parties could opt out of the inclusion/deduction system with respect to a payment that would otherwise qualify as a "support" payment (rather than a property settlement) under the tests described above. The parties could not, however, opt "into" the inclusion/deduction system with respect to a payment that does not otherwise qualify because, say, there is no requirement that the payment stream stop on the recipient's death. Finally, the bill would have simplified the rules regarding who was entitled to the dependency exemptions for minor children of the divorced couple by essentially creating a default rule that the custodial parent got them, unless she properly assigned them to the other parent. Thus, all of the litigation regarding who provided more dollars in support of the children would disappear. 126 128 127 129 Only three people testified with respect to the portion of the bill dealing with divorce taxation at the hearings, but each of the three were powerful and respected commentators. The first was Ronald A. Pearlman, Deputy Assistant Secretary (Tax Policy), Department of the Treasury. He spoke forcefully in favor of proposed I.R.C. § 1041, the anti-Davis provision applicable to in-kind property transfers. With respect to the alimony provisions, however, he objected to "the complete elimination of the periodic payment requirement and 10-year rule requirement presently contained in the code. And the reason he did so was because he believed that these rules adequately distinguish "property settlements" from "support payments" and that only the latter ought to fall within the inclusion/deduction system. He said, "While the precise application of these requirements has generated a fair amount of controversy in the past, they do remain as important safeguards for preventing nondeductible property settlements from being treated as alimony.' Instead, Mr. Pearlman advocated the following changes: ,,131 9130 reducing the ten-year payment period to five years, 132 measuring the period by reference to the first payment instead of the date on which the divorce decree became final, 128 See House Hearing, supra note 112, at 150. Mr. Pearlman is now Professor Pearlman of Georgetown University Law Center. He has indicated to me that he hopes his testimony of 17 years ago will not dissuade Congress and the Treasury Department from taking a "fresh look” at this area of law to determine whether any changes are warranted today. ⚫ providing that any payments mandated for a period of less than five years would not providing that any payments that are not mandated for any specific period would He testified as follows: We recognize that eliminating the contingency rule might have the effect of We also believe this proposed approach is preferable to the rule of the bill 133 The second to testify regarding the divorce provisions was M. Bernard Aidinoff, a partner in the law firm of Sullivan & Cromwell, testifying in his capacity as Chair of the ABA Section of Taxation. 134 He, too, strongly supported proposed I.R.C. § 1041,135 but he disagreed with Mr. Pearlman's criticisms of the proposed changes to the definition of "alimony." I would like to comment, however, on the statement made by Deputy Assistant 133 Id. at 153-54. Mr. Pearlman also strongly supported the proposed amendments concerning which spouse should be entitled to the dependency exemptions for minor children. See id. at 154. 134 See id. at 203. 135 66 "At long last the bill presents a legislative solution to the problems created by the Supreme Court in its 1962 Davis decision which made taxable the transfer of appreciated property in a divorce settlement. This alone wold be a major accomplishment ...." Id. at 204. couples are more anxious to disengage themselves completely when a divorce or In many respects, the tax section would have gone further than what is in the bill. 136 Mr. Aidinoff did have one strong criticism of his own, however, with respect to the proposed amendments, and that was the rule that at least fifty percent of the total payment amount must be paid more than one year after the first payment if the payments are to qualify as includable/deductible payments. Contrary to the overall purpose of Title II [authors note: Title II contained the proposed amendments regarding divorce taxation], as stated in the technical explanation, [the proposed rule] serves to preserve a "periodicity" requirement for alimony as a result of the proposed "one of a series" language. Such a requirement and the "reasonable to expect" and the "at least 50 percent" requirements also inject subjective tests into the alimony rules, especially in cases involving fluctuating amounts for support (e.g., 30 percent of an ex-husband's earned income). As demonstrated by the unfortunate experience under present law, such subjective tests are frequent traps for the unwary, as well as productive of much tax controversy. The effect of [the proposed rule], therefore, would be to continue these extremely undesirable aspects of present law. Also contrary to an apparent objective of Title II, [the proposed rule] flies in the face of local divorce statutes and trends. The comments in the technical explanation imply that a "onetime lump-sum payment" (or similar payment) can never be intended for support. This perception is erroneous, as in the vast majority of states today support needs of one spouse can be and are frequently met, in whole or in part, with a one-time transfer. Moreover, the trend today (particularly if there are no children involved) is for ex-spouses to "disengage" in their relationships with each other; and support to an ex-spouse for a short period--e.g., 6, 12, 18 months--is common. In this regard, the effect of [the proposed rule] is to militate against Federal tax law harmonizing well with State substantive divorce laws. One inference that can be drawn from the comments in the technical explanation on [the proposed rule] is that the proposed rule stems from the notion that it is contrary to sound tax policy for a single one-time lump-sum payment to be accorded "includable/deductible" treatment. The section does not share this view, especially since it believes that the fundamental tax policy for a basic alimony and separate maintenance rule should be that the taxpayer who consumes the payment(s) should be the one to bear the correlative tax. Moreover, in most cases, a one-time lump-sum payment (or a short-term series of payments) involving a relatively small dollar amount is intended to be solely for the recipient's support. On the other hand, if substantial dollars are involved and the payment(s) are plainly intended to meet both support rights and other marital rights, overall tax revenues to the Government would rarely be reduced anyway, due to "bunching of income" for the recipient [which would push the recipient into a 136 Id. higher tax bracket with respect to the payment]. In either case, [the proposed rule] serves no meaningful purpose in relation to the basic objectives of Title II. Another major weakness of [the proposed rule] would appear to be the ease with which it could be avoided, particularly in cases in which substantial dollars (and sophisticated parties and/or counsel) are involved. Thus, it would seem that the situations that the proposed rule is intended to snare would rarely occur, as taxpayers in those situations would simply "draft around" the rule. Realistically, parties for whom [the proposed rule] would pose the most difficulties are likely to be less substantial and/or less well-advised taxpayers. 137 Mr. Aidinoff also made the point that the current flexibility represented by the Lester Rule should continue. An important interpretation of [the treatment of "child support"] is contained in 139 The final person to testify was Marjorie A. O'Connell, a partner in the law firm of O'Connell & Associates, who was a member of the ABA Task Force." Like her predecessors, she supported proposed I.R.C. § 1041.140 With respect to the definition of "alimony" eligible for the inclusion/deduction system, she had several suggested changes. First, with respect to the provision that payments for the transfer of property rights not be eligible for alimony status, she urged that the term "property" be defined to include only "hard assets." "This rule should not apply to any release of an inchoate property right such as rights under an equitable distribution statute. She also urged against the requirement that payments must cease upon the death of the payee. ,,141 While support needs of the recipient is the cornerstone of alimony, death does not always terminate those needs. For example, spouses may value the recipient's support rights for life at $200,000 based on his or life expectancy. Instead of paying this amount for life, the payor may want to pay it over a shorter period. If the recipient dies before the end of the shorter period, any continuing payments would be in respect of a support obligation. The recipient may have postdeath obligations that those payments would run to, such as the pay-off of debts incurred to meet 137 138 Id. at 209-10. Id. at 210. Mr. Aidinoff supported the proposed changes to the dependency exemption provisions as well. See id. at 211. support needs during life. This is often the case where serious medical problems cause the recipient's precipitous death. While I understand the genesis of the post-death prohibition, I urge that the committee seriously consider deleting this provision from the bill. As did Mr. Aidinoff, she also challenged the rule requiring an expectation that at least fifty percent of the total stated payments would be made more than one year from the first payment. This rule is the last vestige of the current periodicity requirements that has caused so many problems. The apparent evil this rule strikes at is a lump sum payment for support in the year of divorce. This type of arrangement is rarely done and virtually never for tax reasons.... Nevertheless, I submit that this 50-percent rule is an unnecessary complication. Moreover, the application of this rule would require a subjective evaluation of future events to determine what is the time period in which it is “reasonable to expect” for payments to be made. 143 Finally, she advocated that the implicit flexibility inherent in the Lester Rule be transformed into an explicit election so that all parties, not only those knowing the magic words, could decide for themselves who pays tax on the amounts paid out as child support. Under [Lester], payments made "for the support of a spouse and children” are all 144 142 Id. at 267-68. 143 144 Id. at 268. Id. She also urged adoption of the proposed changes to the provisions governing dependency exemptions. See id. |