"fixed" as child support would continue to be "excludable/nondeductible" under the “fall-back” rules; and, similarly, courts and parties would continue to have flexibility of creating "unallocated" support arrangements under the Lester principle [which could be designated as "includable/deductible" payments under the new rules].

84

85

The Task Force, however, intended that the concept of private ordering be limited to spousal and child support payments--not to cash property settlements. Recall the difficulty under prior law, however, of identifying whether a cash payment is really a property settlement by looking to whether the payment discharged a support obligation of the payor. The Task Force therefore recommended implementing the limitation with adoption of a mechanical, though complex, "netting rule" in order to prevent cash payments to the payee that are intended to compensate for her interest in property going to the payor from being subject to the inclusion/deduction system of I.R.C. §§ 71 and 115.

,,86

An equal

For example, assume that a couple jointly owns $400,000 of "hard assets. division would direct that $200,000 go to each. Instead, the parties agree that $100,000 worth of the property remain with W and $300,000 go to H--$100,000 more than he should be entitled to-and that H would make payments to W intended to fall within the inclusion/deduction system. Because the payments would be includable, W would presumably demand payments exceeding $100,000--say, $120,000--so that her after-tax position would be the same as would have occurred if she had simply taken the full $200,000 worth of property to begin with (since in-kind property receipts could not fall within the inclusion/deduction system). The deduction by H of the payments would effectively allow him to deduct his "purchase price" for the $100,000 worth of property that exceeded his one-half interest."

,,88

87

The Task Force proposal would prevent the first $100,000 of payments made by H to W from falling within the inclusion/deduction system. "[T]he ‘hard assets' received from one spouse in the property division would first be netted against any Section 71 private ordering payments to such spouse, with only the excess being eligible for an 'includable/deductible' designation. That is to say, the $100,000 worth of property that W transferred to H (the amount in excess of his one-half interest) would be netted against the first $100,000 of cash payments made by H to W, thus preventing it from falling within the inclusion/deduction system. H would be able to deduct (and W would have to include) only the remaining $20,000. The Task Force recognized that the calculation of how much property was "transferred" from W to H (and

84

85

86

The Task Force generally used this term to mean property, whether tangible or intangible, that has a basis for tax purposes. See Task Force Technical Memorandum, supra note 73, at 6-7. It would not include marital rights, such as dower or curtesy, though such rights are "property rights" under state law.

thus how much cash going from H to W is precluded from entering the inclusion/deduction system) would vary between residents of community-property states and common-law states.

To some extent, though, variances as to the impact of the new rules would still ensue, as the determination of "hard asset interest" will differ, but these variances will be due essentially to differences in state property laws, principally differences between the property laws of community property and common law states. Despite the objective of the Task Force's proposals to establish as much uniformity among the various states as possible, some variances due to differences in state property laws probably remain unavoidable.

89

90

Finally, the Task Force recommended that the rules pertaining to who may claim a dependency exemption for minor children of the divorced parents should be simplified." One commentator summarized the pre-1984 authority in this respect as follows:

As a general rule, Congress gave the child exemption to the custodial parent, who
will be assumed for the purposes of this discussion to be the wife. The husband,
as noncustodial parent, was entitled to the exemption if the divorce or the couple's
written agreement named him as the parent entitled to the exemption and he paid
at least $600 for the support of the child in the tax year. If the agreement or
decree were silent, the husband, as noncustodial parent, might still qualify for the
exemption if he provided $1,200 or more in support for the child in the tax year
and the wife could not "clearly establish" that she provided more support. For
example, assume that the wife has custody of the child for the entire year and that
the divorce decree did not address which parent would claim the exemption.
Additionally, assume that the wife provided $700 support for the child, while the
husband provided $1,300 in support. Since the husband provided more than
$1,200 and the wife could not have clearly established that she paid more, the
husband would have been entitled to the child exemption.

Prior to [1984], the statutes established a framework that would have permitted the couple's own agreement to control which spouse would claim the tax exemption for the child. If the couple could not reach such an agreement, difficult questions arose regarding which spouse contributed more "support." The determination of support was the subject of much litigation, for the statutes themselves did not define this critical term. Also, the regulations vaguely defined support as including "food, shelter, clothing, medical and dental care, education, and the like." As a result, much of the interpretation of qualifying expenditures for support was left to the

courts.

Courts generally took a broad view of support to include almost any payment made by the parent on behalf of the child. As one court noted, support was more than the necessities and could include extras, such as summer camp payments, that were available at certain stations in life. The courts, though, set some limits on what types of payments did not meet even this liberal

interpretation of support. Gifts to the child or visits and telephone calls made by the parent to the child did not qualify as support. Likewise, the value of babysitting or other personal services performed by the custodial parent were not includable in the calculation of support, because a payment had not been made on the child's behalf.

In addition, payments must actually have been made by the parent to be considered support. Unpaid child support was not counted even though it was court ordered and enforceable for the tax period in question. Likewise, arrearages for support relating to prior tax periods, but paid in the current tax year, were not included as support. For example, if the husband failed to pay his $500 a year child support for each of the past two years, his payment of the past due $1,000 and the presently due $500 would not entitle him to the child exemption in the current year. This was true even though he paid over $1,200 and technically met the statutory standard necessary to claim an exemption. Finally, government payments, such as welfare aid, made to the custodial parent on behalf of the child were not considered as support contributions by that parent for the determination of tax exemptions.

At a meeting in April of 1982 between the staff of the Joint Committee on Taxation, representatives of the ABA Tax Section, and representatives of the American Institute of Certified Public Accountants (AICPA) Tax Division to consider the Task Force's recommendations, the point most discussed and questioned was the concept of "private ordering." The Task Force therefore issued another document on August 2, 1982, which was intended to clarify the concept and justify its use in the divorce context." In part, it explained:

The advantages to the federal government in adopting the proposed "private
ordering" are difficult to quantify in terms of dollars; but, in light of the
staggering level of tax controversies generated by Sections 71, 215, and 152 and
the probable degree of non-compliance, administrative costs and lost revenue to
the government attributable to present law are plainly substantial."

93

The number of tax cases produced by present rules plainly imposes a heavy
burden on the Internal Revenue Service, state taxing authorities, and the courts.
Illustrative of this number is the fact that as of June 30, 1982, some 481 cases
docketed in the Tax Court involved Sections 71, 215, and/or 152. As most cases
in this area are probably settled at administrative levels, the foregoing number
would appear to be only the "tip of the iceberg.'

,,94

91 Behr, supra note 58, at 802-03 (footnotes with citations omitted).

92

See American Bar Association's Domestic Relations Tax Simplification Task Force, The "Private Ordering" Concept in Proposals for Simplification of Domestic Relations Tax Law (Aug. 2, 1982) (copy on file with author) [hereinafter Task Force Private Ordering].

93 Id. at 2.

94 Id. at 3.

follows:

The Task Force quoted at length from a Tax Court opinion written by Judge Dawson, as

It is well settled that the determination of whether payments are in the nature of
support or part of a property settlement does not turn on the labels assigned to the
payments by the court in the divorce decree or by the parties to the agreement....
This issue is a factual one and requires an examination of all the surrounding facts
and circumstances.... Unfortunately, because of the vexing problems which
frequently arise in determining the nature and extent of a spouse's property rights
under State law, this supposedly factual inquiry has all too often taken on a
metaphysical aura as the courts have struggled to classify a particular payment as
either support or property settlement, when, in reality, the payment possesses a
hybrid nature sharing characteristics of both. In the process, similarly situated
taxpayers have occasionally been accorded disparate treatment merely because of
differences in State marital property laws. For this reason, and because the
confusion in this area has spawned a relentless stream of litigation, it would
appear that legislative reform is warranted. As we stated in Schatz v.
Commissioner ..., some sort of safe harbor is needed so that taxpayers and
divorce courts can predict with confidence the income tax consequences
stemming from periodic payments occasioned by divorce. Until such legislation
is enacted, however, we are left with no alternative but to plunge into the morass
of the decided cases, many of them irreconcilable, and resolve this issue as best
we can by applying the various factors which have been identified by prior
decisions.

95

The document then addressed the question of whether "private ordering" would undermine the progressivity of the federal income tax system and concluded that it would not, denying that the proposals would entail a “radical change in domestic relations tax law in any substantive sense" in view of the ability--if the divorcing parties knew the appropriate magic words--to accomplish under prior law much of the private ordering that the proposals would make explicit.

As noted, "private ordering" in marital settlements substantially exists under present law, although some of the rules are complicated and produce many tax controversies. From the standpoint of practitioners, these rules are frequently viewed as "planning tools"; and, in a large majority of cases, if parties are cooperative and adequately advised, they can "pick and choose" the correlative tax consequences of many aspects of their settlement by utilizing one or a combination of the key planning tools.

96

The document then listed some of these "hidden" private-ordering tools. It noted, for example, that under the I.R.C. § 71(c) principal sum rules, the parties could avoid the excludable/nondeductible conclusion that the statute provided normally applies to a principal

95 Id. at 3-4 (quoting Beard v. Comm'r, 77 T.C. 1275, 1283-84 (1981)).

96 Task Force Private Ordering, supra note 92, at 6.

sum paid out in fewer than ten years "by parties agreeing that payments shall merely be contingent upon the recipient's survival, a condition that is frequently of little practical or actuarial consequence in the eyes of the parties."7 Under the Lester Rule, the parties could decide for themselves whether or not child support was includable/deductible or excludable/nondeductible by specifically “fixing”--or not--an amount for child support in the agreement. Even reductions for contingencies clearly relating to the children would not transform a portion of an unallocated "family support" payment into nondeductible “child support. The document also described the use of “ride-throughs," which were described as follows:

,,98

This term refers to various types of arrangements under which parties agree for
includable/deductible payments to continue beyond standard terminating events
under state law, most typically an ex-wife's remarriage. By entering into a written
agreement that carefully preserves the recipient's right to support for the desired
period, the parties can usually achieve their intended tax consequences,
notwithstanding the occurrence of one or more of the standard terminating events.
In many cases, the "ride-through" technique is coupled with the Lester principle,
with the result that payments to an ex-wife subsequent to her remarriage, plainly
and solely intended to benefit the parties' children, retain their alimony character.
See Revenue Ruling 70-557, 70-2 C.B. 10. A "support package" entailing a “ride-
through" is often utilized in lieu of a larger property allocation to the recipient,
with either or both parties attaining a better after-tax result. Tricky questions
under state law sometimes arise, and anything less than careful planning and
drafting can prove costly. See, e.g., Hoffman v. Commissioner, 54 T.C. 1607
(1970), acq'd, 1981-2 I.R.B. 5, aff'd, 445 F.2d 161 (7th Cir. 1972).

99

In addition, the document addressed how the "support" obligation could be used by the parties.

In most cases, includable/deductible treatment under Section 71 is available only for payments based on the payor's support obligation under state law. In many states, though, this obligation can be met by either a property allocation (perhaps in installments) or includable/deductible periodic payments. Accordingly, parties often attain their objectives by contractually defining the level of the recipient's support need in the desired manner taxwise and then providing for an appropriate stream of payments in the context of either the support section or the property section of their agreement, depending solely on tax considerations. For example, assume that a wife's support needs could be met with $5,000 of alimony per month, that the husband could pay this amount, but that $3,000 of alimony per month would bring the parties' projected taxable incomes into equilibrium. A