Yashiki Gilzene

9/18/2020

Young v. Commissioner
United States Court of Appeals, Fourth Circuit, 2001.
240 F.3d 369

FACTS: In 1969, the Plaintiffs Louise and John Young was married and then divorced in 1988.

In 1989, they both entered into a Mutual Release and Acknowledgement of Settlement

Agreement to resolve their Equitable Distribution of Property claim and all other claim that arose

from the marriage. A promissory note for $1.5 million, payable in five yearly installments plus

interest was delivered to Mrs. Young by Mr. Young. Mr. Young received a deed of trust on 71

acres of property as part of the 1989 Settlement Agreement. In October 1990, Mr. Young

defaulted on his obligations under the 1989 Settlement agreement. Mrs. Young brought the

action to state court. A judgement was entered for Mrs. Young, which she was awarded her

principal, interest and reasonable attorney’s fees which Mr. Young paid. Mr. and Mrs. Young

entered into a Settlement Agreement and Release (“1992 Agreement”), which provided that Mr.

Young would transfer to his former wife, in full settlement of his obligations, a 59-acre tract of

land. However, Mr. Young retained an option to repurchase the land for $2.2 million before

December 1992. Mr. Young assigned the option to a third party, who exercised the option and

bought the land from Mrs. Young for $2.2 million. Mr. and Mrs. Young did not report any gain

on their tax returns from the transfer and sale of the property. A deficiencies was asserted against

both taxpayer by the Commissioner. The Tax Court stated that amount paid to attorney must be

included in Mrs. Young gross income. The Tax Court held that the 1992 transfer from Mr.

Young to Mrs. Young was “related to the cessation of the marriage,” thus neither party

recognized a gain or loss on the transfer, and the same basis in the land that the couple had when
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they were married was took by Mr. Young. Young, 113 T.C. at 156. Mrs. Young challenges the

Tax Court’s finding and argues that the 1992 transfer did not “effect the division of marital

property. The IRS ruled that the husband’s subsequent sale of his one-half interest in the house to

his former wife instead of a third party was an “arm’s-length transaction between two parties that

happen to be former spouses,” and thus did not “effect the division” of marital property pursuant

to section 1041 and its regulations. The 59 acres of land was transferred to Mrs. Young to satisfy

the dissolution of the marriage by her former husband. The main reason of the 1992 Agreement

was to resolve issues from the Youngs’ marriage and the settlement of property. Based on the

facts of this case, Mr. Young’s “interspousal property transfer” cannot be held as a taxable event,

when the purpose behind Mr. Young’s transfer was to satisfy his obligations arising from the

cessation of the marriage. Therefore, the Tax Court’s judgment is in all respects affirmed.

ISSUE: 1. Whether a 1992 transfer of land from a husband to his former wife constitute a

transfer incident to their 1988 divorce for purposes of the non-recognition of gain rules?

2. Whether the wife must include within her gross income the contingent fees paid directly to her

attorneys from the proceeds of her subsequent sale of that land?

DECISION: Yes. The Tax Court held that the 1992 property transfer was “incident to the

divorce,” and that Mr. Young realized no gain through his transfer of this property to his former

spouse. On the other hand, the Tax Court held that the portion of the proceeds from the sale,

which was paid directly to her attorneys, must be included in Mrs. Young’s gross income.
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REASON: The court has concluded that Mr. Young will realize no gain through the transfer of

property, but Mrs. Young would have to include the amount paid to the attorney in her gross

income. Under section 1041, no taxable gain or loss resulting from a transfer of property to a

former spouse if the transfer is “incident to the divorce.”26 U.S.C section 1041(a)(2). The Tax

Court held that the 1992 transfer from Mr. Young to Mrs. Young was “related to the cessation of

the marriage,” thus neither party recognized a gain or loss on the transfer, and Mrs. Young took

the same basis in the land that the couple had when they were married. Young, 113 T.C. at 156.

A safe harbor provision was applied by the court. Mrs. Young challenges the Tax Court’s finding

argues that the 1992 transfer did not “effect the division of marital property. The divorce decree

contemplated a sale of the former marital house, in which each spouse owned a one-half interest,

to a third party. The IRS ruled that the husband’s subsequent sale of his one-half interest in the

house to his former wife instead of a third party was an “arm’s-length transaction between two

parties that happen to be former spouses,” and thus did not “effect the division” of marital

property pursuant to section 1041 and its regulations. Therefore, Mr. Young transferred the 59

acres to satisfy an obligation that originated from the dissolution of the Youngs’ marriage. In this

case, Mr. Young’s transfer of this land was not an independent decision per the cessation of the

marriage. The transaction took place because she was his former spouse enforcing her rights

growing out of the dissolution of their marriage. However, Mrs. Young’s argument based on

state court jurisdiction is no more persuasive. She asserts that the 1992 Agreement could not

have effectuated the division of marital property. The North Carolina District Court did not find

Mrs. Young’s fairness argument compelling because the 1992 Agreement completed the division

of marital property under section 1041.The policy animating section 1041 is clear. Congress has

elected to “treat Mr. and Mrs. Young [and former husband and wife acting incident to divorce] as
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one economic unit, and to defer, but not eliminate, the recognition of any gain or loss on

interspousal property transfers until the property is conveyed to a third party outside the

economic unit. Therefore, no taxable event occurred, and no gain was realized by either Mr. or

Mrs. Young until Mrs. Young sold the 59 acres to a third party. Congress weighed the equities

and established a policy that no gain or loss will be recognized on a transfer between former

spouses’ incident to their divorce. However, when the former spouses decide to transfer the

appreciated property incident to their divorce, the transferee spouse will bear the tax burden of

the property’s appreciated value after selling it and receiving the proceeds. As it relates to the

facts of the case, the Tax Court will not hold Mr. Young’s “interspousal property transfer” as a

taxable event, when the purpose behind Mr. Young’s transfer was to satisfy his obligations

arising from the cessation of the marriage. Therefore, the Tax Court’s judgment is in all respects.

References
Freeland, J. Lind, S.A., Lathrope, D., Stephens, R. (2018). Fundamental of Federal Income
Taxation. Cesarini v. United States. Retrieved from pages 207-212.
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Module 4- Chapter 10
1. Payor Spouse, who pays tax at a flat 30 percent rate, is required to pay Payee Spouse $100,000
per year as alimony or separate maintenance under 203 a pre-2019 divorce instrument. Assume
Payee Spouse pays tax at a flat 15 percent rate. Payor Spouse wants to amend the divorce
instrument to have the post-2018 law apply (i.e. Sections 71 and 215 would no longer apply to
the payments). You represent Payee Spouse.
(a) If Payor Spouse requests a reduction in the payments under the agreement to $70,000, what is
your reaction?
Ans: Payor spouse has to deduct and paid the remaining $70000 so that the agreement under
2019 law does not get effected
(b) What result in (a), above, both spouses pay a flat 30 percent rate?
Ans: The Payee spouse has to pay tax amount of $21000 as he/she has only that income
(c) What result in (a), above, if Payor Spouse pays tax at a flat 30 percent rate and Payee Spouse,
who inherited money, pays a flat 35 percent rate?
Ans: The Payee spouse has to pay tax amount of $24500 as this is only the income source

1. Brad and Jen’s divorce decree becomes final on January 1 of year one. Discuss the tax
consequences of the following transactions to both Brad and Jen:
(a) Pursuant to their divorce decree, Brad transfers to Jen in March of year one a parcel of
unimproved land he purchased 10 years ago. The land has a basis of $100,000 and a fair market
value of $500,000. Jen sells the land in April of year one for $600,000.
Ans: Under §1041, there is no GI and the basis transfers from one spouse to another.  Lisa Marie
will have GI of $500,000.  Lisa is his former spouse and transfer is incident if it occurs within
one year of the date the marriage ceases. Brad has no gain recognized, but gets his basis, if she
sells it one month later or 20 years later, she will have the gain of 500k on that property.
 
(b) Same as (a), above, except that the land is transferred to satisfy a debt that Brad owes Jen.
The land has a basis of $500,000 and a fair market value of $400,000 at the time of the transfer.
Jen sells the land for $350,000.
Ans: The basis of $500,000 is lower than the FMV at time and subsequent sale of even less.
When she sells for $350,000, she would realize a loss of $150,000, 1041 does not have split
basis, it has transferred basis.  She will get loss because of direct operation of 1041.
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(c) What result if pursuant to the divorce decree, Brad transfers the land in (a), above, to Jen in
March of year four.
Ans: In relation to cessation of marriage. Delayed transfer but within 6 years and the decree
calls. Divorce or separation instrument, a broader category, the regulation refers you back to
instrument for section 71, includes all three categories.  Includes a modification or amendment. 
(d) Same as (c), above, except that the transfer is required by a written instrument incident to the
divorce decree.
Ans: Same answer, the regulation picks up broader category of instrument, rather than decree.
(e) Same as (c), above, except the transfer is made in March of year seven.
Ans: Any transfer not pursuant to that instrument and more than 6 years after the cessation is
presumed not related. This may be rebutted but more than 6 years out, presumption it is not
related per section 1041. 
 
2. Brad and Angelina divorce in 2019 and Brad makes the following alimony payments to
Angelina pursuant to their divorce instrument. Consider the tax consequences of the payments.
(a) Brad transfers $200,000 of cash to Angelina in 2019.
Ans: The cash which Brad transfers to Angelina is tax deductible in the hands of Brad and
Angelina would show it as income. Form 1040 is used in case of alimony (the case given above).
(b) Brad is short of cash and to satisfy his obligation to pay $200,000 of cash, he transfers
property worth $200,000 with an adjusted basis of $50,000 to Angelina in 2019.
Ans: The property transferred as alimony is not tax deductible and would invite tax burden as it
would usually in any other case. This is the reason that alimony payments is preferrably done in
cash and not in non-cash property. This would not be a taxable income for Angelina so on the
other hand it would not be tax deductible for Brad.
(c) Brad transfers the property in (b), above, to Angelina in 2029
Ans: That would not change anything. Tax treatment would still be the same.