Steven Matzkin and Sarah Schroeder v. Comm., TCM 2020-117
This post is part of our series on recent important tax cases that may be of interest to accounting, tax, and finance professionals. For more like this, see our Federal Tax Update and California Federal Tax Update, which offer a comprehensive analysis of the year’s most pivotal tax developments.
Amount Paid to Ex-Spouse to Buy Her out of Dental Practice Did Not Increase Taxpayer’s Basis (Steven Matzkin and Sarah Schroeder v. Comm., TCM 2020-117)
In January 2003, Steven Matzkin formed, with a partner, Dental Care Alliance, LLC (DCA). When Dr. Matzkin formed DCA, he was married to Georgeann. In May 2008, after more than 20 years of marriage, Dr. Matzkin filed for divorce. Under Florida law, DCA was a marital asset. An appraisal performed in 2007 valued his interest in DCA at $21 million. The Matzkins’ property settlement and spousal support agreement provided that Steven would pay Georgeann over time $10.5 million for her half of DCA.
Payments did not increase basis. In May 2012, Dr. Matzkin sold his interest in DCA for $93,770,600. On their 2012 return, Steven and Sarah Matzkin claimed a basis in DCA of $85,735,315. The IRS audited the return and made an adjustment for the amount of property settlement payments made to Georgeann, arguing that the payments did not increase his basis in the partnership.
Section 705(a)(1) provides that a partner’s initial basis is increased by the sum of the partner’s distributive share of “(A) taxable income of the partnership as determined under §703(a), (B) income of the partnership exempt from tax under this title, and (C) the excess of the deductions for depletion over the basis of the property subject to depletion.” Steven’s payments to Georgeann and his divorce lawyer did not affect his distributive share of DCA’s income or deductions. Accordingly, these payments did not increase or otherwise affect his basis under §705(a)(1). While the court agreed with Dr. Matzkin that his payments to Georgeann were part of a property settlement, it does not follow that his payments generated additional basis in DCA.
Tax practitioner planning. Section 1041 clearly prohibits a spouse from increasing basis when he or she buys out the former spouse’s interest in a house, for example. Partnership law does not change the result when making payments to buy out the former spouse’s interest in a partnership. Payments to the former spouse do not create basis in the partnership.
Also see.
Joseph R. Belot v. Comm., TCM 2016-113, where $1,580,000 payment from former spouse to buy out his interest in a dancing school business was “incident to a divorce” and not taxable.