advocated abandoning the alimony inclusion, under their approach of questioning whether the amounts paid out constitute "income," the recipient should also be taxed. After all, it would be inconsistent to use the "what-is-income" approach to this question when considering the taxation of the payor but abandon that approach when considering the taxation of the payee. A very different approach, which I advocate, is not to query whether the amounts paid out constitute "income" to the payor and payee, independently of each other, but rather to conclude that such payments ought to be taxed only once within the couple--as they are in an intact marriage--because the payments are directly caused by virtue of that marital relationship. The same would be true of child support payments outside of marriage. Under this approach, the only question to consider is to whom this payment should be taxed. The inclusion/deduction mechanism (or exclusion/nondeduction mechanism) simply becomes the tool used to implement the decision regarding which, between the two parties, ought to be taxed on the payment. Under this perspective, the inclusion and deduction do not have independent significance under an "income" inquiry. In other words, the inclusion and deduction are not ends under a “what-isincome" query but only the means by which to implement a decision under a "which-partyshould-be-taxed" query. I call this approach the "pragmatic paradigm." Since we are not dealing, under this pragmatic paradigm, with something as theoretically fundamental as the question of "what is income," but rather dealing only with a pragmatic decision regarding which of two parties should be taxed on what is concededly income to someone--the main concerns should be what side effects--good and bad--would result from our decision regarding whom to tax. Since all cash payments incident to divorce will be taxed to one or the other spouse, the Federal government is a mere stakeholder regarding the issue of whether a cash payment is includable/deductible or excludable/nondeductible. Only the rate-bracket differential between the parties (if any) can result in a revenue loss, and this loss is self-limiting, as the greater the amount paid to the lower-bracket payee in the includable/deductible system, the higher the tax bracket that will apply to it, until further income-shifting would not produce a revenue loss. Moreover, in the context of a payor in a significantly higher tax bracket than the payee in the includable/deductible system-which is the very context that would appear to result in the most lost revenue any revenue loss is more illusory than real because of the loss of the marriage bonus which occurs on the divorce. Since little revenue is at stake, the parties should be given full power to decide who, between them, should be taxed on all cash transfers incident to divorce. Well-advised taxpayers already have a great deal of power to decide who is taxed, but the power can be implemented only by choosing the correct transactional form for the payment stream. Transactional elections are perhaps defensible in the world of, for example, corporate reorganizations, where choosing one form rather than another can dictate whether or not the transaction is a taxable one, but they are not appropriate in the world of divorce, a common transaction not engaged in for tax reasons, often by people not well informed of the effective elections available to them by choosing the convincing justifications for allowing the parties to choose the inclusion/deduction system if they desire. correct form. Rather than hiding the effective elections, the elections should be made explicit, with simple default rules for those taxpayers who fail to address the issue in their divorce instrument. An explicit election is preferable to trying to further distinguish, for federal tax purposes among alimony, child support, and property settlements. Without exception, the difficulties described above in the litigated cases stem from trying to properly characterize the cash payment as “alimony,” “child support,” or “property settlement" for federal income tax purposes (labels which often deviate from state law characterization of the payment) in order to determine whether they are includable/deductible or excludable/nondeductible. But as illustrated by the litigated cases, these payments are nearly impossible to distinguish on any consistent basis. As indicated by the child support guideline controversy and the continuation of the Lester Rule in all cases not dealing with a reduction in payments related to the children, child support can still easily be cast as alimony if the right form is used. Cash property settlements are also not easy to identify. The underlying assumption of current law is that cash property settlements can, in fact, be differentiated from support payments on a consistent basis and that the "stop-at-death" rule, coupled with the recapture rule in the case of front-loaded payments, serves to adequately police that line. Both contentions are dubious, at best, and reflect outdated notions that family law is increasingly abandoning. With respect to the recapture rule, for example, property settlements may be paid over several years in level payments. Only the constraints of the tax law require the parties to maintain contact for at least three years in order that the status of their "alimony" arrangement be respected as such. It would have been hard to have legislated wisely to limit front-loading. First, many legitimate, non-tax-avoidance factors, particularly the rehabilitative alimony award, lie behind front-loaded settlements. Second, there is little economic incentive for front-loading because it often costs the husband more in loss of the use of his money than he saves in taxes. Thus, a reform that limited the tax avoidance potential of front-loading would have to reach a narrow group of cases at the cost of significantly interfering with accepted family law practice." 235 Moreover, the "stop-at-death” rule serves only to require judges to delve, once again, into state law to try to determine whether any part of an unallocated payment stream might stop automatically if the payee should die, an actuarially unlikely event that the parties never addressed in their agreements, as described earlier. And it results in many payments that are clearly not property settlements-such as the payment of attorney fees, medical expenses, and auto repair expenses-to be so characterized. In 1986, Professor Malman persuasively demonstrated how the line between support payments and property settlements could no longer be policed in any rational way in view of the trends in family law, where "equitable distribution" statutes now blend property rights with support payments in an inextricably mixed payment stream. Often there is not a clear distinction between alimony awards and property distributions. As a result of the adoption of equitable distribution principles, the law in a number of states requires that financial provision for a spouse be made through a property distribution, and that alimony be awarded only if the property that can be divided is insufficient. Other states provide that both alimony awards and property distributions may be used for similar provide for support and to provide for an equitable allocation of assets. purposes-to The similar criteria used by courts to make both alimony awards and property distributions illustrate the lack of a clear distinction between the two. In both situations, courts may consider the parties' ages, needs, and employment skills; the duration of the marriage; and the presence of children. In particular, cases where on divorce one spouse, typically the wife, seeks compensation for financial contributions made toward the other's education or attainment of a degree or professional license illustrate the blurring of alimony awards and property distributions. Courts may consider the wife's contributions to the earning of the degree (or the husband's resulting increased earning capacity) as a factor in determining a property division and/or an award of alimony. Alternatively, the courts may formally identify the degree, license, or education as an asset subject to equitable distribution. Recently, the New Jersey courts introduced the concept of reimbursement alimony, which is designed specifically to compensate a spouse for financial contributions to the other spouse's attainments. The choice of a mechanism may affect the amount of compensation. Nonetheless, the results produced by the various approaches are similar because each may be said to stem from the vision of marriage as a partnership or shared enterprise and each compensates a spouse for contributions to the other spouse's career. 236 Her points have become only more salient in the years since 1986. As just one example, in this dot-com world in which we live, when stock options increasingly are used to compensate workers, family law courts are now arguing that stock options awarded after a divorce do not really represent separate "property" of the stock option owner but rather a future "income" stream that should be factored into the level of support payments. 237 Moreover, the difficulties in differentiating support payments from property settlements should not be attempted to be resolved by adopting the Task Force's complex "netting" proposal, under which only “hard assets” are taken into account in determining how much of a cash payment is actually a "property settlement" and under which payments are disallowed from entering into the inclusion/deduction system to the extent that they do not exceed the value of hard assets transferred to the payor spouse as a result of the divorce. Not only would this approach ignore state-law trends that increasingly recognize the value of intangible property 236 237 Malman, supra note 4, at 379-80 (footnotes omitted). See, e.g., Kerr v. Kerr, Kerr v. Kerr, 77 Cal. App. 4th 87, 91 Cal. Rptr. 2d 374 (1999); Murray v. Murray, 128 Ohio App. 3d 662, 716 N.E.2d 288 (1999). See generally Amy Zipkin, Stock Option Splitsville, N.Y. TIMES, Aug. 9, 2000, at C1 (describing these and other cases). 238 See supra notes 85-89 and accompanying text. 239 rights, but it would also impose vast new complexities imposed on every divorcing couple (requiring "tax-defendable valuation" of all "hard assets" without a market transaction at the time of divorce)." And these complexities would be greatly exacerbated by the fact that each spouse's "interest" in the hard assets would be measured differently in community-property states and common-law states, not to mention states that vest spouses with property rights at the time of divorce under certain equitable distribution or apportionment statutes. For all of these reasons, the statute should not attempt to identify those payments eligible for the inclusion/deduction system by reference to whether or not they fall into a particular category. Moreover, Congress should also reject treating all cash payments either under a rigid exclusion/nondeduction system or rigid inclusion/deduction system in the name of simplification. A mandatory exclusion/nondeduction system for all cash payments is not wise for the following reasons. First, mandatory exclusion/nondeduction for all cash payments would likely increase the aggregate tax burden on divorcing couples, since the couple in different tax brackets (where substantial cash payments are more likely) would lose their marriage bonus at the same time that more of the couple's income would be taxed at the payor's higher marginal rate bracket under the schedule for single filers. Divorce is usually accompanied by financial hardship (and triples the chances of bankruptcy). Therefore, Congress should avoid adopting what would amount to a mandatory divorce tax "penalty" in many cases. Second, a mandatory exclusion/nondeduction rule would also introduce a disparity between less wealthy couples, where support payments must come from future wages of the payor, and wealthy couples, who could still engage in significant income-shifting by transferring income-producing assets to the payee to fund support. It would also be inconsistent with the income-shifting allowed under I.R.C. § 1041, discussed below in Part III, so there would be a new and dramatic difference between the two areas, whereas both now contemplate incomeshifting. Third, a rigid exclusion/nondeduction rule would decrease flexibility in settling other matters in the divorce, with the likelihood of increasing the number of cases that go to full contest in state court. Fourth (and perhaps most important), when the payor is in a higher tax bracket, a mandatory exclusion/nondeduction system would erase the current-law bias that encourages the payor to make larger payments than he or she would otherwise make and that leaves the payee with more after-tax cash than he or she would otherwise have under an exclusion/nondeduction system. 239 While at least informal valuation of all property surely occurs in most divorces, these valuations may not be arrived at by formal appraisals that could be defended in the inevitable tax litigation, when the payor and payee spouses disagree over the valuations used to arrive at how much of the cash payment stream is eligible for the inclusion/deduction system. Such a system would be a nightmare! For example, assume that John and Mary, who have one minor child, age 12, are divorcing. The child will live primarily with Mary, with generous visitation to John. Without taking into consideration the following cash transfers, John, if single, would be in the 36% bracket, and Mary would be in the 15% bracket. Mary demands $1,000 per month in child support for ten years. John does not object to the figure but suggests that they call the payment a "family support payment," with no amount specifically designated as "child support." They agree that if Mary should die before their child is emancipated (an actuarially unlikely event), John will gain full custody. The intent is to structure the payments as includable/deductible "tax alimony." Economically, it doesn't matter whether the payment is called "child support" or "family support” or “alimony.” “Alimony" sounds mercenary and “child support" sounds benevolent, but otherwise there is no difference; the recipient is typically under no duty to account for how the funds are used. Mary would reject that offer, since her $1,000 per month would be worth less to her if she must pay the tax on it. John then offers $1,200 per month. After Mary's 15% tax ($180), she has $1,020, which is more than she would have under a rigid exclusion/nondeduction system under which John would agree to pay no more than $1,000 per month. John is willing to do this only because his net outlay is reduced from $1,000 to $768 ($1,200 less $432 tax savings) because of the deduction. John and Mary effectively save $180 net and share the spoils. (Mary should claim more of the spoils than $20.) 240 As indicated by the above example, which uses current law, this kind of flexibility is already incorporated into the statute, so long as the parties agree that the payments would end on the payee's death and are not excessively front-loaded. Why not make the flexibility explicit? Failing to do so simply rewards the well-advised over the ill-advised. The election is one dependent on knowledgeably structuring the transaction in a certain manner (increasing attorneys' fees and penalizing the ill-informed) rather than one that can be simply made explicit in the divorce agreement. Moreover, since Mary is in a lower tax bracket than John, it would be defensible to assume (since assumptions are unavoidable) that she is in greater need of the funds than John and that structuring the tax system so that she could end up with more after-tax cash is good policy, particularly since payees after divorce do tend to have a lower standard of living than payors. 241 240 This figure represents the $360 that John would have paid on that $1,000 per month if they designated it as "not alimony" less the $180 that Mary will pay on that $1,200 per month if they make sure the definition of alimony in I.R.C. § 71 is satisfied. 241 In 1985, Lenore Weitzman published a book that argued that, following divorce, the average divorced woman's standard of living dropped by 73%, while the average divorced male's standard of living increased by 42%. See LENORE WEITZMAN, THE DIVORCE REVOLUTION 323-56 (1985). Since then, her numbers have been successfully attacked as severely overstated, and even Ms. Weitzman herself admitted that a research assistant made an error. See Sanford L. Braver, The Gender Gap in Standard of Living After Divorce: Vanishing Small?, 88 FAM. L.Q. |