Page 78 - Family Law Services

• Dual enrollment in an institution of higher education

• Educational therapies for students with disabilities

• Reasonable housing

Medical Expenses for Dependent Children

Generally speaking, medical expenses paid for a dependent child, whether paid by the custodial or the
noncustodial parent, are deductible on Schedule A of that individual’s tax return. The taxpayer is not re-
quired to claim the dependency exemption in order to deduct medical expenses; however, these expens-
es are deductible only to the extent that they exceed 7½% of the taxpayer’s adjusted gross income.

Stock Redemptions in Divorce

When divorce engagements involve a closely held business, the business may be one of the largest as-
sets in the marital estate. The financial condition of a closely held business can have a significant impact
on the marital estate and the distribution of assets between the spouses. Larger or mature businesses may
have provided the family with high income and cash flow for many years. Consequently, the marital es-
tate may be very liquid or have ample assets for distribution between the spouses. Start-up or high-
growth businesses, on the other hand, may have the opposite effect on the marital estate. These may
have a high, or potentially high, asset value but may have depleted the family’s liquidity and, if earnings
have been reinvested in the business, may not have generated significant cash flow. In cases in which
the business has liquidity and the business will be buying out the stock of the transferor spouse, effective
tax planning can generate the funds to reach a settlement between the parties. This liquidity can often be
achieved at favorable capital gains tax rates. This is particularly important when there is a significant
difference between tax rates on capital gains and dividends.

Structured properly, cash otherwise locked inside a corporation can be used to redeem a spouse’s stock
ownership interest in a closely held business at capital gains tax rates. If structured improperly, the
spouse retaining the business can be deemed to have received a constructive dividend taxable at ordinary
income tax rates, even though he or she may not have received any cash with which to pay the tax.

On August 3, 2001, the IRS issued IRS Proposed Regulation 1.1041-2T and on January 13, 2003, it is-
sued IRS Final Regulation 1.1041-2. The IRS’s issuance of this final regulation recognizes both the tur-
moil and resulting inconsistency of the prior conflicting court cases, IRS Private Letter Rulings, and
Q&A 9 from the 1984 Temporary Regulations and provides clear guidance about the taxation of stock
redemptions in divorce. The outcome of the final regulation is such that the intended tax outcome of the
spouses will be respected, assuming strict adherence to the requirements of the regulations, as evidenced
by a divorce or separation instrument or a valid written agreement between the spouses. Section C of
IRS Regulation 1.1041-2 defined a special rule in the case of agreements between spouses or former
spouses and identifies the taxable situations and examples in which either the transferor spouse or the
nontransferor spouse will be taxed.

With respect to the transferor spouse being taxable, the regulations indicate that if a divorce or separa-
tion agreement between the spouses or former spouses includes the following, the transferor spouse will
be taxable:

• Both spouses or former spouses intend for the redemption to be treated, for federal income tax
purposes, as a redemption distribution to the transferor spouse.

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