Divorce renders husband and wife separate taxpayers with interests that should (at some point) no longer be presumed to be the same. Various rights and obligations may ensue, and their origins might be –
- ownership of property,
- a legal duty, or
- an agreement.
How should the source of a right or obligation affect its tax treatment?
We might suppose that the event of divorce should vest (or re-vest) each ex-spouse with property rights that can be bought and sold – with all of the tax consequences that should naturally flow from such transactions.
- Should the event of divorce cause us to treat rights that can only exist between a husband and a wife as property that can be bought and sold in commercial transactions? How should we value such rights? 1
United States v. Davis, 370 U.S. 65 (1962)
MR. JUSTICE CLARK delivered the opinion of the Court.
These cases involve the tax consequences of a transfer of appreciated property by Thomas Crawley Davis [footnote omitted] to his former wife pursuant to a property settlement agreement executed prior to divorce ... The Court of Claims upset the Commissioner’s determination that there was taxable gain on the transfer ... We granted certiorari on a conflict in the Courts of Appeals and the Court of Claims on the taxability of such transfers. 2 We have decided that the taxpayer did have a taxable gain on the transfer ...
In 1954, the taxpayer and his then wife made a voluntary property settlement and separation agreement calling for support payments to the wife and minor child in addition to the transfer of certain personal property to the wife. Under Delaware law, all the property transferred was that of the taxpayer, subject to certain statutory marital rights of the wife including a right of intestate succession and a right upon divorce to a share of the husband’s property. [footnote omitted] Specifically, as a “division in settlement of their property,” the taxpayer agreed to transfer to his wife, inter alia, 1000 shares of stock in the E. I. du Pont de Nemours & Co. The then Mrs. Davis agreed to accept this division “in full settlement and satisfaction of any and all claims and rights against the husband whatsoever (including but not by way of limitation, dower and all rights under the laws of testacy and intestacy). ...” Pursuant to the above agreement, which had been incorporated into the divorce decree, one-half of this stock was delivered in the tax year involved, 1955, and the balance thereafter. Davis’ cost basis for the 1955 transfer was $74,775.37, and the fair market value of the 500 shares there transferred was $82,250. ...
The determination of the income tax consequences of the stock transfer described above is basically a two-step analysis: (1) was the transaction a taxable event? (2) if so, how much taxable gain resulted therefrom? ...
We now turn to the threshold question of whether the transfer in issue was an appropriate occasion for taxing the accretion to the stock. There can be no doubt that Congress, as evidenced by its inclusive definition of income subject to taxation, i.e., “all income from whatever source derived, including ... [g]ains derived from dealings in property,” [footnote omitted] intended that the economic growth of this stock be taxed. The problem confronting us is simply when is such accretion to be taxed. Should the economic gain be presently assessed against taxpayer, or should this assessment await a subsequent transfer of the property by the wife? The controlling statutory language, which provides that gains from dealings in property are to be taxed upon “sale or other disposition,” [footnote omitted] is too general to include or exclude conclusively the transaction presently in issue. Recognizing this, the Government and the taxpayer argue by analogy with transactions more easily classified as within or without the ambient of taxable events. The taxpayer asserts that the present disposition is comparable to a nontaxable division of property between two co-owners [footnote omitted], while the Government contends it more resembles a taxable transfer of property in exchange for the release of an independent legal obligation. Neither disputes the validity of the other’s starting point.
In support of his analogy, the taxpayer argues that to draw a distinction between a wife’s interest in the property of her husband in a common law jurisdiction such as Delaware and the property interest of a wife in a typical community property jurisdiction would commit a double sin; for such differentiation would depend upon “elusive and subtle casuistries which ... possess no relevance for tax purposes,” Helvering v. Hallock, 309 U.S. 106, 309 U.S. 118 (1940), and would create disparities between common law and community property jurisdictions in contradiction to Congress’ general policy of equality between the two. The taxpayer’s analogy, however, stumbles on its own premise, for the inchoate rights granted a wife in her husband’s property by the Delaware law do not even remotely reach the dignity of co-ownership. The wife has no interest – passive or active – over the management or disposition of her husband’s personal property. Her rights are not descendable, and she must survive him to share in his intestate estate. Upon dissolution of the marriage, she shares in the property only to such extent as the court deems “reasonable.” 13 Del. Code Ann. § 1531(a). What is “reasonable” might be ascertained independently of the extent of the husband’s property by such criteria as the wife’s financial condition, her needs in relation to her accustomed station in life, her age and health, the number of children and their ages, and the earning capacity of the husband. [citation omitted].
This is not to say it would be completely illogical to consider the shearing off of the wife’s rights in her husband’s property as a division of that property, but we believe the contrary to be the more reasonable construction. Regardless of the tags, Delaware seems only to place a burden on the husband’s property, rather than to make the wife a part owner thereof. In the present context, the rights of succession and reasonable share do not differ significantly from the husband’s obligations of support and alimony. They all partake more of a personal liability of the husband than a property interest of the wife. The effectuation of these marital rights may ultimately result in the ownership of some of the husband’s property as it did here, but certainly this happenstance does not equate the transaction with a division of property by co-owners. Although admittedly such a view may permit different tax treatment among the several States, this Court in the past has not ignored the differing effects on the federal taxing scheme of substantive differences between community property and common law systems. E.g., Poe v. Seaborn, 282 U.S. 101 (1930). To be sure, Congress has seen fit to alleviate this disparity in many areas, e.g., Revenue Act of 1948, 62 Stat. 110, but in other areas the facts of life are still with us.
Our interpretation of the general statutory language is fortified by the longstanding administrative practice as sounded and formalized by the settled state of law in the lower courts. The Commissioner’s position was adopted in the early 40's by the Second and Third Circuits, and, by 1947, the Tax Court had acquiesced in this view. This settled rule was not disturbed by the Court of Appeals for the Sixth Circuit in 1960 or the Court of Claims in the instant case, for these latter courts, in holding the gain indeterminable, assumed that the transaction was otherwise a taxable event. Such unanimity of views in support of a position representing a reasonable construction of an ambiguous statute will not lightly be put aside. It is quite possible that this notorious construction was relied upon by numerous taxpayers, as well as the Congress itself, which not only refrained from making any changes in the statutory language during more than a score of years, but reenacted this same language in 1954.
Having determined that the transaction was a taxable event, we now turn to the point on which the Court of Claims balked, viz., the measurement of the taxable gain realized by the taxpayer. The Code defines the taxable gain from the sale or disposition of property as being the “excess of the amount realized therefrom over the adjusted basis. ...” I.R.C. § 1001(a). The “amount realized” is further defined as “the sum of any money received plus the fair market value of the property (other than money) received.” I.R.C. § 1001(b). In the instant case, the “property received” was the release of the wife’s inchoate marital rights. The Court of Claims, following the Court of Appeals for the Sixth Circuit, found that there was no way to compute the fair market value of these marital rights, and that it was thus impossible to determine the taxable gain realized by the taxpayer. We believe this conclusion was erroneous.
It must be assumed, we think, that the parties acted at arm’s length, and that they judged the marital rights to be equal in value to the property for which they were exchanged. There was no evidence to the contrary here. Absent a readily ascertainable value, it is accepted practice where property is exchanged to hold, as did the Court of Claims in Philadelphia Park Amusement Co. v. United States, 126 F. Supp. 184, 189 (1954), that the values “of the two properties exchanged in an arms-length transaction are either equal in fact or are presumed to be equal.” Accord, United States v. General Shoe Corp., 282 F.2d 9 (CA6 1960); International Freighting Corp. v. Commissioner, 135 F.2d 310 (CA 1943). To be sure, there is much to be said of the argument that such an assumption is weakened by the emotion, tension, and practical necessities involved in divorce negotiations and the property settlements arising therefrom. However, once it is recognized that the transfer was a taxable event, it is more consistent with the general purpose and scheme of the taxing statutes to make a rough approximation of the gain realized thereby than to ignore altogether its tax consequences. [citation omitted].
Moreover, if the transaction is to be considered a taxable event as to the husband, the Court of Claims’ position leaves up in the air the wife’s basis for the property received. In the context of a taxable transfer by the husband, [footnote omitted] all indicia point to a “cost” basis for this property in the hands of the wife. [footnote omitted] Yet, under the Court of Claims’ position, her cost for this property, i.e., the value of the marital rights relinquished therefor, would be indeterminable, and, on subsequent disposition of the property, she might suffer inordinately over the Commissioner’s assessment which she would have the burden of proving erroneous, Commissioner v. Hansen, 360 U.S. 446, 468 (1959). Our present holding that the value of these rights is ascertainable eliminates this problem; for the same calculation that determines the amount received by the husband fixes the amount given up by the wife, and this figure, i.e., the market value of the property transferred by the husband, will be taken by her as her tax basis for the property received.
Finally, it must be noted that here, as well as in relation to the question of whether the event is taxable, we draw support from the prior administrative practice and judicial approval of that practice. We therefore conclude that the Commissioner’s assessment of a taxable gain based upon the value of the stock at the date of its transfer has not been shown erroneous. [footnote omitted]
Reversed in part and affirmed in part.
Notes and questions:
1. What answer did the Court give to the question posed at the outset of this section of the text, i.e., the effect of the source of a right or obligation on its tax consequences?
2. There are some rights or interests for which there is simply no market. When a transaction entailing those rights or interests must occur, there is nowhere to look to determine the value of those rights or interests. How did the Court deal with these valuation problems?
Does § 1041 create opportunities to save divorcing spouses income taxes? What if the tax brackets of the divorcing spouses are not going to be the same?
3. In the second-to-last paragraph of the case, how does the Court implicitly treat the exchange that Mrs. Davis made? What should be the basis of her “inchoate marital rights?”
4. Congress responded to Davis.
- Read § 1041. The division of property between divorcing spouses is now a non-recognition event.
- How would the result in Davis have been different if § 1041 were the law at the time the case was decided?
- In what ways does § 1041 differ from § 1015?
5. The “law” imposes various duties upon persons. The source of a duty may be a relationship. For example, a parent may have a duty to provide “necessaries” for his/her minor child.
- If a parent fails in that duty and a third person steps up and pays money to fulfill that duty, does the parent realize gross income?
- If a family member has a duty to another that requires some payment of money to fulfill, should such payment give rise to a deduction?
- What answers do cases such as Flowers, Hantzis, Smith, and Ochs imply?
- Consider –
Gould v. Gould, 245 U.S. 151 (1917)
MR. JUSTICE McREYNOLDS delivered the opinion of the Court.
A decree of the Supreme Court for New York County entered in 1909 forever separated the parties to this proceeding, then and now citizens of the United States, from bed and board, and further ordered that plaintiff in error pay to Katherine C. Gould during her life the sum of $3000 every month for her support and maintenance. The question presented is whether such monthly payments during the years 1913 and 1914 constituted parts of Mrs. Gould’s income within the intendment of the act of Congress approved October 3, 1913, 38 Stat. 114, 166, and were subject as such to the tax prescribed therein. The court below answered in the negative, and we think it reached the proper conclusion.
In Audubon v. Shufeldt, 181 U.S. 575, 577-578, we said:
Alimony does not arise from any business transaction, but from the relation of marriage. It is not founded on a contract, express or implied, but on the natural and legal duty of the husband to support the wife. The general obligation to support is made specific by the decree of the court of appropriate jurisdiction. ... Permanent alimony is regarded rather as a portion of the husband’s estate to which the wife is equitably entitled than as strictly a debt; alimony from time to time may be regarded as a portion of his current income or earnings. ...
The net income of the divorced husband subject to taxation was not decreased by payment of alimony under the court’s order, and, on the other hand, the sum received by the wife on account thereof cannot be regarded as income arising or accruing to her within the enactment.
The judgment of the court below is
Notes and questions:
1. What basis of the obligation to pay alimony does the Court recognize?
2. The holding in Gould was the rule until World War II. At that time, tax brackets increased so much that many men came out below $0 when they paid alimony and the income tax on the alimony. Congress acted.
3. Read § 61(a)(8), § 71, § 215, and § 62(a)(10).
- Does it not seem – at least implicitly – that the source of a duty to pay alimony is no longer law or morals but rather agreement (or quasi-agreement)?
- 1865 reads