Jilting By The IRS – Income Tax For Divorce

divorce
Harold Hamm was born in Lexington, Oklahoma, the 13th child of Oklahoma sharecroppers. He graduated from high school then went straight to work in an oilfield. But he didn’t let his modest background slow him down. He hit his first gusher at age 25. Today, he’s CEO of Continental Resources, and his net worth approached $18 billion before the recent fall in oil prices.

In 1988, Harold married his second wife. Sue Ann Hamm was no “bimbo trophy wife” — she’s a lawyer who met Harold while she was negotiating land deals for his company. (And just because you’ll ask: nope, no prenup.) But sadly, the couple’s love was not to last, and in 2012, Sue Ann filed for divorce. The case attracted unusual attention because the amounts were so large. Oklahoma courts typically split the value of any assets that result from the efforts or skills of either spouse. So, how much would Sue Ann get? Would it be more than the record-setting $4.5 billion that Elenea Rybolovlev got from her ex-husband, Russian potash producer Dmitry?

Last week, the judge issued his ruling and surprised most experts by ordering Harold to pay Sue Ann a total of just $995.5 million, or six percent of his peak net worth. While most people would consider that a nice gusher of cash, Sue Ann has already announced plans to appeal. (As for Harold, if you ask him why divorce is so expensive, he’ll probably tell you “because it’s worth it.”)

So, will our friends at the IRS be excited by the outcome? Probably not, even if Sue Ann wins a richer share of her ex-husband’s fortune. Internal Revenue Code section 1041 provides that transfers of property “incident to divorce” are tax-free. That means Harold can transfer as little or as much as the court orders to Sue Ann, with no income tax consequences — it’s neither taxable to her nor deductible to him. And there are no gift tax consequences, either.

The IRS may reap a nice windfall, however, if Sue Ann sells any of her shares from the divorce. Harold launched the company back in 1967, and still controls 68% of the company’s stock. His “basis” in that stock — the amount the IRS uses as the “purchase” price for figuring gain or loss on a sale — is probably next to nothing. And that basis carries over to Sue Ann. That means that when she sells, she’ll be subject to a capital gains tax of up to 20%, plus the new net investment income tax of 3.8%. Sell a hundred million of stock, and walk away with a lousy $76.2 million!

The real payoff will have to wait until Sue Ann caps that great well in the sky. At that point, any taxable estate over a $5.43 million is assessed at 40%. On the bright side, her basis in that stock will be “stepped up” to its fair market value as of the date of her death, which means her heirs can sell without paying income tax on all that appreciation during her lifetime.

As for alimony and child support, which won’t factor into the Hamms’ case, courts use alimony to shift income from the higher-earning spouse to the lower-earning spouse. So alimony is deductible by the payor and taxable to the payee. Child support is nontaxable either way, meaning there’s no tax consequence to paying it or receiving it.

You’ve probably heard the joke about the husband who asks his long-suffering wife what she wants for Christmas. She says “a divorce,” and he says “I wasn’t planning on spending that much.” If you are married we wish you a happy and prosperous long term marriage. However, sometimes you have to make decisions which are in the best interest of both parties. Divorce is hard enough under most circumstances — it’s good to know the tax man won’t be jumping your claim, too. So call us at (773) 728-1500 when you’re ready to cut out the IRS — we’ll give you the plan you need to protect your stake!