Deferred divorce-settlement payments receive nonrecognition and transfer-tax relief

Plain-English summary

Two spouses used a written settlement agreement to divide their marital property through equal annual payments over a redacted number of years, with an option for a discounted lump-sum prepayment. Some payments would occur more than six years after the divorce, but the IRS accepted the parties’ reasons for the longer schedule and ruled that the payments remained incident to divorce under IRC § 1041. That means neither the periodic payments nor a lump-sum prepayment produces recognized gain or loss. Sections 483 and 1274 do not impute interest to a transfer governed by § 1041, and the IRS also ruled that § 7872 would not recharacterize part of the payments as interest. Because the divorce followed the written agreement within the period required by § 2516, the payments were for full and adequate consideration and were not subject to gift tax. If the paying spouse dies before completing the schedule, the estate may deduct amounts actually and timely paid under the agreement.

Ruling snapshot

• Question: What income, interest, gift-tax, and estate-tax rules apply to deferred property-settlement payments incident to divorce?
• Outcome: Approved (nonrecognition, no imputed interest, no gift tax, and an estate deduction for qualifying payments).
• Key authorities: IRC §§ 483, 1041, 1274, 2043, 2053, 2501, 2516, and 7872.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202137005 Third Party Communication: None
Release Date: 9/17/2021 Date of Communication: Not Applicable
Index Number: 1041.00-00
Person To Contact:
--------------- --------------------, ID No. -----------------
---------------------------- Telephone Number:
-------------------- --------------------
Refer Reply To:
CC:ITA:B04
PLR-128868-20
Date:
June 16, 2021

Taxpayer = -----------------------------------------

Spouse = ---------------------------------------

State = -------------

Date 1 = -------------------

Date 2 = ------------------

$X = -----------

B Years = ----

E days = ---

F days = ---

Dear -----------:

This letter responds to your private letter ruling request, dated December 14, 2020,
related to your divorce decree and property distribution. Specifically, you requested the
following rulings: (1) that the annuity payment arrangement set forth in Taxpayer and
Spouse’s (collectively, “the parties”) Stipulation and Settlement agreement
(“agreement") qualifies for nonrecognition of gain as transfers that are incident to a
divorce pursuant to § 1041 of the Internal Revenue Code; (2) that no portion of the
payments under the parties' annuity payment arrangement will be characterized as
interest under § 483, 1274, or 7872; (3) that the payments by Taxpayer to Spouse
under the parties' annuity payment arrangement will constitute transfers for "full and
PLR-128868-20 2

adequate consideration in money or money's worth" under § 2516; and (4) that in the
event of Taxpayer’s death prior to the full satisfaction of the payments under the
settlement agreement, the payment of the outstanding amount will be deductible under
§ 2053. This letter ruling is being issued electronically in accordance with Rev. Proc.
2020-29, 2020-21, I.R.B. 859. A paper copy will not be mailed to Taxpayer.

                                     FACTS

Taxpayer represents that the facts are as follows.

On Date 1, Taxpayer and Spouse entered into an agreement regarding their marital and
property rights. Among other things, the parties intended that the agreement serve to
effectuate a complete and total division of property between Taxpayer and Spouse
under the equitable distribution provisions of State A law and except to the extent
provided in the agreement, Taxpayer and Spouse mutually waived their rights and
released each other from any claims for maintenance, distribution of marital property,
distributive awards, and special relief or claims regarding separate property.

Pursuant to the agreement, Taxpayer agreed to pay Spouse $X annually, with the first
payment due on the anniversary date of the entry of the divorce decree, for a period of
B Years. The agreement set forth the date and amount of each equal annual payment.
The agreement also stated that Spouse could elect to receive a discounted lump sum
prepayment of all remaining annual payments if Spouse made the election and gave E
days’ prior notice to Taxpayer. The agreement did not provide for stated interest on the
annual payments or on any prepayment.

The agreement further provided that upon Taxpayer’s death, prior to the payment of all
amounts due to Spouse, the executor is required to promptly pay any annual payment
then due plus any prepayment amount then reflected in the agreement within F days of
the appointment of the legal representative of Taxpayer’s estate, and such unpaid
balance becomes a first charge and lien against Taxpayer's estate and any trust
Taxpayer may create during the Taxpayer’s lifetime. Similarly, in the case of
Taxpayer’s incompetence, Taxpayer's legal representative is obligated to pay any
annual payment then due plus any prepayment amount then reflected in the agreement
within F days of a determination of Taxpayer's incompetence. A reciprocal set of similar
provisions apply in the case of Spouse’s death or determination of incompetence.

On Date 2, a divorce decree was granted by the Court in State A. The Court ordered
that all of the terms and provisions of the agreement are legally enforceable, and that
Taxpayer and Spouse are directed to comply with all legally enforceable terms and
provisions of the agreement. The Court retained jurisdiction for purposes of enforcing
the settlement.
PLR-128868-20 3

                              LAW AND ANALYSIS

Ruling 1

Section 1041(a) provides that no gain or loss is recognized on a transfer of property
from an individual to a spouse or former spouse if the transfer is incident to a divorce.
The purpose of § 1041 is to defer the tax consequences, recognition of gain or loss,
until the transferee disposes of the property.

Section 1041(b)(1) and (2) provides that in the case of any transfer to which § 1041(a)
applies, the property is treated as acquired by the transferee by gift for Federal income
tax purposes, and further, that the transferee’s basis is the transferor's adjusted basis
immediately before the transfer.

Under § 1041(c)(2), in order for a transfer of property to be "incident to a divorce," the
transfer must occur within one year after the date of divorce or must be related to the
cessation of the marriage. Q&A7 of Temporary § 1.1041-lT(b) of the Income Tax
Regulations provides that the transfer of property is treated as related to the cessation
of the marriage if the transfer is pursuant to a divorce or separation instrument, as
defined in § 71(b)(2), and the transfer occurs not more than six years after the date on
which the marriage ceases. Any transfer not pursuant to a divorce or separation
instrument and any transfer occurring more than six years after the cessation of the
marriage is presumed to be not related to the cessation of the marriage. This
presumption may be rebutted only 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. For example, the presumption may be rebutted by showing that (a) the
transfer was not made within the one and six-year periods described above because of
factors which hampered an earlier transfer of the property, such as legal or business
impediments to transfer or disputes concerning the value of the property owned at the
time of the cessation of the marriage, and (b) the transfer is effected promptly after the
impediment to transfer is removed.

Here, Taxpayer and Spouse entered into an agreement on Date 1 to effectuate a
complete and total division of property in anticipation of divorce. Pursuant to the
agreement, Taxpayer agreed to pay Spouse $X annually for a period of B Years, with
some payments extending past the six-year presumptive period. The agreement set
forth the date and amount of each equal annual payment.

Since some of the payments extend past the six-year presumptive period, Taxpayer
may rebut the presumption and show that the payments are being made to effect the
division of property at the time of the divorce. Here, Taxpayer and Spouse have
structured their agreement to extend the transfers beyond the six-year period for
reasons we find reasonable in light of all the circumstances. Accordingly, under § 1041,
we find the $X annual payment for a period of B Years, as well as any lump sum
PLR-128868-20 4

discounted prepayment, to be incident to the divorce. Therefore, no gain or loss is
recognized on any periodic or lump sum payment made pursuant to the agreement.

Ruling 2

Sections 483 and 1274

Sections 483 and 1274 contain rules for partially recharacterizing as interest certain
deferred payments made in connection with the sale or exchange of non-publicly traded
property pursuant to a contract (§ 483) or debt instrument (§ 1274), whichever Code
section is applicable. In general, §§ 483 and 1274 provide that the contract or debt
instrument must provide for adequate stated interest. If the contract or debt instrument
does not provide for adequate stated interest, a portion of each deferred payment may
be recharacterized as interest for tax purposes under either § 483 or § 1274, whichever
is applicable.

Sections 483 and 1274 do not apply to a contract or debt instrument that is related to a
transfer of property subject to § 1041. See §§ 1.483–1(c)(3)(i) and 1.1274–1(b)(3)(iii).
Because the agreement, pursuant to which the periodic payments and lump sum
discounted prepayments are to be made, is related to a transfer of property subject to
§ 1041, §§ 483 and 1274 do not apply to characterize any portion of those payments as
interest.

Section 7872

Section 7872 recharacterizes a below-market loan (a loan on which the interest rate
charged is less than the applicable Federal rate) as two transactions. First, there is an
arm’s length transaction in which the lender makes a loan to the borrower in exchange
for a note requiring the payment of interest at the applicable Federal rate; second, there
is a transfer of funds by the lender to the borrower (“the imputed transfer”). The timing
and characterization of the imputed transfer by the lender to the borrower are
determined in accordance with the substance of the transaction.

The legislative history of § 7872 indicates that the term “loan” should be interpreted
broadly. Any transfer of money that provides the transferor with a right to repayment
may be a loan. For example, deposits of all kinds may be treated as loans. H.R. Conf.
Rep. No. 861, 98th Cong., 2d Sess. 1018 (1984), 1984–3 (Vol. 2) C.B. 272.

Congress intended that § 7872 would apply only to the below-market loans enumerated
in subparagraphs (A) through (F) of § 7872(c)(1), including gift loans and tax avoidance
loans. Under § 7872(c)(1)(E), a loan that is not specifically enumerated may also be
subject to § 7872 to the extent provided in regulations if the interest arrangement has
significant effect on the tax liability of the borrower or the lender. H.R. Conf. Rep. No.
861 at 1018–19.
PLR-128868-20 5

Section 7872(f)(3) provides that the term “gift loan” means any below-market loan
where the foregone interest is in the nature of a gift. In general, there is a gift if property
(including foregone interest) is transferred for less than full and adequate consideration
under circumstances where the transfer is a gift for gift tax purposes. A sale, exchange,
or other transfer made in the ordinary course of business (i.e., a transaction which is
bona fide, at arm’s length and free from donative intent) generally is considered as
made for full and adequate consideration. H.R. Conf. Rep. No. 861 at 1018.

Section 7872(c)(1)(D) states that § 7872 applies to any below-market loan which has as
one of its principal purposes the avoidance of any Federal tax. The legislative history of
§ 7872 provides that a below-market loan is a tax-avoidance loan if one of the principal
purposes of the interest arrangement of the loan is the avoidance of any Federal tax by
either the borrower or the lender. Tax avoidance is a principal purpose of the interest
arrangement if it is a principal factor in the decision to structure the transaction as a
below-market loan, rather than a loan requiring the payment of interest at a rate that
equals or exceeds the applicable Federal rate and a payment by the lender to the
borrower. H.R. Conf. Rep. No. 861 at 1019.

Section 7872(f)(3) provides that, for purposes of § 7872, a husband and wife shall be
treated as one person and, therefore, any loan between a husband and wife is ignored
for purposes of § 7872. In addition, the transfers in the instant case were negotiated
between a husband and wife at arm’s length in order to divide marital property incident
to a divorce. Further, the transfers were not motivated by donative intent or with a
principal purpose of the avoidance of any Federal tax. Based on the foregoing, we do
not believe § 7872 was intended to apply to transactions such as the transaction in the
instant case and, therefore, § 7872 does not apply to characterize any portion of the
periodic or lump sum discounted prepayments as interest.

Ruling 3

Section 2501(a) imposes a gift tax for each calendar year on the transfer of property by
gift during the calendar year. Section 2511 provides that the gift tax applies whether the
transfer is in trust or otherwise, whether the gift is direct or indirect, and whether the
property is real or personal, tangible or intangible.

Section 2512(b) provides that where property is transferred for less than an adequate
and full consideration in money or money's worth, then the amount by which the value
of the property exceeded the value of the consideration shall be deemed a gift, and
shall be included in computing the amount of gifts made during the calendar year.
Section 25.2512-8 of the Gift Tax Regulations provides, in relevant part, that a
relinquishment or promised relinquishment of dower or curtesy, or of a statutory estate
created in lieu of dower or curtesy, or other marital rights in the spouse's property or
estate, shall not be considered to any extent a consideration “in money or money's
worth.” However, § 25.2512-8 indicates that § 2516 and the regulations thereunder
provide specific rules with respect to certain transfers incident to a divorce.
PLR-128868-20 6

Section 2516 provides, in relevant part, that where a husband and wife enter into a
written agreement relative to their marital and property rights and divorce occurs within
the three-year period beginning on the date one year before such agreement is entered
into (whether or not such agreement is approved by the divorce decree), any transfers
of property or interests in property made pursuant to such agreement to either spouse in
settlement of his or her marital or property rights shall be deemed to be transfers made
for a full and adequate consideration in money or money's worth. Section 25.2516-1(a)
provides that transfers of property or interests in property made under the terms of a
written agreement between spouses in settlement of their marital or property rights are
deemed to be for an adequate and full consideration in money or money's worth
(whether or not the agreement is approved by a divorce decree), if the spouses obtain a
final decree of divorce from each other within two years after entering the agreement.

Here, Taxpayer and Spouse entered into the agreement on Date 1. A final divorce
decree was issued on Date 2, within the three-year period provided under § 2516. On
these facts, we conclude that Taxpayer’s payments to Spouse in settlement of Spouse’s
marital or property rights are treated as transfers made for a full and adequate
consideration in money or money's worth and therefore will not be subject to gift tax
under § 2501.
Ruling 4

Section 2053(a)(3) provides that the value of the taxable estate shall be determined by
deducting from the value of the gross estate such amounts for claims against the estate
as shall be allowable by the laws of the jurisdiction under which the estate is being
administered. Under § 2053(c)(1), the deduction allowed for claims against the estate,
when founded on a promise or agreement, is limited to the extent the claim was
contracted bona fide and for an adequate consideration in money or money's worth.
Section 2053(e) provides a cross-reference to § 2043(b)(2) treating certain
relinquishments of marital rights as consideration in money or money's worth.
Section 2043(b)(1) provides a general rule that for estate tax purposes, a
relinquishment or promised relinquishment of marital rights in a decedent's property or
estate is not considered to any extent a consideration in “money or money's worth.”
However, § 2043(b)(2) provides that a transfer of property that satisfies the
requirements of § 2516 relating to certain property settlements shall be considered to be
made for an adequate and full consideration in money or money's worth.
Section 20.2053-1(d)(1) provides, in part, that to take into account properly events
occurring after the date of a decedent’s death in determining the amount deductible
under § 2053, the deduction for any claim is limited to the total amount actually paid in
settlement or satisfaction of that item.
Section 20.2053-4(a) provides, in part, that liabilities imposed by law or arising out of
contracts or torts are deductible if they meet the applicable requirements set forth in
§§ 20.2053-1 and 20.2053-4. To be deductible, a claim against a decedent's estate
must represent a personal obligation of the decedent existing at the time of the
PLR-128868-20 7

decedent's death. Except as otherwise provided in § 20.2053-4(b) and (c) and to the
extent permitted by § 20.2053-1, the amounts that may be deducted as claims against a
decedent's estate are limited to the amounts of bona fide claims that are enforceable
against the decedent's estate (and are not unenforceable when paid) and claims that
are actually paid by the estate in satisfaction of the claim. Events occurring after the
date of a decedent's death shall be considered in determining whether and to what
extent a deduction is allowable under § 2053. See § 20.2053-1(d)(2).
On Taxpayer’s death prior to the payment of all amounts due to Spouse, Taxpayer’s
executor is required to promptly pay any annual payment then due plus any prepayment
amount then reflected in the schedule of payments that is part of the agreement. The
Court in State A has retained jurisdiction for purposes of enforcing the agreement, if
need be. As discussed above, the agreement satisfies the requirements of § 2516 such
that transfers made pursuant to it are considered to be made for an adequate and full
consideration in money or money's worth within the meaning of § 2053(c)(1).
Accordingly, we conclude that a deduction is allowable for the amounts actually and
timely paid pursuant to the agreement in satisfaction of the schedule of payments.
Based on the facts and representations submitted by the Taxpayer, we rule as follows:

(1) Section 1041 applies to the transfers made by Taxpayer to Spouse pursuant to
the agreement and are nontaxable transfers pursuant to § 1041.
(2) No portion of the transfers made by Taxpayer to Spouse pursuant to the
agreement will be characterized as interest under § 483, 1274, or 7872.
(3) Taxpayer’s payments to Spouse in settlement of Spouse’s marital or property
rights are treated as transfers made for a full and adequate consideration in
money or money's worth and therefore will not be subject to gift tax under §
2501.
(4) A deduction is allowable for the amounts actually and timely paid pursuant to the
agreement in satisfaction of the schedule of payments.

Pursuant to section 7.06 of Rev. Proc. 2021-1, 2021-1 I.R.B. 1, Taxpayer must attach a
copy of this letter ruling to any Federal income tax return to which it is relevant. If
Taxpayer files its returns electronically, it may satisfy this requirement by attaching a
statement to the return that provides the date and control number of this letter ruling.

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter.

The ruling contained in this letter is based upon information and representations
submitted by Taxpayer and accompanied by a penalty of perjury statement executed by
an appropriate party. However, this office has not verified any of the material submitted
in support of the request for this ruling, and therefore it is subject to verification on
examination.
PLR-128868-20 8

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) provides
that it may not be used or cited as precedent.

Pursuant to the provisions of a power of attorney currently on file, we are sending a
copy of this letter ruling to Taxpayer’s authorized representative.

If you have any questions concerning this matter, please contact ------------------------ at --
---------------------.

                                    Sincerely,



                                    Ronald J. Goldstein
                                    Senior Technician Reviewer
                                    (Income Tax & Accounting)

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