US Tax Court TC Memo. 2016-113 Belot 

The Petitioner formed and jointly owned with his wife three businesses during their marriage. Pursuant to the settlement agreements they agreed to jointly own and operate the businesses as equal partners. This was no more successful than their marriage. Ms. Belot filed suit to seeking a buyout of Mr. Belot. The Belot’s settled  and 16 months after the initial settlement and divorce Ms. Belot purchased Mr. Belot’s 50% interest. The IRS accessed Mr. Benoit for taxes resulting from a gain on the sale of his interest. The question before the Tax Court was did the sale of Mr. Belot’s interests qualify for non-recognition treatment as a property settlement related to the Divorce.

Section 1041 excludes any gain on the transfer of property incident to a divorce. A transfer is presumed to be incidental to a divorce if it occurs within one year of the cessation of the marriage or is related to the cessation of the marriage. There is a presumption that the transfer is incident to a divorce if it occurs not more than six years after the divorce AND is pursuant to a divorce or separation instrument. The six year presumption may be rebutted.

The Tax Court held that  the transfer was incidental to the divorce! The IRS unsuccessfully argued that the transfer from Mr. Belot to Ms. Belot was not made under a separation agreement. The Tax Court however, points out that the presumption that the transfer was not made according to the separation agreement may be rebutted by showing that “… the transfer was made to effect the division of property owned by the former spouses at the time of the cessation of marriage.”

The IRS also argued that the transfer was not due to “… legal or business impediments that prevented a transfer …” Again the Tax Court disagreed stating that this is not the only reason the presumption may be rebutted. The IRS also argued that the fact Ms. Benoit filed suit in superior civil court and not the family court indicated that the settlement concerned a business dispute and not a dispute over the settlement of marital property. The Tax Court disagreed stating the “…application of section 1041 to transfer resulting from the settlement of a lawsuit is not determined by the forum in which the lawsuit is filed.”

Basically, the Tax Court looked at the sale as part of an ongoing process to divide the marital property. Citing the Court of Appeals’ opinion in Young:

“The policy animating § 1041 is clear. Congress has chosen to ‘treat a husband and wife [and former husband and wife acting incident to divorce] as one economic unit, and to defer, but not eliminate, the recognition of any gain or loss on interspousal property transfers until the property is conveyed to a third party outside the economic unit…’”

See the link below for the actual opinion.