Divorce Estate Planning Opportunity

Adding flexibility to estate and tax plans is crucial given the uncertainties in our current estate tax laws and the uncertainties of our market and individual client situations. Creative estate planning attorneys have found a great number of ways to add this type of flexibility given specific client facts and goals. Private Letter Ruling 12572406 provides an example of one way that divorcing spouses can add flexibility to their tax and estate plans using property settlement agreements.

The facts in this particular letter ruling are as follows: Husband and wife signed a property settlement agreement pursuant to their divorce proceeding. The husband was the CEO of a publicly traded company and he owned approximately 24% of the company stock at the time that they entered into the agreement.

The agreement provided that the husband would include a provision in his will for his wife to receive a portion of the shares equal to 24% of the company stock held by the husband. The divorce court approved the property settlement agreement.

An undisclosed number of years later, the husband and wife renegotiated the property settlement agreement to provide that the husband would currently turn over one half of the amount of stock to his wife that the husband had agreed to, with the other one half to be turned over to the wife upon the husband’s demise.

The IRS ruled that this accelerated lifetime payment by the husband to the wife was (1) not taxable income to the husband or wife and (2) not a taxable gift from the husband to the wife.

The IRS reasoned that the accelerated lifetime payment by the husband to the wife was not taxable income to the husband or wife because the transfer was “related to the cessation of marriage.” The IRS reached this conclusion even though it appears that the modification of the property settlement agreement occurred “years after the divorce.”

The IRS reasoned that the accelerated lifetime payment by the husband to the wife was not a taxable gift from the husband to the wife based on the same reasoning.

As in this private letter ruling, taxpayers can add flexibility to their tax and estate plans by entering into financial-motivated property settlement agreements. This type of arrangement could prove invaluable in reducing estate tax liabilities where one ex-spouse’s assets are expected to increase substantially over time prior to that spouses demise.

If the assets do increase in value or the spouse (say as CEO of a company whose stock is subject to the agreement, assuming that no insider trading rules are violated or that the stock is for a privately held company) expects that the asset is about to appreciate substantially in excess of any estate tax exclusion available for the owner, the owner would have the option of making a tax-free lifetime transfer to the ex-spouse (apparently) any time before the death of either spouse.

Given the right facts, this estate tax freeze technique could be much more powerful than other more common estate tax freeze techniques.