Here is another great post from Family Law Taxation.
In Pfister v. Commissioner, the United State Court of Appeals for the Fourth Circuit (Fourth Circuit) addressed the issue of whether the taxpayer was taxable on amounts received from her former husband's military retirement pay pursuant to a divorce.
The taxpayer's former husband served in the United States Air Force and, upon his retirement, received a pension. In anticipation of their divorce, the couple entered into an agreement which provided that the taxpayer was to be the owner of one-half of the husband's disposable retired pay and would receive one-half of the payments (as provided by the Uniformed Services Former Spouses' Protection Act, P.L. 97-252 (1982), or USFSPA). This agreement was incorporated into their final divorce decree.
The taxpayer treated the payments she received during 1997 as nontaxable distributions on her 1997 Federal income tax return (on the belief that they were neither alimony nor retirement pay). The Tax Court held that the pension payments constituted taxable income to the taxpayer.
Pension income: Gross income is defined as 'all income from whatever source derived,' including pensions (see IRC section 61). The Fourth Circuit rejected the taxpayer's primary argument that disposable retired pay under USFSPA (10 U.S.C. 1408) entitles her to a portion of her former husbands retirement pay without any tax liability because disposable retired pay is determined after taxes are withheld. The Fourth Circuit interpreted this argument as to whether the taxpayer owned a portion of her husband's retirement pay.
USFSPA was enacted in 1981 to enable spouses and former spouses of military retirees to have an ownership interest in a retiree's retirement pay. Previously, a military retiree's retirement pay was property in which the retiree's spouse or former spouse could not claim an interest (see McCarty v. McCarty, 453 U.S. 210 (1981)). The sole purpose of enacting USFSPA was to overturn McCarty. The Fourth Circuit concluded that USFSPA applied to the retirement pay in question since the taxpayer's husband began receiving his retirement pay after 1981, and the couple divorced after 1981.
The Fourth Circuit held that the taxpayer was the owner of one-half of her husband's retirement pay; therefore, she is liable for the tax liability on this income. The language of USFSPA and the taxpayer's own agreement with her husband provided that the taxpayer would be the owner of one-half of the retired pay.
Nontaxable transfer incident to divorce: The taxpayer also argued that the retirement pay was not taxable on the premise that it was a transfer of property incident to the divorce from an individual to a spouse or former spouse (see IRC section 1041).
The Fourth Circuit concluded that although the transfer of the property right was nontaxable, the income produced from the property transferred is a taxable distribution since the taxpayer had no basis in this property; therefore, the distributions from the pension are includible in taxpayer's gross income.
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(Via FAMILYLAWTAXATION.)
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