New Regulation Helps Plan Stock Redemptions

To understand the significance of the final regulation, it is helpful to review the transaction pattern that these regulations address. In our example, Spouse B (the business spouse) operates a business that is owned by a corporation (X Corp.), all the stock of which is owned by B or by B and N (the non-business spouse) as marital property. Pursuant to the marital settlement agreement between B and N, B will end up owning all the stock of the corporation, through which B will continue to operate the business, and N will be paid his or her share in cash, usually through deferred payments. The parties anticipate that the income used to make the deferred payments will be generated by the business, and that payments to N for N's marital share will be made ' directly or indirectly ' by X Corp. The income used for this purpose is taxable to either or both spouses. How much and to whom will depend on the structure of the settlement worked out by the parties.

Prior to the proposed regulations, the tax effects were uncertain, and even careful planning might not have prevented unexpected and harmful tax consequences. The proposed regulations, however, contained a 'special rule' that endorsed a more certain tax result if the parties chose to treat B as the taxable party. Furthermore, according to the proposed regulations, the tax treatment of payments to N would have been determined for both spouses under a single test. The final regulation takes this one step further by permitting the parties to choose the tax effect that gives them the most
cost-effective solution, provided that both parties agree in writing to report
the transaction consistently for tax purposes.