Often there is insufficient cash or other property to satisfy a division of marital assets when there is a privately-held family corporation. The transfer of ownership of the stock for cash in a divorce may involve two steps where the desired result is sole ownership of the family business: (1) transfer of the stock from one spouse to the other, followed by (2) the recipient spouse transferring her shares to the corporation in redemption of all the shares received from the ex (or soon to be ex)-spouse. Where there is no obligation to transfer the stock by the recipient spouse, or no obligation to redeem the stock by the corporation, the spouse redeeming the shares will be responsible for the income tax on the redemption (IRS Letter Ruling 9046004). If blocks of stock were held by each spouse, a transfer under step (1) would not be necessary.

The tax consequences of a redemption is with the nontransferring spouse and not the actual redeeming spouse when the redemption (transfer) is made "on behalf of" the nontransferring spouse to the corporation in satisfaction of the division of property. When one spouse satisfies the obligation to divide marital property by using funds of a jointly owned privately-held company, that spouse will be treated as redeeming the ownership interest rather than the actual redeeming spouse. See Craven V. United States, No. 99-12803 (11th Cir 6/19/00). resolving several issues in this area.

This can be a tax-trap for the unsuspecting spouse that requests a redemption. Sometimes, it is "understood" that the corporation will redeem the shares, without any obligation to do so specified in writing as part of the settlement. Even if the spouse receiving the shares agrees to an immediate transfer of the stock to the corporation in a redemption, the redemption will be taxed to the redeeming spouse.

SOURCE: DivorceSource