                        T.C. Memo. 2016-113



                  UNITED STATES TAX COURT



              JOSEPH R. BELOT, Petitioner v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 13232-13.                         Filed June 13, 2016.



       Petitioner and Ms. Belot formed and jointly owned three
businesses during their marriage. They were divorced in 2007.
Pursuant to the settlement agreement entered into at the time of
petitioner’s divorce, they agreed to own and operate the businesses as
equal partners. When it became clear that they were unable to operate
the businesses together to their mutual satisfaction, Ms. Belot filed a
lawsuit against petitioner to gain full control over the businesses. In
2008, 16 months after the initial settlement and divorce, they entered
into a settlement agreement under which petitioner transferred his
interests in the businesses to Ms. Belot in exchange for payment.

       Held: The division of property held during the marriage of
petitioner and Ms. Belot accomplished by the 2008 settlement
agreement qualifies for nonrecognition treatment under I.R.C. sec.
1041.
                                         -2-

[*2] John J. Eagan, for petitioner.

      Rachel L. Schiffman, Shawna A. Early, and Jamie J. Song, for respondent.



                            MEMORANDUM OPINION


      COLVIN, Judge: Respondent determined that petitioner had deficiencies of

$199,625 for 2008 and $287 for 2010 and is liable for penalties under section

6662(a) of $39,925 for 2008 and $57 for 2010. After concessions, the issue for

decision is whether petitioner’s sale of his interests in the marital businesses to Ms.

Belot pursuant to the 2008 settlement agreement qualifies for nonrecognition

treatment under section 1041.1 We hold that it does.

      The parties submitted this case fully stipulated under Rule 122, reflecting

their agreement that the relevant facts could be presented without a trial. We

granted that motion.2




       1
        Section references are to the Internal Revenue Code, as amended and in
effect for the years at issue. Rule references are to the Tax Court Rules of Practice
and Procedure. We have rounded monetary amounts to the nearest dollar.
       2
      The burden of proof is generally on the taxpayer, see Rule 142(a), and the
submission of a case under Rule 122 does not alter that burden, see Borchers v.
Commissioner, 95 T.C. 82, 91 (1990), aff’d, 943 F.2d 22 (8th Cir. 1991).
                                         -3-

[*3]                                Background

        Petitioner resided in New Jersey when he filed the petition. Petitioner and

Ms. Belot (his former spouse) were married from July 1, 1989, through January 8,

2007.

A.      The Marital Businesses

        In September 1989 petitioner and Ms. Belot opened a traveling dance school,

for which they reported income and expenses on Schedule C, Profit or Loss From

Business. In 1996 they incorporated Gotta Dance, Inc. (Gotta Dance), in New

Jersey as a C corporation. Its primary business activity was the operation of dance

studios. From the time of its incorporation through March 24, 2006, Ms. Belot was

the sole shareholder of Gotta Dance.

        On March 6, 1997, petitioner and Ms. Belot formed Gotta Dance Boutique,

LLC (Boutique). Its primary business activity was the retail sale of dancewear and

accessories. From the time of its formation through May 22, 2008, they each

owned 50% of Boutique.

        On July 1, 1999, petitioner and Ms. Belot formed Jobee Realty, LLC (Jobee).

Jobee was treated as a partnership for Federal tax purposes. Its primary business

activities involved holding and leasing real estate, including leasing dance studios

to Gotta Dance. From the time of its formation through March 24, 2006, Ms. Belot
                                         -4-

[*4] owned 49% of Jobee and petitioner owned 51% of Jobee. Petitioner and Ms.

Belot jointly made decisions with respect to Gotta Dance, Boutique, and Jobee

(businesses). Petitioner focused on managing the financial aspects of the

businesses. Ms. Belot was primarily responsible for dance-related aspects of the

businesses, including instruction, hiring, training, recruitment, and payroll.

B.    The Divorce and the 2007 Settlement Agreement

      In 2005 Ms. Belot hired an attorney and began the process of filing for

divorce from petitioner. On January 24, 2006, the divorce action commenced in

the Superior Court of New Jersey, Chancery Division, Family Part, Somerset

County (family court).

      On March 24, 2006, petitioner and Ms. Belot signed a consent order with the

family court. Pursuant to that order, they equalized their ownership interests in

Gotta Dance and Jobee. Ms. Belot transferred 50% of the stock in Gotta Dance to

Petitioner. This transaction is reflected in a stockholders agreement among Gotta

Dance, petitioner, and Ms. Belot. Also on March 24, 2006, petitioner transferred a

1% interest in Jobee to Ms. Belot. This transaction is reflected in an operating

agreement among Jobee, petitioner, and Ms. Belot. Once these transactions were

complete, petitioner and Ms. Belot each owned a 50% interest in Boutique, Gotta

Dance, and Jobee.
                                         -5-

[*5] On January 8, 2007, the family court entered a dual judgment of divorce.

The following documents were attached to the dual judgment of divorce: (1) a

settlement agreement dated January 8, 2007; (2) a final consent order regarding

custody and parenting time filed March 24, 2006; and (3) a consent order filed on

March 29, 2006, which included the Gotta Dance stockholders agreement and the

Jobee operating agreement. The dual judgment of divorce incorporated a property

settlement agreement (2007 settlement agreement), which included the March 2006

consent order.

C.    The 2008 Settlement Agreement

      On September 21, 2007, Ms. Belot filed a verified complaint for emergent

and injunctive and other damages and relief against petitioner and Gotta Dance.

Ms. Belot contended that petitioner had mismanaged the business and sought to

remove petitioner as director and employee of Gotta Dance and to compel him to

sell his shares of Gotta Dance either to the corporation or to Ms. Belot.

      On April 11, 2008, petitioner and Ms. Belot entered into a settlement

agreement (2008 settlement agreement) regarding the lawsuit. Pursuant to the 2008

settlement agreement, Ms. Belot agreed to purchase from petitioner all of his

interests in Gotta Dance, Boutique, and Jobee for a total of $1,580,000, paid as

follows: (1) $900,000 to be paid at closing and (2) the balance of $680,000,
                                         -6-

[*6] evidenced by a promissory note, payable in equal monthly installments on the

first of each month beginning June 1, 2008, over 10 years bearing interest at the

fixed rate of 5% on the principal amount outstanding. The amount of each monthly

payment under the promissory note was $7,212.46.

      On May 22, 2008, petitioner and Ms. Belot executed a stock and

membership interest purchase agreement regarding the ownership of the

businesses. The stock and membership interest purchase agreement allocated the

total $1,580,000 among the interests in the businesses as follows: (1) $1,080,000

for the interest in Gotta Dance; (2) $475,000 for the interest in Jobee; and

(3) $25,000 for the interest in Boutique. Petitioner’s basis in each business is not

in dispute. Petitioner executed a stock power instrument in which he sold,

assigned, and transferred his 500 shares of Gotta Dance, representing a 50%

interest, to Ms. Belot. Petitioner also executed an assignment of membership

interest in which he transferred his 50% interest in Jobee and 50% interest in

Boutique to Ms. Belot. On July 18, 2008, the general equity court entered a

consent order of dismissal in the lawsuit.
                                          -7-

[*7]                                   Discussion

A.     The Issue for Decision

       The issue for decision is whether petitioner’s sale to Ms. Belot of his

interests in the marital businesses pursuant to the 2008 settlement agreement

qualifies for nonrecognition treatment under section 1041.

B.     Section 1041

       Section 1041 provides:

       SEC. 1041. TRANSFERS OF PROPERTY BETWEEN SPOUSES OR
                  INCIDENT TO DIVORCE.

              (a) General Rule.--No gain or loss shall be recognized on a
       transfer of property from an individual to (or in trust for the benefit
       of)--

                    (1) a spouse, or

                   (2) a former spouse, but only if the transfer is incident to the
             divorce.

                    *      *       *       *        *      *       *

              (c) Incident to Divorce.--For purposes of subsection (a)(2), a transfer
       of property is incident to the divorce if such transfer--(1) occurs within 1
       year after the date on which the marriage ceases, or (2) is related to the
       cessation of the marriage.

Congress enacted section 1041 in response to United States v. Davis, 370 U.S. 65

(1962), in which the Supreme Court held that a transfer of appreciated property to a
                                          -8-

[*8] spouse (or a former spouse) in exchange for the release of marital claims

results in the recognition of gain to the transferor. The Ways and Means

Committee Report accompanying the enactment of section 1041 provided the

following reasons for the change:

             The committee believes that, in general, it is inappropriate to tax
      transfers between spouses. This policy is already reflected in the Code
      rule that exempts marital gifts from the gift tax, and reflects the fact
      that a husband and wife are a single economic unit * * * Often the
      [current] rules have proved a trap for the unwary, as, for example,
      where the parties view property acquired during marriage * * * as
      jointly owned, only to find that the equal division of the property upon
      divorce triggers recognition of gain. [H.R. Rept. No. 98-432 (Part 2),
      at 1491 (1984), 1984 U.S.C.C.A.N. 697, 1134.]

C.    Temporary Regulations

      Section 1.1041-1T(b), Q&A-7, Temporary Income Tax Regs., 49 Fed. Reg.

34453 (Aug. 31, 1984) (regulation), provides the following (we have numbered the

sentences to facilitate our references to the regulation):

      [1] A 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 section 71(b)(2), and the transfer occurs not
      more than 6 years after the date on which the marriage ceases.
      [2] A divorce or separation instrument includes a modification or
      amendment to such decree or instrument. [3] Any transfer not
      pursuant to a divorce or separation instrument and any transfer
      occurring more than 6 years after the cessation of the marriage is
      presumed to be not related to the cessation of the marriage. [4] 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
                                          -9-

      [*9] the time of the cessation of the marriage. [5] 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.

D.    Analysis

      Petitioner and Ms. Belot made two attempts to satisfactorily divide their

marital businesses. The first attempt was the 2007 settlement agreement, in which

they agreed to equalize their interests in the businesses and to run the businesses as

partners. The 2007 settlement agreement quickly proved unsatisfactory. In the

2008 (second) settlement agreement, which settled a lawsuit brought by Ms. Belot,

petitioner agreed to sell to her all of his interests in the marital businesses in

exchange for specified payments.

      Respondent does not contend that the division of property under the second

settlement agreement was not “made to effect the division of property owned by the

former spouses at the time of the cessation of the marriage.” Instead, respondent

contends that the transfer under the second settlement agreement does not qualify

under the regulations because the transfer did not relate to the divorce instrument.

We disagree. Respondent’s contention that the division of marital property must
                                        - 10 -

[*10] relate to the divorce instrument is based on the first, second, and third

sentences of the regulation (which refer to the divorce instrument) but overlooks

the fourth sentence. The third sentence of the regulation provides that there is a

presumption that section 1041 does not apply to “[a]ny transfer not pursuant to a

divorce or separation instrument”. Consistent with section 1041, the fourth

sentence makes clear that the presumption may be rebutted “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.” See, e.g., Young v. Commissioner, 240

F.3d 369, 374 (4th Cir. 2001), aff’g 113 T.C. 152 (1999); see also Barnum v.

Commissioner, 19 T.C. 401, 407 (1952). Petitioner has made that showing here.

      Respondent contends that petitioner did not rebut the presumption as

provided in the fourth sentence of the regulation because petitioner’s transfer of his

interests in the businesses to Ms. Belot under the second settlement agreement was

not due to “legal or business impediments that prevented a transfer called for by the

divorce decree”. Respondent bases that argument on the fifth sentence of the

regulation. We disagree with respondent’s argument because the fifth sentence

provides examples and does not create a requirement that petitioner must satisfy to

rebut the presumption.
                                         - 11 -

[*11] Respondent points out that the divorce settlement resolved all of the property

issues between petitioner and Ms. Belot. However, neither section 1041 nor the

regulations limits application of section 1041 to one, or the first, division of marital

property. Respondent points out that in form and in substance the division of the

marital businesses made by the second settlement agreement was a sale. However,

neither section 1041 nor the regulations bars application of section 1041 to

divisions of marital property accomplished through sales. See Young v.

Commissioner, 240 F.3d at 374-375. Respondent characterizes Ms. Belot’s

dissatisfaction with the first settlement agreement as a business dispute. It is true

that the marital property at issue consists of stock in businesses operated by

petitioner and Ms. Belot during and after their marriage. However, section 1041

and the regulations can apply to marital property which consists of business-related

property.

      Respondent contends that the fact Ms. Belot filed the 2008 lawsuit in the

superior court civil part rather than the family court (which had jurisdiction over

petitioner’s divorce) shows that the lawsuit concerned a business dispute, not a

marital dispute. We disagree. The application of section 1041 to a transfer

resulting from the settlement of a lawsuit is not determined by the forum in which

the lawsuit is filed. Young v. Commissioner, 240 F.3d at 375.
                                         - 12 -

[*12] In considering respondent’s arguments which, if adopted, would add

conditions to qualification under section 1041 that are not in the statute or the

regulations, we are reminded of the following passage from the Court of Appeals’

opinion in Young:

             The policy animating § 1041 is clear. Congress has chosen to
      “treat a husband and wife [and former husband and wife acting
      incident to divorce] as one economic unit, and to defer, but not
      eliminate, the recognition of any gain or loss on interspousal property
      transfers until the property is conveyed to a third party outside the
      economic unit.” Blatt v. Commissioner, 102 T.C. 77, 80, 1994 WL
      26306 (1994) (emphasis added). See also H.R.Rep. No. 98-432, at
      1491 (1984), reprinted in 1984 U.S.C.C.A.N. 1134. Thus, no taxable
      event occurred and no gain was realized by either Mr. or Mrs. Young
      until Mrs. Young sold the 59 acres to a third party. [Id.]

      Respondent urges us to disregard the holding in Young on the basis of

alleged factual distinctions between Young and this case, i.e., that in Young, the

second settlement agreement resolved a dispute concerning the terms and

obligations of the first settlement agreement (relating to the dissolution of their

marriage), but here the 2008 settlement agreement did not resolve a dispute

concerning the terms and obligations of the 2007 settlement agreement. We

disagree that the cases are distinguishable on that basis. In both Young and here, a

former spouse alleged shortcomings with implementation of the first settlement

agreement by the other spouse, and as a result in both cases the parties negotiated a
                                       - 13 -

[*13] second settlement agreement employing different terms for disposition of

their marital assets than were contained in their first settlement agreement. The

transfers made pursuant to the second settlement agreements in Young and here

were made (as required by the fourth sentence of the regulation) to “effect the

division of property owned by the former spouses at the time of the cessation of the

marriage”; and as required by section 1041 were “related to the cessation of the

marriage.”3




       3
       The Court of Appeals in Young v. Commissioner, 240 F.3d 369, 374 (4th
Cir. 2001), aff’g 133 T.C. 152 (1999), referred to Priv. Ltr. Rul. 9306015 (Feb. 12,
1993) (ruling) and pointed out that letter rulings may not be cited as precedent.
See sec. 6110(k)(3). In the ruling, the Commissioner said sec. 1041 does not
apply to the transfer of one spouse’s interest in the jointly owned marital house to
the other spouse where the spouses had previously agreed that the other spouse
had a right to continue to live in the house under various circumstances or to sell
the house to a third party. The situation in the ruling is distinguishable from that
in Young. Young v. Commissioner 240 F.3d at 374-375. It also is distinguishable
from the situation here, where there was no prior agreement to authorize one of the
former spouses to sell the marital businesses to a third party. Petitioner and Ms.
Belot’s ownership of the marital businesses was equalized by the first settlement
agreement, but soon petitioner agreed to transfer his entire interest in the marital
businesses to Ms. Belot. As discussed in the text, this situation qualifies for sec.
1041 treatment under the terms of the regulations. We also note that the policy of
sec. 1041 (to “treat a husband and wife [and former husband and wife acting
incident to divorce] as one economic unit, and to defer, but not eliminate, the
recognition of any gain or loss on interspousal property transfers until the property
is conveyed to a third party outside the economic unit”, see supra p. 12) is well
served by application of that section here.
                                       - 14 -

[*14] E.    Conclusion

      We conclude that the sole purpose of the 2008 (second) settlement

agreement was to transfer property “incident to the divorce” as that phrase is used

in section 1041 and the regulations thereunder. Thus, the transfer at issue here

qualifies for nonrecognition treatment under section 1041.


                                                Decision will be entered for

                                      petitioner.
