Arizona Family Law Lawyer & Attorney : NRG - Nirenstein Ruotolo Group

In PLR 200442003, the IRS recently addressed the tax consequences of a present-value buy-out of future SERP payments. This ruling is particularly useful for taxpayers structuring divorce settlements where significant marital assets consist of inchoate promises from the employee's employer to pay both spouses pension benefits in the future, but payment of those benefits are subject to the claims of the employer's creditors until the payments are actually made. This ruling is timely in light of the enactment of new Section 409A by the 2004 American Jobs Creation Act (P.L. 108-357) on October 22, 2004. This new section dramatically changed the rules governing nonqualified deferred compensation, such that more buy-outs, like the
one discussed in PLR 200442003, may presently be under active consideration.

By way of background, in Rev. Rul. 2002-22, 2002-19 I.R.B. 849, the IRS issued guidance on the tax consequences of transactions where nonqualified deferred compensation is transferred to a former spouse pursuant to a divorce. Basically, the former spouse is subject to income tax with respect to the transferred amounts. In connection with Rev. Rul. 2002-22, the IRS also issued Notice 2002-31, 2002-19 I.R.B. 908, setting forth its proposed treatment of the FICA, FUTA, income tax withholding and reporting consequences for divorce-related transfers. In June, 2004, the IRS finalized those proposed
rules in Rev. Rul. 2004-60, 2004-24 I.R.B. 1051, which places the burden of paying the individual share of FICA tax associated with the transferred amounts on the former spouse, but the employee gets credit for these amounts as FICA wages for purposes of determining Social Security benefits.

In PLR 200442003, the parties' original marital property settlement required the employee (H) to pay the ex-spouse (W) a portion of each SERP distribution as the distributions were made (presumably in the form of installments or an annuity payable over the life expectancy of the employee). The distributions would not begin until H retired after a certain age. After many years passed, H attained the minimum age for distributions to begin, but H choose to continue working and, therefore, did not begin to receive SERP payments. W believed that H's continued employment was primarily intended to disenfranchise her from receiving her agreed upon portion of the SERP payments, in as much as if H died while still employed, the death benefits under the SERP would go to H's estate (and thus, would not inure to the benefit of W). W filed an action with the divorce court seeking either to compel H to pay her the distributions that should have been made from the SERP had H retired, or to compel H to buy out her share of the SERP stream of payments in a lump sum or installments. The parties settled on a lump sum buy-out amount and transferred the amount into a trust held by H's attorney, which would be disbursed to W only upon the receipt of a favorable private letter ruling as to the tax treatment of the transfer. The parties stipulated that, while the settlement amount was held by H's attorney, H had not surrendered dominion and control over the funds, such that W had not received any economic benefit of the amount held in trust and would not be in constructive receipt of the amount held in trust. The transfer raised three issues: (1) whether the buy-out amount was taxable income to W; (2) whether W's release of her claims against the SERP distributions was taxable income to H under an assignment of income theory; and (3) whether gift tax applied to the transactions.

PLR 200442003 stated that the parties were divorced more than six years before they amended their marital property settlement to reflect the negotiated SERP buy-out. Even though Regs. Section 1.1041-1T(b) Q&A 7 specifically sets forth a six-year look back rule for tax-free marital transfers, the IRS noted that cases decided after the regulations were issued have held that any order from a divorce court that specifically modifies an original divorce instrument must be considered related to the cessation of the marriage, even if such order occurs many years after the divorce. Accordingly, since the buy-out was an amendment of their original divorce instrument, it satisfied the requirements for a tax-free transfer pursuant to divorce under Section 1041. Furthermore, the ruling concluded that the courts and the IRS have long recognized that the assignment of income doctrine does not apply to transfers of income rights between divorcing spouses because such transfers are not voluntary assignments within the scope of that doctrine. Therefore, since
this transfer was in connection with a divorce, the transfer would not be subject to the assignment of income doctrine. Finally, the ruling concluded that no gift tax would be assessed as a result of the transaction because it was a transfer for "full and adequate consideration in money or money's worth" under Section 2516 and, therefore, was not a gift by either H or W to the other. (PLR 200442003 ; IRS, 6/22/04, released 10/15/04)

[The IRS cautions that private letter rulings are directed to the taxpayers who request them, and that they may not be used or cited as precedent.]