tax-oriented agreement could provide for the $3,000 monthly alimony, but 100 The document summarized by saying that "progressivity is not, and has not been, a significant element of the present domestic relations tax system. Contrary to undermining the progressivity principle, therefore, the Task Force's recommendations are intended to simplify the mechanism by which parties may effect the kind of income-shifting sanctioned by present law "101 ,,102 Perhaps it was the explicit use of the term "income-shifting" in the last-quoted sentence that raised red flags. That term has always carried negative connotations involving abuse entailed by shifting income from someone in a higher tax bracket to someone in a lower tax bracket while nevertheless retaining control over it by keeping it "all in the family.' In any event, a further meeting between various government officials, representatives of the ABA Tax Section, and the AICPA Tax Division on November 19, 1982, raised the question of whether "income-shifting" between divorcing spouses under I.R.C. §§ 71 and 215 ought to be ended entirely by repealing those sections altogether. This prompted the Task Force to issue yet another report in January of 1983, defending the income-shifting principle in divorce. The members of the Task Force "unanimously concluded (1) that repeal of Sections 71 and 215 would not simplify federal tax law, (2) that such a measure would be contrary to other basic tax policies, such as equity and rationality, and (3) that appropriate tax simplification can be achieved without such a drastic step. ,,104 103 With respect to item (1), the Task Force report is not completely persuasive. Making all payments in divorce tax-neutral, period, should, in fact, be simple. An argument to the contrary was that states would react by creating property rights in the wife regarding the ex-husband's income stream that would operate to shift taxation to the wife in any event, frustrating the repeal of I.R.C. § 71 and introducing new complexities. 101 Id. at 8. The document also argued that the "private ordering" proposals were consistent with trends in substantive state domestic relations law, particularly the increasing emphasis on privately negotiated divorce agreements (as opposed to judicially crafted ones). See id. at 8-9. 102 See infra notes 252-301 and accompanying text (describing the assignment-ofincome doctrine). 103 See American Bar Association's Domestic Relations Tax Simplification Task Force, The "Income-Shifting" Principle in Proposals for Simplification of Domestic Relations Tax Law (Jan. 20, 1983) (copy on file with author) [hereinafter Task Force Income Shifting]. 104 Id. at 1-2. From the standpoint of state legislatures, if the recent "anti-Davis statutes" are It's difficult to evaluate whether the dire forecasts regarding the reaction of states to such a legislative change would actually transpire. The Task Force's stronger arguments were that such a change would be contrary to common notions of fairness and flexibility and that repealing I.R.C. §§ 71 and 215 in the stated name of simplification would be tantamount to throwing out the baby with the dirty bath water, as "most of the attainable goals in terms of tax simplification can still be achieved with other reform measures." While the high war-time marginal rates in 1942 surely were the precipitating factor in shifting the tax burden on "tax alimony" (which, as we have seen, is a term that mirrors "alimony" for state law purposes only coincidentally) to the payee, taxation of the recipient also accorded with other commonly held norms of tax fairness. The commonplace perception that income-shifting under Sections 71 and 215 is fair and equitable as a matter of federal tax policy stems from numerous factors. For purpose of clarity, though, it should be noted that the term "income-shifting" is misleading. The question presented is not whether income should be shifted from one spouse or ex-spouse to the other, but whether the income that in fact is shifted between the parties by local law should or should not be taxed to the recipient. As indicated, various factors point to an affirmative answer to the foregoing question... 106 107 The Task Force then listed some of these factors. First on the list was the fact that the recipient has control over the cash received, which has always been a prime factor in the incomeshifting area in determining who, between two parties, should be taxed on income. "[T]hese elements of control make it far more equitable to tax alimony to the recipient, the party who is actually consuming it and who has the 'cash flow' from which the tax dollars can reasonably be 107 doctrine). Id. at 5. See infra notes 252-301 and accompanying text (describing the assignment-of-income 71-870 2001 - 3 ,,108 ,,109 expected to come.' The Task Force next contended that eliminating income-shifting would discriminate between well-to-do couples with income-producing property, who would effectively be able to continue to engage in income-shifting by transferring such property in satisfaction of support obligations, and less wealthy couples. "Specifically, a rigidly excludable/nondeductible system would discriminate between wealthy and not-so wealthy taxpayers in that the former could transfer income-producing property or fund certain types of trusts so as to nevertheless effect income-shifting in another manner, whereas less well-to-do taxpayers would simply have to draw upon current income to meet support obligations to ex-spouses.' The Task Force also argued that the collective tax burden on the divorced couple would be higher if I.R.C. §§ 71 and 215 were repealed than under either the current law at that time or the proposed changes, since most payors were probably in higher tax brackets than their recipients. That is to say, denying deduction to the higher bracket taxpayer and allowing exclusion to the lower-bracket taxpayer would probably result in more dollars going to the Treasury than under either a rigid inclusion/deduction system or private ordering. "Since divorce frequently strains liquidity to the breaking point anyway, in the view of the Task Force, such a harsh result--i.e., divorce per se pushing incomes into higher brackets--should be avoided, if possible. Finally, the Task Force derided the sacrifice in flexibility inherent in a rigid exclusion/nondeduction system. ,,110 [T]he "Lester" principle ... allows parties with children considerable room for Almost exactly six months to the day later, the Ways and Means Committee of the House of Representatives introduced H.R. 3475, the Tax Law Simplification and Improvement Act of 1983, a portion of which dealt with divorce taxation, and convened hearings. The bill П12 112 Id. at 8. See Tax Law Simplification and Improvement Act of 1983: Hearings on H.R. 3475 Before the House Committee on Ways and Means, 98th Cong. 2d Sess., Serial 98-40 (July 25, 1983) [hereinafter House Hearing]. ,,113 ,,114 proposed to enact a new Code section, I.R.C. § 1041, which would provide that "[n]o gain or loss shall be recognized on a transfer of property from an individual to (or in trust for the benefit of) (1) a spouse, or (2) a former spouse, but only if the transfer is incident to divorce.' The transferee would exclude the value of the property as though it were received as a “gift, and the recipient would take a carryover basis in the property received. A transfer would be considered incident to divorce if it occurred within one year on which the marriage ceases or was "related to the cessation of the marriage.' Section 1015, which normally governs the basis of property received by gift, was proposed to be amended so that transfers described in I.R.C. § 1041 would be governed by the carryover basis rule described there instead of the general gift basis rules. Thus, Davis would be put to rest, with no “private ordering" option provided to the divorcing parties to opt out of the new provision so that a transfer could be a recognition event for the transferor and result in a fair market value basis for the transferee. 116 ,,115 With respect to I.R.C. §§ 71 and 215, the bill cherry-picked some of the Task Force's recommendations, rejecting others. Consistent with the Task Force's recommendations, it carried forward the Lester Rule intact. That is to say, amounts "fixed" for child support would be excludable/nondeductible payments, with no mention that reductions relating to contingencies connected to the children would result in a portion of such payments being labeled as “child support." Thus, private ordering would be de facto continued, with parties able to determine for themselves (so long as they knew the magic words) how much of a total "family support" obligation--if any--should be taxable to the recipient and deductible by the payor, or vice versa. 117 The bill also accepted the Task Force's view that only cash payments should be eligible for the inclusion/deduction system of I.R.C. §§ 71 and 215118 but that cash payments intended to compensate the recipient for an interest in property should not fall within it. It rejected, however, the Task Force's suggested means by which to differentiate cash support obligations from cash property settlements. The Task Force's approach" required netting cash payment paid against the value of any "hard assets" surrendered by the cash recipient, with only the excess amount being eligible for the inclusion/deduction system. Rather, the proposals appear to 113 Id. at 18. 114 119 Gifts, subject to exceptions not relevant here, are excludable from gross income under I.R.C. § 102(a). 115 House Hearing, supra note 112, at 19. 116 See id.; see also infra note 301 (describing the gift basis rules in connection with considering whether I.R.C. § 1041 ought to be amended to carve out transfers between spouses not incident to divorce). have attempted to differentiate cash property settlements from support obligations in the following three-pronged manner. ,,120 121 To be eligible for the inclusion/deduction system, the payment could not be "made for a transfer of property by the payee spouse. That, obviously, would constitute an explicit carveout for cash property settlements. But what if the parties don't label the cash payment as a payment for an interest in property? Disguised property settlements were attempted to be identified through the following two, more subtle requirements. First, the liability to make the payment had to end with the recipient's death, and there could not be any obligation to make any substitute payments after the death of the payee spouse. The notion, presumably, is that a recipient spouse would demand that even her estate be entitled to payment after her death if the payment is really a cash property settlement rather than a support payment. Thus, she would agree to the payments stopping on her death only if, in fact, they constituted support payments (which, since she was dead, she would no longer need). You might recall that inserting this kind of contingency clause was one means by which taxpayers could prove that a payment was "periodic" under the 1942 rules, since the contingency transformed the payment amount into an "indefinite" amount. 122 What the drafters did here was essentially to incorporate into the statute that one means of proving that a payment was “periodic," removing the "periodic" language itself but keeping its "soul," if you will. Second, the payment had to be "1 of a series of cash payments where it is reasonable to expect at least 50 percent of the amount payable under such series will be paid more than 1 year after the date on which the first of such payments is made. "123 The underlying assumption here is that payments telescoped into a short period after the divorce are more likely to constitute a property settlement than a support payment. Instead of the more-than-ten-year payment period required under the 1942 rules, however, the bill proposed to shorten it dramatically-essentially, to just over a year. 124 The one new nod to "private ordering" adopted in the proposed bill was that payments otherwise eligible for the inclusion/deduction system could be labeled as excludable/nondeductible payments by the parties in their agreement. In other words, the 124 125 For example, suppose that a decree required that a payment of $10,000 be made on January 20 of year 1 and a second payment of $11,000 be made on January 25 of year 2. Both payments could be eligible for the inclusion/deduction system, since at least 50 percent of the stream of payments was paid more than one year after January 20 of year 1, the date of the first payment. 125 See House Hearing, supra note 112, at 21. |