With some exceptions, any transfer of property is subject to the gift tax, including transfers made pursuant to a settlement agreement in a divorce action. gift boxThat is the general rule. So generally, your settlement agreement would, or is supposed to be, subject to the gift tax as prescribed by the Federal Internal Revenue Code, where one spouse transfers property to the other spouse….
But it is one confusing mess because, first of all, there are all these exceptions to the general rule. And second of all, the tax laws change so frequently, that it is never a good idea to say: this is the law. I can say this used to be the law about a year ago. But who knows what changes have occured since? That is why it is always wise to have a tax accountant as part of your divorce team….(Check out these posts too,
Normally, it used to be (and likely still is) the rule, that if the transfer of property (example, cash, real estate, etc) in a divorce action fell within these exceptions, you did not pay a gift tax:
1. Transfer based on a court decree (where the settlement agreement is incorporated into the divorce decree);
2. a deductible transfer between spouses (made during a calendar year the couple was married even if they divorced by the end of the year);
3. a transfer made pursuant to the annual $10,000 exclusion, the exclusion for educational or medical expenses or the exclusion for waiver of pension rights (doesn’t matter if you are married or not);
4. A transfer where consideration is deemed given (usu. where a husband and wife have an agreement prior to even discussing divorce that they would handle their property in a certain way and they later (no more than 2 years) decided to divorce, any transfer that was made in this set up is not subject to the gift tax).
5. A transfer where support rights are relinquished (property in exchange for support is not subject to the gift tax)
6. A transfer where an immediately enforceable right in property is relinquished.
(See the Internal Revenue Code Section 25 generally) See also, Harris v. Commissioner of Internal Revenue, 178 F.2d 861, 50-1 USTC P 10746 (2d Cir. 1949); See also New York Law of Domestic Relations by Alan Scheinkman.)
But all the goobledeegook basically boils down to the United States Supreme Court holding in Harris v. Commissioner of Internal Revenue where the Supreme court basically held that “settlement agreements  between spouses are not regarded as taxable gifts when the settlement agreement is incorporated into the divorce decree.” That is pretty much the bottom line.
The thing that is confusing about that, certainly in New York, is that nobody can get divorced without a judge signing off on the divorce decree. Even an UNCONTESTED DIVORCE must be signed off on by a judge. There must be a decree and findings of facts and conclusions of law. Thus, my big question is, when would a property settlement ever be subject to the gift tax if all settlements will be subject to a divorce decree? If the answer is “never”, if a property settlement is never subject to the gift tax, then why even have all this confusing goobledeegook in the statute in the first place making an exception for divorce decrees? Is that solely to confuse me? Or what?
I must be missing something… If anybody out there can articulate something contrary or give a specific example of when a property settlement would be subject to the gift tax, I would be happy to entertain it. But I can’t see when it ever would be since all property settlements (certainly in New York) are subject to a court decree (the judge has to sign off on each and every divorce for it to be valid!) and thus would never incur a gift tax on said settlement.
So, again. In theory. The general rule is, you don’t pay gift taxes on your settlement agreement and any property that is transferred between spouses in this agreement so long as the agreement is “incorporated into your divorce decree.”
Originally published April 21, 2009
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