Young v. Comm'r of Internal Revenue

• Decision Date: 07 December 2000
• Docket Number: No. 00-1244,No. 00-1261,00-1244,00-1261
• Citation: 240 F.3d 369
• Parties: (4th Cir. 2001) LOUISE F. YOUNG, a/k/a Louise Y. Ausman; JAMES R. AUSMAN, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. JOHN B. YOUNG; MARTHA H. YOUNG, Petitioners-Appellees, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant. . Argued:
• Court: U.S. Court of Appeals — Fourth Circuit

Page 369

240 F.3d 369 (4th Cir. 2001)

LOUISE F. YOUNG, a/k/a Louise Y. Ausman; JAMES R. AUSMAN, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

JOHN B. YOUNG; MARTHA H. YOUNG, Petitioners-Appellees, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.

No. 00-1244 No. 00-1261.

UNITED STATES COURT OF APPEALS, FOR THE FOURTH CIRCUIT.

Argued: December 7, 2000.

Decided: February 16, 2001.

Appeals from the United States Tax Court. (Tax Ct. Nos. 97-21489, 97-20435) [Copyrighted Material Omitted] COUNSEL: ARGUED: Frank Hilton Lancaster, ROBINSON, BRADSHAW & HINSON, P.A., Charlotte, North Carolina, for Appellants. Jonathan Samuel Cohen, Tax Division, UNITED STATES DEPARTMENT OF JUSTICE, Washington, D.C.; William Mimms Claytor, BAUCOM, CLAYTOR, BENTON, MORGAN & WOOD, P.A., Charlotte, North Carolina, for Appellees. ON BRIEF: Robert W. Fuller, III, ROBINSON, BRADSHAW & HINSON, P.A., Charlotte, North Carolina, for Appellants. Paula M. Junghans, Acting Assistant Attorney General, Michelle C. France, Tax Division, UNITED STATES DEPARTMENT OF JUSTICE, Washington, D.C., for Appellee Commissioner.

Before WILKINS, MICHAEL, and MOTZ, Circuit Judges.

Affirmed by published opinion. Judge Motz wrote the opinion in which Judge Michael joined. Judge Wilkins wrote an opinion concurring in part and dissenting in part.

OPINION

DIANA GRIBBON MOTZ, Circuit Judge:

This case presents two tax questions arising from the settlement of a property dispute between former spouses. The first is whether a 1992 transfer of land from a husband to his former wife constitutes a transfer "incident to" their 1988 divorce for purposes of the nonrecognition of gain rules. The second is whether the wife must include within her gross income the contingent fees paid directly to her attorneys from the proceeds of her subsequent sale of that land. We agree with the Tax Court's holding that both questions must be answered in the affirmative.

I.

Louise Young¹ and John Young married in 1969 and divorced in 1988. The following year they entered into a Mutual Release and Acknowledgment of Settlement Agreement ("1989 Settlement Agreement") to resolve "their Equitable Distribution [of] Property claim and all other claims arising out of the marital relationship." Pursuant to this agreement, Mr. Young delivered to Mrs. Young a promissory note for $1.5 million, payable in five annual installments plus interest, which was secured by a deed of trust on 71 acres of property that Mr. Young received as part of the same 1989 Settlement Agreement.

In October 1990, Mr. Young defaulted on his obligations under the 1989 Settlement Agreement; the next month Mrs. Young brought a collection action in state court in North Carolina. On May 1, 1991, that court entered judgment for Mrs. Young, awarding her principal, interest, and reasonable attorneys' fees. Mr. Young paid only $160,000 toward satisfaction of that judgment, thus prompting Mrs. Young to initiate steps to execute the judgment. Before execution, however, Mr. and Mrs. Young entered into a Settlement Agreement and Release ("1992 Agreement"), which provided that Mr. Young would transfer to Mrs. Young, in full settlement of his obligations, a 59-acre tract of land (42.3 of the 71 acres that had collaterized his $1.5 million note and 16.7 acres adjoining that tract). Pursuant to the 1992 Agreement, Mr. Young retained an option to repurchase the land for $2.2 million before December 1992. Mr. Young assigned the option to a third party, who exercised the option and bought the land from Mrs. Young for $2.2 million.

On her 1992 and 1993 federal income tax returns, Mrs. Young reported no capital gain from the sale of the property nor the $300,606 portion of the $2.2 million that went directly to pay her attorneys' fees. At the same time, Mr. Young did not report any gain from his transfer of property, in which he had a $130,794 basis, to satisfy his then almost $2.2 million obligation to Mrs. Young. Thus, the appreciation of this property went untaxed despite the occurrence of a taxable event, i.e., the transfer or the sale.

The Commissioner asserted deficiencies against both Mr. Young and Mrs. Young. Each then petitioned the Tax Court, which consolidated the two cases. After trial, the Tax Court ruled that the capital gain was properly taxable to Mrs. Young under 26 U.S.C. S 1041(a)(2) (1994), which provides that "[n]o gain or loss shall be recognized on a transfer of property . . . to . . . a former spouse, . . . if the transfer is incident to the divorce." See Young v. Commissioner, 113 T.C. 152, 156 (1999). Because the Tax Court held that the 1992 property transfer was "incident to the divorce," it concluded that Mr. Young realized no gain through his transfer of this property to his former spouse. Id. Rather, according to the Tax Court, Mrs. Young took Mr. Young's adjusted basis in the land and should have recognized a taxable gain upon the subsequent sale of that property. In addition, the Tax Court held that the portion of the proceeds from the sale, which was paid directly to her attorneys, must be included in Mrs. Young's gross income. As a result of these holdings, the Tax Court ruled that Louise Young and her then husband, James Ausman, owed $206,323 in additional income tax in 1992, and Louise alone owed $262,657 in additional income tax in 1993.

Mrs. Young and James Ausman appeal both rulings. The Commissioner files a protective cross-appeal on the S 1041 issue, urging that if we do not agree with the Tax Court's conclusion that Mrs. Young (and Mr. Ausman) realized taxable capital gains, we also reverse its holding with respect to Mr. Young so that he is required to recognize the gain.

II.

We first consider the Tax Court's ruling involvingS 1041, which provides that no taxable gain or loss results from a transfer of property to a former spouse if the transfer is "incident to the divorce." 26 U.S.C. S 1041(a)(2). Section 1041 further provides that "a transfer of property is incident to the divorce" if it is"related to the cessation of the marriage." 26 U.S.C. S 1041(c)(2). The statute does not further define the term "related to the cessation of the marriage," but temporary Treasury regulations provide some guidance. Those regulations extend a safe harbor to transfers made within six years of divorce if also "pursuant to a divorce or separation instrument, as defined in S 71(b)(2)." Temp. Treas. Reg. S 1.1041-1T(b) (2000). Section 71(b)(2) defines a "divorce or separation instrument" as a "decree of divorce or separate maintenance or a written instrument incident to such a decree." 26 U.S.C. S 71(b)(2) (1994). A property transfer not made pursuant to a divorce instrument "is presumed to be not related to the cessation of the marriage." Temp. Treas. Reg. S 1.1041-1T(b). This presumption may be rebutted "by showing that the transfer was made to effect the division of property owned by the former spouses at the time of the cessation of the marriage." Id.

The Tax Court held that the 1992 transfer from Mr. Young to Mrs. Young was "related to the cessation of the marriage," thus neither party recognized a gain or loss on the transfer, and Mrs. Young took the same basis in the land that the couple had when they were married. Young, 113 T.C. at 156. The court applied the regulatory safe harbor provision, but also found that the transfer"completed the division of marital property" and, regardless of the safe harbor provision, it "satisfied the statutory requirement that the transfer be `related to the cessation of the marriage.'" Id. We agree with the Tax Court that the 1992 land transfer was "related to the cessation of the marriage," finding that it "effect[ed] the division of[marital] property." Temp. Treas. Reg. S 1.1041-1T(b).

The factual underpinnings of this case are not questioned. It is undisputed that the parties formulated and entered into the 1989 Settlement Agreement to resolve their "respective claims for equitable distribution of property" and "all other claims arising out of the marital relationship." The parties also agree that the 1992 Agreement was to resolve disputes arising from that 1989 Settlement Agreement. In fact, an entire section of the 1992 Agreement details the marital background of the dispute, beginning with the Youngs' divorce and subsequent execution of the 1989 Settlement Agreement, and expressly provides that the 1992 Agreement was to "fully settle all claims under the Judgment and Deed of Trust" that arose out of the 1989 Settlement Agreement. Not surprisingly then, the Tax Court explicitly found that the 1992 transfer "completed the division of marital property." Young, 113 T.C. at 156.²

Nonetheless, Mrs. Young challenges the Tax Court's finding and argues that the 1992 transfer did not "effect the division of [marital] property." In support of her contention, Mrs. Young notes that she was a judgment creditor when she entered into the 1992 Agreement. But the only status relevant for S 1041 purposes is "spouse" or "former spouse." Beyond her position as a former spouse, Mrs. Young's status makes no difference when determining whether the transfer is taxable; S 1041 looks to the character of and reason for the transfer, not to the status of the transferee as a creditor, lien-holder, devisee, trust beneficiary, or otherwise.³ Indeed, in Barnum v. Commissioner, 19 T.C. 401, 407-08 (1952), although the former wife had obtained a judgment against her husband for alimony arrearage, the Tax Court found the resulting settlement to be "incident to a divorce" because, like the 1992 Agreement in this case, it settled the"dispute over obligations arising from a divorce decree." Id.

Additionally, Mrs. Young's reliance on a private letter ruling issued to another taxpayer is misplaced. P.L.R. 9306015 (Feb. 12, 1993).⁴ In that case, the divorce decree contemplated a sale of the former marital house, in which each spouse owned a one-half...