A Gift by Any Other Name is Still a Gift in the Court’s Eyes (Hughes v. Comm’r)

Hughes v. Comm’r, T.C. Memo. 2015-89, 2015 WL 2180505 (2015)

(a) Facts: A husband owned stock in a consulting business that was growing in value. He was afraid that if he retained the stock, his former wife would seek to reopen their divorce decree. He therefore gave the stock to his present wife.

When his present wife sold the stock, the couple reported capital gains computed on the assumption that the basis of the stock was its fair market value at the time of the gift. The IRS agreed and assessed a deficiency, based upon the stock having a zero basis.(b) Issue: Did the stock have a zero basis?

(c) Answer to Issue: Yes.

(d) Summary of Rationale: The husband noted correctly that transfers incident to divorce normally are not taxable events under 1041. He then noted that there is an express exception where the transferee spouse is a nonresident alien. I.R.C. § 1041(d). Because his present wife was a nonresident alien, he argued that § 1041 somehow gave her a fair market value basis in the stock.

The court agreed that § 1041 did not apply. But this fact meant less than the husband thought. The husband relied on cases involving transfers incident to divorce before § 1041 was enacted, but the instant transaction was not a transfer incident to divorce. Such a transfer is fundamentally an exchange of ownership of property for rights in other property, or sometimes other rights under domestic relations law. In the present case, the husband simply made a gift to his current wife; he received nothing in return. Under longstanding principles of tax law, where gifted property has appreciated, a donee assumes the donor’s basis. The husband paid nothing for the stock—it was a benefit of employment—so his basis was zero.

Lessons:

1. Remember that 1041 does not apply to transfers to nonresident aliens.

2. There is little gain in trying to apply 1041, or federal cases decided before § 1041, to transfers that are not, in substance, exchanges of property for other property or other rights under the law of domestic relations. The federal courts know a divorce settlement when they see one. Hughes did not involve a divorce settlement.