A couple with a combined $4 million net worth walks into your office. Six months later, one of them walks in alone. Every assumption in their plan is shattered. The exam tests what happens when the marital deduction does not apply.
Congress did not want divorcing couples forced to liquidate appreciated assets just to split them, so §1041 treats all spousal transfers as non-recognition events with carryover basis. All transfers between spouses (or former spouses if "incident to the divorce") are treated as gifts. No gain or loss. The receiving spouse takes a carryover basis. A transfer is incident to the divorce if it occurs within one year of the marriage ending or is related to the cessation within six years.
Section 1041 settles the income tax question and says nothing about gift tax. A divorce settlement is exactly the shape the gift tax was built to catch: one spouse hands over property and receives no money back.
Section 2516 is that relief. Where spouses enter a written agreement covering their marital and property rights, and the divorce occurs within the three-year period beginning one year before the...
Common mistakes
- Confusing the QDRO penalty exception. The 10% penalty waiver applies only to distributions taken directly from the qualified plan. Once rolled into an IRA, the exception vanishes. Trap: "Roll to an IRA first for better investment options, then withdraw", that triggers the 10% penalty before age 59 1/2.
- Treating pre-tax and after-tax assets as equivalent. A $500,000 brokerage account with a $400,000 basis is worth far more after tax than a $500,000 traditional IRA. The exam expects you to identify when an apparently equal split is economically unequal.
- Applying the marital deduction to unmarried partners. The marital deduction requires legal marriage under federal law. Domestic partnerships, civil unions, and long-term cohabitation do not qualify. Trap: "Sandra qualifies for the marital deduction as Robert's long-term partner."
Bottom line
- Section 1041: divorce property transfers are tax-free with carryover basis, creating hidden tax liabilities the planner must quantify
- QDRO penalty exception: distributions taken directly from the plan are penalty-free; roll to an IRA first and the exception vanishes
- Post-2018 alimony: non-deductible by payor, non-taxable to recipient; the decree date controls, not the payment date
- Unmarried partners: no marital deduction, portability, gift-splitting, or QTIP; planning relies on trusts, ILITs, and GRATs instead
Exam shortcut
Divorce questions almost always involve a trap where two assets look equal but carry different tax burdens. Ask immediately: "What is the after-tax value of each asset?" For the QDRO penalty question, remember: "Direct from plan = no penalty. Roll to IRA first = penalty." For unmarried partners: "No ring, no marital deduction, no portability, no gift-splitting." Decree date decides alimony treatment. "Decree Date Decides."
The full lesson (about 2,894 words, 19 min read) adds 2 worked examples, all 5 common mistakes, a self-check, free in the app.
Learning objectives
- G.63
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