June 14, 2016

Delayed Sale to Former Spouse Not Taxable

Houston Tax Attorney Blog

Houston Tax Attorney

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In Belot v. Commissioner, T.C. Memo. 2016-113, the U.S. Tax Court concluded that the sale of businesses to a former spouse was not taxable even though the sale occurred more than a year after the parties were divorced.

The facts and procedural history are as follows:

  • Mr. and Ms. Belot were married in 1989 through 2007.
  • They were in the entertainment industry. Specifically, they were in the business of providing dance instruction and training to others.
  • During this time, they created and operated three dance and dance-related businesses.
  • Their divorce agreement provided that they would each own 50% of each business.
  • Nine months after the divorce, Ms. Belot brought suit against Mr. Belot to oust him from the companies.
  • A little over a year after their divorce was final, Mr. and Ms. Belot settled the lawsuit by transferring the businesses to Ms. Belot in exchange for cash payments and installment payments pursuant to a promissory note.
  • Mr. Belot did not report the sales proceeds as taxable income on his 2008 Federal income tax return, which the IRS challenged.

The issue for the court was whether the sales proceeds were tax exempt as transfers under Section 1041. Section 1041 provides that gain or loss is not recognized on transfers from a spouse or former spouse if the transfer is incident to the divorce. A transfer is incident to divorce if it (1) occurs within one year after the date on which the marriage ceases or (2) is related to the cessation of the marriage.

The IRS argued that the transfer did not qualify for nonrecognition under Section 1041 because the transfer did not relate to the divorce instrument. To the IRS, the lawsuit was simply a business dispute that was not related to the divorce. The IRS even noted that the lawsuit was not even brought in the family court, which hears divorce cases. So the ensuing settlement was simply a business sale according to the IRS.

The court did not agree with the IRS. It held that the transfer did qualify for nonrecognition under Section 1041. The court found that the transfer was made to effect the division of property owned by the former spouses at the time of the cessation of the marriage. Thus, the court concluded that the sales proceeds were not taxable income to Mr. Belot.

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