpayment interest rates will remain the same for the calendar quarter beginning January 1, 2014. The rates will be:

  • three (3) percent for overpayments [two (2) percent in the case of a corporation];
  • three (3) percent for underpayments;
  • five (5) percent for large corporate underpayments; and
  • one-half (0.5) percent for the portion of a corporate overpayment exceeding $10,000.

Under the Internal Revenue Code, the rate of interest is determined on a quarterly basis. For taxpayers other than corporations, the overpayment and underpayment rate is the federal short-term rate plus 3 percentage points.

Generally, in the case of a corporation, the underpayment rate is the federal short-term rate plus 3 percentage points and the overpayment rate is the federal short-term rate plus 2 percentage points. The rate for large corporate underpayments is the federal short-term rate plus 5 percentage points. The rate on the portion of a corporate overpayment of tax exceeding $10,000 for a taxable period is the federal short-term rate plus one-half (0.5) of a percentage point.

The rate for large corporate underpayments is the federal short-term rate plus 5 percentage points. The rate on the portion of a corporate overpayment of tax exceeding $10,000 for a taxable period is the federal short-term rate plus one-half (0.5) of a percentage point.

Interest factors for daily compound interest for annual rates of 0.5 percent are published in Appendix A of Revenue Ruling 2011-32. Interest factors for daily compound interest for annual rates of 2 percent, 3 percent and 5 percent are published in Tables 7, 9, 11, and 15 of Rev. Proc. 95-17, 1995-1 C.B. 561, 563, 565, and 569.

Minnesota Department of Revenue Launches New e-Services System

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On October 3, 2011, the Minnesota Department of Revenue announced the launch of its new e-Services online system. This new system is replacing e-File Minnesota and will offer a wider variety of services to 400,000 business taxpayers. The new system was the product of at least four years of diligent work by the Department.

The new E-Services not only provides the ability for business taxpayers to file and pay their taxes, it also allows taxpayers to update their contact information, register new accounts, and send the department secured messages. In addition, business taxpayers will have the ability to view all account information in one location. They can now view their payment history, returns they have filed and all correspondence sent to them by the Department of Revenue.

The functionality being added provides more security flexibility to the business taxpayer. Businesses can create unique user ID’s and passwords which grant online access to tax practitioners and accounts they partner with.

Finally, e-Services will also allow self-service activities 24 hours a day, seven days a week. Business taxpayers now have the ability to handle their tax needs online when it is convenient for them.

The transition to the new system will begin on October 17, 2011 and is currently projected to finish by mid-January of 2012. During the transition, groups of taxpayers will be added each Monday, until all 400,000 business taxpayers have access to e-Services.

Tax Filing Deadline Extended to April 18, 2011

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On January 4, 2011, IRS extended the tax filing and tax payment deadline for individual taxpayers until April 18, 2011. The extension is made due to the Emancipation Day, a holiday observed in the District of Columbia, which falls this year on Friday, April 15, 2011.

Taxpayers who request an extension will have until October 17, 2011, to file their 2010 tax returns.

This year, the IRS expects to receive more than 140 million individual tax returns this year, with most of those being filed by the April 18 deadline.

The IRS also cautioned taxpayers with foreign accounts to properly report income from these accounts and file the appropriate forms on time to avoid stiff penalties. IRS Commissioner Doug Shulman stated earlier that the IRS “will continue to focus on offshore tax compliance and people with offshore accounts need to pay taxes on income from those accounts.”

Sherayzen Law Office is an experienced tax law firm that has helped numerous clients in Minnesota and across the United States to bring their affairs, including proper reporting of foreign financial accounts, into full compliance with the U.S. tax laws.

Contact Sherayzen Law Office NOW to discuss your case with an experienced Minneapolis tax attorney!