Structuring the Tax Consequences of Marriage and Divorce After the Tax Cuts and Jobs Act (TCJA)

Carlyn S. McCaffrey of McDermott, Will & Emery LLP, Linda J. Ravdin of Pasternak & Fidis, P.C., and Scott L. Rubin of Fogel & Rubin discussed marriage and divorce in the current environment and addressed selected issues relating to both tax and non-tax planning for divorce.

Ms. McCaffrey opened by walking us through a review of the current tax laws applicable to married individuals, such as permitting couples to combine all of their income, losses and deductions and benefit from the ability to net the losses of one spouse against the income of the other, as well as reduced tax rates as compared to unmarried individuals. Further, married individuals are permitted to transfer assets between each other without consideration of the federal gift tax or federal estate tax implications. However, upon divorce, the tax benefits (and encumbrances) are changed.

IRC Section 1041 states that the transfer of property incident to divorce does not result in the recognition of realized gain or loss, and instead is treated as if the property were a gift between married individuals. In drafting settlement agreements, application of Section 1041 to certain kinds of transfers should be considered, including:

• With respect to the transfer of property where liabilities are in excess of basis, what basis should be attributed to the transferred property?
• What occurs if both spouses own stock in a family corporation and one is required to dispose of their shares upon dissolution of the marriage? Is the remaining shareholder taxed on the transaction by having the redemption treated as a constructive dividend, or is this deemed a non-taxable event? (It could be either depending on the required obligation.)
• What about the charitable remainder trust (CRT) that is currently structured to benefit both individuals? Upon divorce, how does the settlement agreement account for this trust and what is required? Is the CRT required to be split and continue for the benefit of each spouse? If so, is the allocation treated as a taxable event due to the potentially different interests now held by each? (Generally speaking, the allocation should not be a taxable event under Section 1041.)

The panel then addressed certain tax considerations and consequences surrounding transfers to trusts, specifically the application of Section 1041 to a trust structured for the benefit of minor children versus a trust structured for the benefit of minor children and the former spouse. As understood, Section 1041 determines that no gain or loss will be recognized on a transfer incident to divorce. Section 1041 also includes transfers of property in trust to a former spouse, with the carryover adjusted basis being equal to the basis in the property immediately prior to the transfer. However, if the trust is structured to support the transferor’s minor children and not the former spouse, Section 1041 will not apply. Consideration should be given to structuring the trust to benefit both the former spouse and the minor children. Section 1041 does not specify the level of interest that a former spouse is required to have, therefore, the potential for the former spouse to share the benefit of a tax-free benefit with the minor children is sufficient. It should be noted that temporary regulations have not addressed this issue directly and, until they do, the possibility of the IRS requiring the bifurcation of the trust remains.

One cannot discuss the impact of the TCJA on divorce without addressing alimony. Historically, alimony payments have been taxable to the payee and deductible by the payor in the year received and paid, respectively. If the settlement agreement was executed prior to January 1, 2019, this treatment remains constant. However, if the settlement agreement was executed after December 31, 2018, alimony payments are no longer included as income to the payee or as a deduction to the payor. 

In considering structuring and re-structuring due to marriage and a subsequent divorce, it is clear there are a myriad of tax and non-tax issues to consider. Certain considerations will remain beneficial and some will remain a burden; however, one item that will remain constant is, as Ms. McCaffrey stated, “Marriage is a tax relationship with tax implications.”

To read more Heckerling content, please see below:

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• Qualified Small Business Stock: The Next Big Bang
• Getting the 411 on IRC 199A: Just the Facts, Ma’am
• Recent Developments 2018
• Make Your Charitable Estate Plan Great Again
• Having Your Cake and Eating It Too
• Structuring the Tax Consequences of Marriage and Divorce After the Tax Cuts and Jobs Act (TCJA)