Swaim v. Commissioner, 50 T. C. 302 (1968)

A husband must recognize gain when a court awards his wife property as part of a divorce settlement, if the property was deemed his before the divorce.

Summary

In Swaim v. Commissioner, the U. S. Tax Court ruled that Harry Swaim realized a taxable gain when a Kentucky court awarded his wife, Mildred, an installment note from their joint property sale as part of their divorce settlement. The court found that under Kentucky law, the note was Harry’s property before the divorce. The decision was grounded in the Supreme Court’s ruling in United States v. Davis, which held that transfers of property in divorce settlements are taxable events. This case illustrates that state law determinations of property ownership in divorce can have significant federal tax consequences.

Facts

Harry and Mildred Swaim sold their jointly owned Jeffersontown property in 1959, electing to report their profit using the installment method. In 1962, during their divorce proceedings, the Jefferson Circuit Court in Kentucky ordered Mildred to restore all property to Harry, including two installment notes from the property sale, before awarding her alimony. The court awarded Mildred one of the notes as part of her lump sum alimony, while ordering her to transfer the other note back to Harry.

Procedural History

Harry Swaim filed a federal income tax return for 1962 without reporting income from the transfer of the note to Mildred. The IRS Commissioner determined a deficiency, asserting that Harry realized a gain when the court awarded the note to Mildred. Swaim petitioned the U. S. Tax Court, which upheld the Commissioner’s position and ruled in favor of the respondent.

Issue(s)

1. Whether Harry Swaim realized a gain under section 453(d)(1) of the Internal Revenue Code when the Jefferson Circuit Court awarded his wife an installment note as part of their divorce settlement.

Holding

1. Yes, because under Kentucky law, the note was deemed Harry’s property before the divorce, and its transfer to Mildred constituted a taxable disposition under the rule established in United States v. Davis.

Court’s Reasoning

The Tax Court applied the Supreme Court’s decision in United States v. Davis, which held that transfers of property in divorce settlements are taxable events. The court determined that the Jefferson Circuit Court’s ruling that the note was Harry’s property before the divorce meant that its award to Mildred constituted a taxable disposition by Harry. The court rejected Harry’s argument that the tax result should not hinge on state law, noting that the Supreme Court had considered and rejected this argument in Davis. The court also distinguished this case from others where the property was not deemed to belong to one spouse before the divorce.

Practical Implications

This decision underscores that state law determinations of property ownership in divorce proceedings can trigger federal tax consequences. Attorneys handling divorce cases should consider the potential tax implications of property awards, especially when the court deems property to belong to one spouse before the divorce. The ruling may affect how divorce settlements are structured to minimize tax liabilities. Subsequent cases, such as Pulliam v. Commissioner, have followed this precedent, confirming its application to similar situations.