Jill has been divorced for five years. Her separation agreement stated she would receive $5,000 per month of spousal maintenance for four years. She was also owed a property settlement payment of $200,000. This was to be paid at the rate of $50,000 per year with each payment made on January 1st.
Jill moved to Denver and hired Devon (a local CPA experienced working in divorce matters) to compile her tax return. In looking over her 2018 tax return, Devon found that Jill’s previous CPA had been including $60,000 per year in her taxable income (spousal maintenance payments), PLUS the $50,000 property settlement payment! This meant that for four years, Jill had paid taxes on a $200,000 property settlement note that should not have been taxed.
Under IRC 1041, no gain or loss shall be recognized on a transfer of property from an individual to a spouse or former spouse if the transfer is incident to the divorce. In addition, the transferee’s basis and holding period in the property is the adjusted basis and holding period of the transferor. Also, if interest is being charged on the note it has to be declared as taxable income.
On Jill’s behalf, Devon filed amended returns for the prior years and was able to recover the taxes Jill had mistakenly paid. This was clearly a situation where an error was made due to one’s misunderstanding of the rules. Here is a perfect example of how professionals experienced in divorce matters can add significant value to the client, and the team of divorce professionals serving them.