In Uncategorized on 08/05/2020 at 18:35

Not From Your Ex

Judge Albert G (“Scholar Al”) Lauber’s infinite variety is again at center-stage, as he shuts down Steven R. Matzin and Sarah Schroeder, 2020 T. C. Memo. 117, filed 8/.5/20. It’s Steve’s story, because it involves Steve’s property split with Sarah’s predecessor, Georgeann.

Steve’s Sub S owned 70% of a cash-cow LLC that provided dental support around this broad land. This was the couple’s largest asset, and Steve ran up $160K in legal fees in negotiating the property deal and the divorce.

After whacking up cash on hand, life insurance, real estate, and a to-be-decided-later split of furniture and art, Steve works out a payout to Georgeann for the worth of the Sub S stock which owns 70% of the cash-cow LLC. Steve pays Georgeann’s share of some debts, and pays her some interest on the promissory note he gave her for the paydown on the Sub S stock. Steve didn’t want to split the Sub S stock with Georgeann; he didn’t want to be in business with her, and the other members of the cash-cow LLC would have to consent to let her in. She knew nothing about dentistry, leaving it to the lawyers to pull as many of Steve’s teeth as they could.

Eventually the cash-cow LLC is sold. Steve gets a sweet $85.7 million capital gain, of which he owes Georgeann 50% , but IRS claims Steve’s gain is greater by $5 million, although they settle out at no more than $3 million extra. We should all have such troubles.

But Steve needs more basis, so he claims what he paid Georgeann and his attorney increased his basis in the Sub S stock. No question what he paid Georgeann wasn’t deductible alimony, or rehabilitative alimony under then-applicable local (FL) law. Obligation to pay survived her death, and was neither income to her nor deductible to Steve.

Judge Lauber lets in parol evidence, finding the divorce agreement between Steve and Georgeann ambiguous. Any lawyer who can’t find an ambiguity in any document should find another way to make a living.

“The negotiating history makes absolutely clear that the parties desired to effect an equitable distribution of marital assets, including… Steven’s indirect interest in [cash-cow]. The payments specified in the agreement are consistent with the parties’ understanding, as shown in the negotiating history, that $10.5 million of value would be placed on Georgeann’s side of the ledger on account of Steven’s indirect interest in [cash-cow]. Because it was impractical for Georgeann to receive a $10.5 million partnership interest in [cash-cow], the parties agreed that she would be paid that value in the form of cash, a promissory note, and Steven’s discharge of her share of certain liabilities.” 2020 T. C. Memo. 117, at p. 10. And though there was a payout over time, it was still a lump-sum property split.

Yes, it’s property settlement. So what?

So Section 705(a)(1) doesn’t work to increase or decrease Steve’s basis in the Sub S (taxed as a partnership), because whatever Steve paid Georgeann didn’t change his distributions from the Sub S. And Steve neither gave the Sub S money or property, nor paid off any of the Sub S’s liabilities. So Sections 722 and 752(a) are off the table. Finally, neither Steve nor Georgeann acquired any greater interest in the Sub S than the 70% Steve had to begin with, squelching Section 742.

If the marital split involved shares of publicly-traded stock, Steve’s handing over half to Georgeann wouldn’t increase Steve’s basis in the remainder.

As for the legal fees, whatever claims Georgeann had to Steve’s interests in the Sub S had nothing to do with the cash-cow LLC. What Steve paid to Georgeann and his attorneys didn’t defend or perfect title to real or personal property, so whether or not to capitalize those costs per Reg. Section 1.263(a)- 2T(e)(1) is beside the point. Anyway, the Sub S paid nothing to defend or protect its title to the 70% interest in the cash-cow; it was all Steve.

Georgeann had, under then-applicable local law, only a claim to a piece of the value of all Steve’s assets, not any specific asset, and local law made it clear that designating property as marital property was for evidentiary purposes and not to vest title. If she wanted a piece of the cash-cow action, she’d be like any other creditor. She’d have to get a court to give her a charging order, directing the Sub S to fork over some or all of Steve’s share of the Sub S’s distributions. A creditor of a partner gets no lien on partnership assets, as I once had to teach a senior associate half-an-hour before our firm got sued.

Judge Scholar Al puts the cap on this bottle. “In effect, petitioners argue that any debtor who honors his obligations is entitled to capitalize those payments on the theory that he is removing a cloud on his title to assets that might be subject to collection action if he defaulted. That is plainly not the law; if it were, every payment by a partner on a personal debt would increase his basis in the partnership.” 2020 T. C. Memo. 117, at p. 18. (Footnote omitted, but it says that, though local law says even a spurious request for a charging order gives rise to a cloud on title, the case cited relates to a real claim, not a hypothetical.)

I really wanted to give Steve’s trusty attorneys a Taishoff “Good Try, third class,” but they blew it with this one.

“Finally, petitioners complain that, if we do not allow a basis increase, they will have no way of recovering the costs of Steven’s divorce against his taxable income. That is correct and unsurprising. Steven agreed to a property settlement through which Georgeann received an equitable share of the marital assets.  Spousal payments made pursuant to a property settlement are not tax-deductible. Had Steven made payments that qualified as ‘alimony’ for Federal income tax purposes, those payments would have been deductible. See sec. 215. But the agreement explicitly stated the parties’ understanding that, for income tax purposes, the payments would be neither taxable to Georgeann nor deductible by him.” 2020 T. C. Memo. 117, at pp. 20-21.

Sorry, chaps, we taxpayers aren’t paying for your divorce.







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