Mr. and Mrs. Davis were
getting a divorce. As part of the settlement, Mr. Davis agreed to give
some stocks to his ex-wife.
Ms. Davis didn't give
anything to Mr. Davis in return.
The IRS claimed Mr. Davis owed
taxes because he had a realized gain
from the transfer of stock, despite the fact he didn't receive anything.
The IRS argued that Davis
received the benefit of being released from his legal, marital
obligations (like paying alimony) to Ms. Davis. The IRS felt that relief
must be worth something.
There is known value of
relief for marital obligations. However, the value of the stock is
known. So the IRS assumed that the value of the relief was equal to the
value of the stock.
That's the analysis used
in Philadelphia Park Amusement Co. v. United States (126 F.Supp. 184 (1954)).
Therefore, the IRS argued
that Mr. Davis' realized gain was
the value of what he got (relief from marital obligations (aka the amount
realized)), - the initial cost of the
stocks (aka the adjusted basis),
and based on 26 U.S.C. §1001, you have to pay taxes on realized
gains.
The US Supreme Court found for
the IRS.
The US Supreme Court agreed
with the IRS's analysis.
Mr. Davis argued that in a
community property State, the stock would have been considered to be
legally-owned by both spouses, while it would not be in a common-law
State. So it is a violation of equal protection. However the Court disagreed.
In response to this decision,
Congress passed §1041, which
basically reversed Davis and said that during a divorce, the recipient and
the transferor of the property will not have any income.
Congress felt that divorce
was difficult enough without dragging tax issues into the division of
property.
