## Facts

- Former spouses Louise F. Young (later Ausman) and John B. Young divorced in 1988.
- In 1989 they executed a marital settlement resolving equitable distribution and related claims; John gave Louise a $1.5 million promissory note secured by a deed of trust on 71 acres John received.
- John defaulted in 1990; Louise obtained a 1991 state-court judgment for principal, interest, and attorneys’ fees and pursued collection.
- In 1992 the parties entered a new agreement settling John’s obligations by transferring 59 of the 71 acres to Louise; John retained a time-limited repurchase option for $2.2 million.
- John assigned the option to a third party, which exercised it and purchased the 59 acres from Louise for $2.2 million.
- Neither John nor Louise reported gain from the transactions; the IRS issued deficiency notices to both.
- The Tax Court held the 1992 transfer was incident to divorce under I.R.C. § 1041 (nonrecognition to John; carryover basis to Louise), that Louise recognized capital gain on the $2.2 million sale, and that contingent attorneys’ fees paid directly from sale proceeds were included in Louise’s gross income.
- Louise appealed; the Commissioner also appealed aspects of the Tax Court’s rulings; the Fourth Circuit reviewed the consolidated matters.

## Issues

1. Whether the 1992 transfer of land from John to Louise, occurring several years after divorce, was a transfer “incident to the divorce” under I.R.C. § 1041.
2. Whether contingent attorneys’ fees paid directly to Louise’s counsel from the land-sale proceeds were includible in Louise’s gross income under the assignment-of-income doctrine.

## Decision

- The Fourth Circuit affirmed the Tax Court in all material respects.
- The court held the 1992 land transfer was “incident to” the divorce under § 1041 because it resolved obligations and disputes arising from the divorce-related 1989 marital settlement and its enforcement.
- The court held John recognized no gain on the 1992 transfer and Louise took John’s adjusted (carryover) basis in the property.
- The court held Louise’s amount realized on the later $2.2 million sale included amounts paid directly to her attorneys as contingent fees; those fees could be addressed, if at all, through deduction rather than exclusion.

## Legal Principles

- I.R.C. § 1041 applies to transfers between former spouses that are causally connected to the cessation of the marriage; a transfer can be “incident to divorce” even when made years after the decree if it settles or enforces divorce-related property obligations.
- When § 1041 applies, the transferor recognizes no gain or loss, and the transferee takes the transferor’s basis; taxable gain is deferred and may be realized by the transferee upon later disposition.
- Under the assignment-of-income doctrine, a taxpayer generally must include in gross income the full proceeds attributable to property the taxpayer owns, even if the taxpayer directs that part of the proceeds be paid to an attorney under a contingent fee arrangement.
- Amounts paid to counsel from sale proceeds do not reduce the taxpayer’s amount realized for gross-income inclusion; they are treated as expenses potentially deductible subject to applicable limits.

## Conclusion

The Fourth Circuit treated a post-divorce transfer made to satisfy and settle obligations arising from a marital property agreement as incident to divorce under § 1041, shifting built-in gain to the recipient spouse through carryover basis, and required the recipient to include in gross income the full sale proceeds notwithstanding direct payment of contingent attorneys’ fees to counsel.


Young v. Comm’r, 240 F.3d 369 (4th Cir. 2001)