Page 69 - Family Law Services

Someone who is married on December 31 but who pays for and maintains a home for a qualifying child
for more than one-half of the year may qualify to file as head of household. The taxpayer must live apart
from the spouse for the last six months of the year to qualify. This filing status offers more advantageous
tax brackets than the married filing separately or single status. The taxpayer is not required to claim the
dependency exemption for the qualifying child in order to file as head of household.

Division of Property and Related Tax Effects

Although certain requirements must be met (some exceptions exist), most marital property transfers in
divorce can be achieved without creating a taxable event.

IRC Section 1041

As reflected in the tax reform legislation enacted in 1984 and amended in part in 1986, Congress real-
ized that the impact of taxes on divorcing spouses should be minimized as much as possible, particularly
with respect to property distributions. In response to this, IRC Section 1041, which fundamentally al-
tered the taxation of asset distributions in divorce cases, was created. Previously, such distributions were
governed by case law. See United States v. Davis, 370 U.S. 65 (1962).

Under IRC Section 1041 and Regulation Section 1.1041- IT, marital property transfers are generally
treated as gifts with carryover basis. Under IRC Section 1041(a), no gain or loss is recognized on trans-
fers incident to divorce. A transfer is considered incident to divorce if it

• occurs within one year after the divorce or

• is related to the ending of the marriage

— pursuant to a divorce or separation instrument and

— occurs within six years after the date which the marriage ended.

Special rules apply under Regulation Section 1.1041-2 when transferring or redeeming stock in a close-
ly-held business in connection with a divorce. Stock redemptions in divorce are explained later in this
practice aid.

In a number of circumstances, the relevant sections of the IRC may conflict with accepted definitions of
property. For instance, IRC Section 1041 addresses the transfer of property, not services. Also, the trans-
fer of property versus the assignment of income is often an area of conflict between divorcing parties,
taxpayers, and the IRS. There has been considerable conflict within the IRS about whether the transfer
of deferred compensation and nonqualified stock options constituted the transfer of marital assets or the
assignment of income. With the issuance of IRS Revenue Ruling 2002-22 (explained later in this prac-
tice aid), this issue was partially resolved favorably for the taxpayer by the IRS.

Community Property Law

Community property laws generally require that spouses pay tax on their 50% share of the community
income during the period that the community may exist under local law. It can become difficult to com-
ply with these provisions if one spouse does not notify the other of the details of the community income
prior to the due date of that individual’s income tax return. The CPA should be familiar with the exist-

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