transfer of partnership interest in divorce

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There has been considerable speculation that one consequence of the Coronavirus will be an increase in the divorce rate resulting from togetherness imposed by the quarantine that pushes marriages already on shaky ground over the brink.  Whether divorces will increase in the future due to Covid-19 remains an open question, but what is certain is that a sizable number of future divorces will involve the transfer of a business ownership interest between spouses as part of the divorce.  To address this situation, this post focuses on key business issues that arise when one spouse (the “Divesting Spouse”) transfers an ownership interest in a business to the other spouse (the “Recipient Spouse”) as part of a divorce settlement.  Addressing these issues will help the Recipient Spouse continue to run the business successfully and also avoid future conflicts with the Divesting Spouse, as well as with future investors and potential buyers of the business.

1. Don’t Rely on Divorce Decree or Settlement Agreement to Document  the Transfer of a Business Ownership Interest Between Spouses

A divorce decree and settlement agreement will document the terms of the divorce and the division of property between spouses, but it is not a good idea to rely on the decree or the divorce settlement to memorialize the transfer of a business interest between spouses.  There are a number of reasons for the Recipient Spouse to insist on securing a stock transfer agreement (or its equivalent), including the fact that the Recipient Spouse will likely be required to show the transfer document to third parties in the future, including banks or other lenders, new investors, company officers or managers, and potential future buyers.  The Recipient Spouse will not want to show the decree or settlement agreement to these third parties, however, because they include private matters unrelated to the business.  This will therefore require the Recipient Spouse to prepare a heavily redacted document for review by third parties.  It is more efficient to simply require a transfer document to be signed that is limited solely to issues related to the business.

Another reason for the use of a transfer document is that it will include many provisions that are not normally part of a settlement agreement.  The decree or settlement agreement will become a very lengthy document if it includes all of the provision that are traditionally set forth in a separate document that covers the transfer of a business interest.

2. Secure a Separate Release of the Divesting Spouse’s Claims Against the Business

After the business is transferred and the divorce becomes final, the Recipient Spouse will not want to defend claims that are brought by the Divesting Spouse against the business.  This requires the Recipient Spouse to secure a broad release of claims against the business from the Divesting Spouse.  This release of the business is separate from and in addition to the release that the Divesting Spouse provides to the Recipient Spouse, individually.

For example, if the Divesting Spouse was an officer, employee, director or manager of the company, the Divesting Spouse’s release needs to include a release of all employment claims, such as claims for unpaid wages/back pay, vacation time, unpaid expenses, and commissions.  The release will also include the Divesting Spouse’s release all claims for wrongful termination, claims related to the distribution of any profits generated by the company and all other business related claims.  The release will also confirm that the Divesting Spouse has resigned from all positions with the company and has no further right or authority to take any action for or make any statements on behalf of the company.

3. Confirm Broad Transfer of All Rights by Divesting Spouse

The provisions that confirm the transfer of ownership in the business by the Divesting Spouse need to be broadly described in the transfer agreement to include all rights, title and interest of every kind related in any way to the business.  This includes all rights of the Divesting Spouse in any and all intellectual property of the company, such as company names, trademarks, trade secrets and patent rights.  This is particularly important if the Divesting Spouse worked in the business, because the Recipient Spouse does not want to be faced with a situation in the future where the Divesting Spouse later claims that he or she developed some software, designs or other intellectual property rights that are not owned by the business, and which are now being used by the Divesting Spouse in direct competition with the company.

4. Consider Requesting Divesting Spouse to Accept Restrictive Covenants

In a normal M&A transaction, a company buyer secures a set of restrictive covenants from the seller as part of the purchase agreement to prevent the seller from competing in any way with the company after the sale takes place.  The buyer will require the seller to provide all of the following restrictive covenants that will last for two to five years:  (i) a covenant not to compete, restricting any involvement by the Divesting Spouse — whether as an owner, employee, consultant, etc., — in a business that is competitive with the subject business for a reasonable period of time within a reasonable geographic area, (ii) an agreement not to interfere with the business’s relationship with its customers and vendors or to solicit customers, or attempt to persuade the business’s customers and vendors to cease doing business with the company, and (iii) an agreement not to hire or solicit the hiring of any of the employees of the business, or otherwise attempt to persuade any of the employees of the business to cease their employment relationship with the company.

If the Recipient Spouse is concerned that the Divesting Spouse may compete in business against the company after the divorce, the Recipient Spouse may want to request the Divesting Spouse to agree to accept some or all of these restrictions.  The Divesting Spouse will not agree to accept these post-divorce restrictions, however, without a corresponding commitment from the Recipient Spouse to provide some amount of additional consideration in the divorce settlement.

5. Request Confidentiality Agreement from Divesting Spouse

Confidentiality agreements are similar to restrictive covenants in that they prevent the person who is subject to the agreement from taking actions that are harmful to the business.  The confidentiality agreement is specific, however, in prohibiting the individual officer or employee from using or transferring any of the company’s confidential information or trade secrets.  All of the company’s officers and employees are subject to a common law duty not to use or misuse any of the company’s confidential information, but a written confidentiality agreement makes this prohibition clearer on the use of confidential information and trade secrets.

If the Divesting Spouse has not already entered into a confidentiality agreement with the company, the Recipient Spouse will want to request the Divesting Spouse to accept and sign a confidentiality agreement to protect the company’s valuable confidential information and trade secrets.  The Recipient Spouse wants to make sure that the company’s confidential information, technology and trade secrets are maintained in strict confidence.

6. Secure “Tail Coverage” of Divesting Spouse From D&O Carrier

  If the company has a directors and officers liability insurance policy (a “D&O Policy”) that provides protection for officers and directors from third party claims, these polices will generally remain for one or two years after the company’s officers and directors are no longer affiliated with the company.  The Recipient Spouse will therefore want to secure “tail coverage” to provide continuing insurance coverage for claims made against the Divesting Spouse.  In this regard, the Recipient Spouse may want to secure a tail policy will extend the D&O coverage over former officers and directors for a total period of five years.

The Recipient Spouse may feel like securing a tail policy that extends coverage for third party claims against the Divesting Spouse is unnecessary because it provides a benefit solely for the Divesting Spouse.  In fact, a tail policy provides insurance protection that protects both the Recipient Spouse and the Divesting Spouse, and it is also a benefit to the company.  If third party claim is made against the Divesting Spouse after the divorce related to the business, the Divesting Spouse will likely demand that the company indemnify him or her.  If the D&O policy is still in place, however, the tail policy will enable the company tender a defense of the claim against the Divesting Spouse, because the D&O carrier will cover all of these legal defense costs.  Fortunately, a tail policy that extends D&O coverage is often not too expensive to secure.

7. Specify Treatment of Future Tax Filings

Dealing with all of the tax issues involved in the transfer of the business is an extensive subject that goes beyond the scope of this post, and spouses engaging in the transfer of a business interest are strongly advised to consult with a tax advisor during their divorce.  But there is one tax issue that the Recipient Spouse should consider addressing up front.  Many businesses held in marriages are structured as pass through entities (i.e., LLC’s partnerships, Sub S corporations), which means that the owners pay the taxes on all profits that are generated by the company.  As a result, in the year following the divorce, Recipient Spouse may be required to issue a K-1 to the Divesting Spouse based on the ownership interest held in the business by the Divesting Spouse during the year in which the divorce took place.

If the K-1 issued in the year after the divorce reflects any income that is apportioned to the Divesting Spouse, he or she may expect to receive a cash distribution from the company that is sufficient to cover the Divesting Spouse’s federal tax liability based on this income.  If the company does not issue any distribution to the Divesting Spouse, that would create what is known as “phantom income” because the Divesting Spouse has to pay taxes on this income even though no distribution was issued by the Company.  The issuance of phantom income to the Divesting Spouse is likely to provoke a heated dispute at that point.

The Recipient Spouse will therefore want to address in the divorce settlement how the future K-1 that will be issued to the Divesting Spouse will address any income generated by the business in the year of the divorce.  If the Recipient Spouse is prepared to issue a distribution to the Divesting Spouse, that will take care of the issue.  If the Recipient Spouse has no intention of authorizing the company to issue any distributions in the future to the Divesting Spouse, however, this issue will need to be dealt with by the Recipient Spouse in a manner that will not lead to a future legal dispute with the Divesting Spouse.

The transfer of ownership interests in business is common in divorce settlements.  But if business issues related to the transfer of this type of interest are not considered at the time of the divorce, the parties may find themselves engaging in continuing disputes they did not anticipate.  The Recipient Spouse, in particular, needs to take steps to ensure that the transfer takes place in a manner that allows the business to continue to run successfully, and to head off potential future conflicts with the Divesting Spouse and others after the divorce.

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What Will Happen to My Partnership Interest in a Divorce?

Most partnership agreements have anti-assignment provisions that prevent a partner from assigning their partnership interests to a non-partner third party. While at the same time most partnership agreements allow for the assignment of a partner’s right to distributions even where the party receiving the distribution is not technically a partner. Consequently, many marital settlement agreements require a transfer of a right to distributions between the spouses that is treated as a gift under Section 1041. However, the holder of a mere right to distributions, as opposed to the holder of a complete assignment of a partner’s partnership interest, has a disadvantaged legal status under general partnership law that can only be somewhat mitigated by agreements between the former spouses. A holder of a mere right to distributions is not accorded the rights held by a partner under general partnership law. As such they are not legally empowered to compel distributions, not owed the typical fiduciary duties a partner can expect from the other partners, and are not legally entitled to financial reports or granted the right to inspect the partnerships books and records.

How Does this Affect divorce Tax Planning?

An opportunity exists to use IRC § 1041 to achieve overall tax savings in situations where the ex- spouses are in substantially different income tax brackets, though assignment of income principles, or whom enjoy substantially different capital gain rates, through selective distribution of marital assets. In negotiating the martial settlement agreement and ultimately the division of the martial estate, H and W should be counseled to consider allocating to the spouse with the lower comparative capital gain rates the marital assets that have appreciated and thus are carrying built in gains.  The spouse with the higher marginal capital gain rate should be allocated assets that have not appreciated or that have declined in value.

For additional insight as to how this mechanism can work, consider a scenario where W expects to sell depreciated stock that will generate a substantial capital loss following the divorce. To mitigate the $3,000 annual limitation on the deductibility of capital losses, H and W should contemplate transferring to W sufficient appreciated capital assets to absorb the anticipated capital loss.

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TAX ISSUES WHEN DIVIDING PROPERTY INCIDENT TO DIVORCE

Tax-free transfers incident to divorce, general rule, meaning of “incident to divorce”.

Section 1041 applies to all transfers between spouses and also to transfers between former spouses, to the extent made incident to divorce between the former spouses. (IRC § 1041, subd (a).) A transfer of property is “incident to the divorce” if the transfer (1) occurs within one year after the date on which the marriage ceases, or (2) is related to the cessation of the marriage. (IRC § 1041, subd (c).)

Treasury Regulation 1.1041-IT(b) states that a transfer is “related to” the cessation of the marriage when the transfer is required under the divorce or separation instrument, and the transfer takes place within six years from the date of the divorce.”

If the transfer is not made pursuant to a divorce or separation instrument, or occurs more than six years after cessation of the marriage, it is presumed to be unrelated to cessation of the marriage. (Treas. Regs. § 1.1041-1T, A-7; see Ltr.Rul. 9306015.) The presumption may be rebutted “only by showing that the transfer was made to effect the division of property owned by the former spouses” at the time their marriage ceased. (Regs. § 1.1041-1T, A-7.)

“For example, the presumption may be rebutted by showing that (a) the transfer was not made within the one-and six-year periods described above because of factors which hampered an earlier transfer of the property, such as legal or business impediments to transfer or disputes concerning the value of the property owned at the time of the cessation of the marriage, and (b) the transfer is effected promptly after the impediment to transfer is removed.” (Id.)

In Private Letter Ruling 9235026 (May 29, 1992), the IRS ruled that the six-year presumption was overcome when the transfer of the Wife’s interest in business property to her ex-husband was incident to divorce even though the transfer occurred more than six years after the divorce. The IRS found that the transfer was delayed because of a dispute over the purchase price and payments terms, and that the transfer was effected promptly after the dispute was resolved. The IRS noted that Temp. Treas. Reg. §1.1041-1T, A-7 specifically provides that the presumption may be rebutted if factors such as “disputes concerning the value of the property” to be transferred prevented an earlier transfer.

Transfer to Non-Resident Alien Spouse

When the spouse who receives property incident to divorce is a nonresident alien, taxable gain will be recognized on the transfer. (IRC §1041, subd. (d).) The spouse making the transferor will be taxed on the gain (the difference between the fair market value of the property transferred and his or her adjusted tax basis in the property). The rationale for treating nonresident aliens differently is that the IRS assumes that it will eventually receive taxes on any gain realized when a spouse who receives property incident to divorce sells the property, since the spouse takes the transferor’s basis in the property; however, in the case of a nonresident alien, there may be little chance that the gain is ever reported or that tax will be paid.

Assignment of Income Doctrine

Income is ordinarily taxed to the person who earns it; one vested with the right to receive income cannot escape taxes by an assignment of the right to receive that income to another. (Lucas v. Earl (1930) 281 U.S. 111 (1930); Harrison v. Schaffner, 312 U.S. 579, 580; IRS Regulations, § 1.454-1(a).) Under the assignment of income doctrine, the transferor remains obligated to pay taxes on the accrued income he or she has assigned.

The assignment of income doctrine applies when the right to receive the income has already accrued, and the parties assign that right to the spouse who did not earn the income. For example, in a transfer of Series E or EE United States Savings Bonds to a spouse or former spouse, the transferor must include the accrued interest on the bonds in his or her gross income in the year of the transfer. (Rev. Rul. 87-112.) IRC § 1041 cannot be used to avoid recognition of the gain by transferring the right to receive the income already earned.

However, when an income-producing asset is transferred, the right to receive future income is transferred along with the underlying asset, such that the spouse receiving the asset is responsible for paying taxes on that income. For example, if a spouse is awarded an apartment building in a divorce, the spouse receiving the building will not recognize any gain on the transfer and will be responsible for reporting the rental income on his or her tax return.

On the other hand, if the parties make an agreement that one spouse will be solely responsible for paying taxes on the past rental income from the building (when it was held as marital property), the assignment of income doctrine will override that contractual allocation and require both parties to report the taxes.

Another example is where Wife agrees to pay Husband 40% of her bonus income as taxable spousal support. When Wife receives the bonus, she will have to report 100% of it as taxable wages, however she gets a deduction for the portion she pays to Husband as alimony. Revenue Ruling 2002-22 held that a taxpayer who transfers interests in nonstatutory stock options and nonqualified deferred compensation to the taxpayer’s former spouse incident to divorce is not required to include an amount in gross income upon the transfer.

The ruling also concludes that the former spouse, rather than the taxpayer, is required to include an amount in gross income when the former spouse exercises the stock options or when the deferred compensation is paid or made available to the former spouse.

The ruling states: . . . applying the assignment of income doctrine in divorce cases to tax the transferor spouse when the transferee spouse ultimately receives income from the property transferred in the divorce would frustrate the purpose of § 1041 with respect to divorcing spouses. That tax treatment would impose substantial burdens on marital property settlements involving such property and thwart the purpose of allowing divorcing spouses to sever their ownership interests in property with as little tax intrusion as possible.

Further, there is no indication that Congress intended § 1041 to alter the principle established in the pre-1041 cases such as Meisner [v. United States, 133 F.3d 654 (8th Cir. 1998] that the application of the assignment of income doctrine generally is inappropriate in the context of divorce.(Rev. Ruling 2002-22, see also Rev. Ruling 2004-60 (FICA taxes are deducted from the payment is made to the non-employee spouse).)

Interest on Equalizing Payments

If a spouse is required to pay interest to the other spouse regarding an equalizing payment, the interest will be treated as income to the spouse who received it. The spouse who pays the interest can take a deduction for those payments only if the debt was incurred to buy-out the other spouses interest in business or investment property. (See Armacost v. C.I.R. (1998) TC Memo 1998-150.)

The court in Armacost held Interest on indebtedness must be allocated in the same manner as its underlying debt. [Citation.] Underlying debt is allocated by tracing specific disbursements of the proceeds to specific expenditures. If the underlying debt is incurred as a personal expenditure, the interest on that debt may not be deducted under section 163 except to the extent such interest is qualified residence interest.

[Citations.] But if the underlying debt is incurred to acquire investment property, the interest on that debt is deductible under section 163 as investment interest. [Int.Rev. Code §163 (h)(2)(B).] Investment interest is defined as any interest paid on indebtedness properly allocable to investment property. Section 163(d).

Investment property includes property producing gross income from interest, dividends, annuities or royalties not derived in the taxpayer’s trade or business, or property held in the course of the taxpayer’s trade or business which is neither a passive activity nor an activity in which the taxpayer materially participates. Section 163(d)(5)(A), 469(e)(1).

State Law May be Different

Section 1041 applies only to taxes under federal law. The transfer could still be taxable under state law.

CONSIDERING TAX BASIS WHEN DIVIDING PROPERTY

Community property laws require the court to divide the community estate “equally” unless required otherwise by law or absent the written agreement of the parties. (See, e.g., Cal. Fam. Code, § 2550.) If tax consequences are not considered when dividing assets, the ultimate division is often far from being equal.

It is the attorney’s role to investigate the tax implications of the proposed division and to advise the client accordingly. In particular, the difference between the fair market value of an asset and its tax basis must be taken into account when evaluating whether there is an “equal” division of the marital estate. In negotiating settlements, the parties are free to discount property based on built-in tax liability associated with an asset.

California Rule

Family courts at least in California, on the other hand, have been reluctant to take tax effects into account except when it is clear that the party will suffer immediate tax consequences from an expected sale of the property or from the transfer itself. An often-cited case in this area is In re Marriage of Fonstein (1976) 17 Cal.3d 738 where the California Supreme Court held :

“Regardless of the certainty that the tax liability will be incurred if in the future an asset is sold, liquidated or otherwise reduced to cash, the trial court is not required to speculate on or consider such tax consequences in the absence of proof that a taxable event has occurred during the marriage or will occur in connection with the division of the community property.” (Id. at p. 749, fn. 5.)

In Fonstein, the trial court assigned husband’s minority interest in a law partnership to him in a marital dissolution action after discounting its value for future tax consequences when sold. Under the partnership agreement, the husband had the right to withdraw from the partnership voluntarily and would receive a sum of money based on a formula set forth in the agreement. Although the husband had no intention of withdrawing from the partnership, the trial court discounted the value of the partnership interest by the taxes he would have to pay if he later decided to withdraw.

The California Supreme Court phrased the issue before it in the following terms:”In valuing Harold’s interest in the law partnership on the basis of his contractual right to withdraw from the firm, did the trial court err by taking into account the tax consequences which he might incur if he did withdraw at some later time, and by reducing the value of his interest accordingly, even though Harold was not withdrawing and had no intention to withdraw?”(Id. at p. 747 (emphasis added).)

The court answered the question as follows:”…[S]ince there is no indication in the record that Harold is withdrawing, must withdraw, or intends to withdraw from his firm in order to obtain the cash with which to pay Sarane her share of the community property, there is no equitable reason for allocating to Sarane a portion of the tax liability which may be incurred if and when he does withdraw. [Citation.]

In short, …, although Harold conceivably may do a number of things concerning his law partnership which may create tax consequences, ‘there is no indication that he must or intends to do’ any of them.” (Id. at p. 750.)In making its ruling, the court referred to the “immediate and specific tax liability” language it used in its earlier decision in Weinberg v. Weinberg (1967) 67 Cal.2d 557. (Fonstein, 17 Cal.3d at p. 749, fn. 5.)

This remains the rule in California, however when property is ordered sold and the proceeds divided, the court must take income taxes on the sale into account. (See In re Marriage of Epstein (1979) 24 Cal.3d 76.) In Epstein, the trial court ordered the family residence sold and the proceeds divided between the parties in such a manner as to equalize the division of the community property.

Since husband received personal property of substantially greater value than that awarded wife, she was due to receive the larger share of the proceeds from the sale of the house. The trial court’s order, however, did not mention the possibility that the parties might incur state and federal capital gains tax liability as a result of the sale of the residence. The wife appealed, arguing that the trial court erred by not expressly considering tax liability in its order.

The California Supreme Court agreed with wife that the court’s division of community property should take account of any taxes actually paid as a result of the court-ordered sale of the residence. The court explained: “Unlike Fonstein, which involved a speculative future tax liability arising on the hypothetical sale of an asset, in the present case the taxable event, the sale of the residence, occurs as a result of the enforcement of the court’s order dividing the community property.” (Epstein (1979) 24 Cal.3d at p. 88.)

Exclusion of Gain on Sale of Residence

In calculating gain on the sale of a principal residence, Internal Revenue Code section 121 provides that a taxpayer can exclude up to $250,000 of gain from the sale of principal residence if filing a separate tax return, or up to $500,000 for a joint return, if the following requirements are met:

• During the 5-year period ending on the date of the sale or exchange, the residence must have been owned by either spouse and used by both spouses as their principal residence for periods aggregating 2 years or more.
• An individual shall be treated as using property as such individual’s principal residence during any period of ownership while such individual’s spouse or former spouse is granted use of the property under a divorce or separation instrument.
• If a residence is transferred to a taxpayer incident to a dissolution of marriage, the time the taxpayer’s spouse or former spouse owned the residence is added to the taxpayer’s period of ownership.
• The exclusion can only be applied to one residence every two years, excluding pre-May 7, 1997 sales. (Treas. Regs. § 1.121-2; California has passed conforming legislation, Cal. Rev. & Tax. Code §17152.)
• (Treas. Regs. § 1.121-2; California has passed conforming legislation, Cal. Rev. & Tax. Code §17152.)

Need for Records

Temporary Regulations provide that “a transferor of property under §1041 must, at the time of the transfer, supply the transferee with records sufficient to determine the adjusted basis and holding period of the property as of the date of the transfer…. Such records must be preserved and kept accessible by the transferee.” (Temp. Treas. Reg. § 1.1041-1T, A-14.)

The judgment should specifically require the exchange of this information.

CARRYFORWARDS

The right to deduct losses associated with an asset may be transferred together with the asset which generated the loss, or may be personal to the taxpayer and not subject to transfer, depending on the type of asset transferred. This is a complicated area because the loss carryforward was typically reported on a joint tax return during marriage and then, after the divorce, it may have to allocated between the parties for their separate returns. Still, the effort may be worthwhile due to the value of these carryforwards.

Net Operating Losses

A net operating loss from the operation of a business may be carried back to the prior two years (by amending the tax returns for the prior years) or carried over to the succeeding 20 years as a net operating loss deduction. (IRC § 172.) If the spouses filed a joint tax return for each year involved in figuring NOL carrybacks and carryforwards, the NOL is treated as a joint NOL. (IRS Publ. 536, p. 10.) Each spouse may carryover to his or her separate return his or her share of the joint NOL. (Huckle v. Commissioner, T.C. Memo 1968-45.)

Capital Loss Carry Forwards

For individuals, losses from the sales or exchanges of capital assets are allowed only to the extent of gains from such sales or exchanges plus up to $3,000 of ordinary income ($1,500 if the return is married, filing separate). (IRC § 1211, subd. (b).) Any capital loss that could not be deducted in one year may be carried over for an unlimited time until fully used up. (Id.)

If separate returns are filed after a net loss was reported on a joint return, the carryover is allocated to each taxpayer based on their individual net long-term and short-term capital losses for the preceding taxable year. (IRC § 1212, subd. (b)(1); Treas. Reg. 1.1212-1(c).) If incurred in a community activity, the losses are split equally on separate returns. Therefore, each spouse may carry forward his or her half of the loss to postdissolution income. (See Regs. § 1.172-7; Rose v. Commr., TC Memo. 1973-207.)

Suspended Passive Activity Losses

A passive activity is generally any trade or business in which the taxpayer does not materially participate, including rental activity whether or not there is material participation (subject to special rules for real estate rental activities and real estate professionals). (IRC § 469.) As a general rule, losses from passive activities may only be deducted from income from passive activities, and not against other types of income such as wages, interest or dividends. (Id.)

If a passive activity loss exceeds passive activity income for the year, the loss is “suspended” indefinitely as a deduction from passive activity income in the next succeeding tax years. (Id.)

If the asset which generates the passive activity loss is divided in-kind, the suspended passive activity loss is divided equally between the parties along with the underlying asset. On the other hand, if the passive asset is transferred entirely to one spouse and there is a suspended passive loss associated with that asset, the transferor cannot deduct the accumulated loss but the transferee’s basis increases by the amount of the unused suspended loss pursuant to IRC § 469(j)(6)(A). (IRS Publ. 504, p. 19; IRS Publ. 925; but see Pvt. Ltr. Ruling, Tech. Adv. Mem. 9552001 (dealing with S corporations).)

Suspended Loss Carryforwards re Subchapter S Corporations

In a Subchapter S corporation, the taxable income or loss is passed-through to the shareholders. (IRC § 1366.) Losses which exceed the shareholder’s basis in stock and debt in the corporation are suspended and carried forward to the succeeding tax years. (IRC § 1366, subd. (d)(1) (aggregate amount of losses and deductions taken into account by a shareholder for any taxable year shall not exceed the sum of the adjusted basis of the shareholder’s stock in the S corporation and the shareholder’s adjusted basis of any indebtedness of the S corporation to the shareholder).)

When the stock in such a corporation is owned as community property and transferred or divided incident to divorce, the suspended loss carryforwards associated with the stock are transferred along with the stock on a pro rata basis based on the number of shares owned by each spouse during the tax year. (See IRC § 1367.) In an inkind division of the stock which was equally owned by the parties during marriage, each spouse will receive one-half of the suspended loss carryforward.

However, if the stock is awarded entirely to one spouse, the other spouse’s share of the suspended loss carryforward is not transferred to the other spouse. The carryforward is personal (having already passed-through to that spouse’s tax return when the loss was realized). (IRC § 1366, subd. (d)(2).)

The party receiving the stock will only have the benefit of his or her one-half share of the carryforward; the other half will be lost. It is not added to the basis in the stock, as the loss was disallowed in the year in which it occurred and carried forward. (Pvt. Ltr. Ruling, Tech. Adv. Mem. 9552001.) The spouse receives the transferor’s basis in the stock per IRC § 1041, which does not include the loss carryforward associated with the transferee’s stock. (See Taft, Tax Aspects of Divorce and Separation, § 5B.03[3][b].)

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If you’re getting a divorce, you know it’s a highly stressful time. But if you’re a business owner, tax issues can complicate matters even more. Your business ownership interest is one of your biggest personal assets and your marital property will include all or part of it.

Transferring property tax-free

You can generally divide most assets, including cash and business ownership interests, between you and your soon-to-be ex-spouse without any federal income or gift tax consequences. When an asset falls under this tax-free transfer rule, the spouse who receives the asset takes over its existing tax basis (for tax gain or loss purposes) and its existing holding period (for short-term or long-term holding period purposes).

For example, let’s say that, under the terms of your divorce agreement, you give your house to your spouse in exchange for keeping 100% of the stock in your business. That asset swap would be tax-free. And the existing basis and holding periods for the home and the stock would carry over to the person who receives them.

Tax-free transfers can occur before the divorce or at the time it becomes final. Tax-free treatment also applies to postdivorce transfers so long as they’re made “incident to divorce.” This means transfers that occur within:

• A year after the date the marriage ends, or
• Six years after the date the marriage ends if the transfers are made pursuant to your divorce agreement.

Future tax implications

Eventually, there will be tax implications for assets received tax-free in a divorce settlement. The ex-spouse who winds up owning an appreciated asset — when the fair market value exceeds the tax basis — generally must recognize taxable gain when it’s sold (unless an exception applies).

What if your ex-spouse receives 49% of your highly appreciated small business stock? Thanks to the tax-free transfer rule, there’s no tax impact when the shares are transferred. Your ex will continue to apply the same tax rules as if you had continued to own the shares, including carryover basis and carryover holding period. When your ex-spouse ultimately sells the shares, he or she will owe any capital gains taxes. You will owe nothing.

Note that the person who winds up owning appreciated assets must pay the built-in tax liability that comes with them. From a net-of-tax perspective, appreciated assets are worth less than an equal amount of cash or other assets that haven’t appreciated. That’s why you should always take taxes into account when negotiating your divorce agreement.

In addition, the IRS now extends the beneficial tax-free transfer rule to ordinary-income assets, not just to capital-gains assets. For example, if you transfer business receivables or inventory to your ex-spouse in divorce, these types of ordinary-income assets can also be transferred tax-free. When the asset is later sold, converted to cash or exercised (in the case of nonqualified stock options), the person who owns the asset at that time must recognize the income and pay the tax liability.

Avoid adverse tax consequences

Like many major life events, divorce can have major tax implications. For example, you may receive an unexpected tax bill if you don’t carefully handle the splitting up of qualified retirement plan accounts (such as a 401(k) plan) and IRAs. And if you own a business, the stakes are higher.  Contact us – a Weaver tax advisor can help you minimize the adverse tax consequences of settling your divorce under today’s laws.

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Tax considerations when dividing property in divorce

Marital estate division offers challenges and opportunities for advisers..

• Personal Financial Planning
• Tax Planning

The emotional aspects of a divorce often interfere with planning for the efficient distribution of the marital estate. The shock and ill feelings may create a barrier between spouses that prevents even discussing issues. Tax practitioners need to know how to explain to a divorcing client the tax realities, to avoid any post-divorce tax surprises. Mistakes in property division or fraud can produce consequences that the tax practitioner may be unable to reverse.

OPPORTUNITIES FOR CPAs

Divorce engagements can require CPAs to act in either or both of two roles. One role is that of a forensic accountant in locating all assets and liabilities for marital division. The other role requires the CPA to apply his or her tax expertise to separating marital assets and payments.

In the forensic role, the CPA investigates and analyzes financial evidence and interviews parties to ensure all marital assets are included to prevent fraud. This forensic examination may be used as evidence at trial. Many states require forensic accountants to register as private investigators. The tax adviser role of a CPA helps divorcing couples make an orderly division of marital assets with the least tax burden.

Since divorcing spouses may have competing interests, CPAs with clients in divorce must take care to avoid professional conflicts of interest or their appearance. Generally, this means that although tax advisers may have represented both spouses in the past, they should represent one party but not both, or else obtain conflict-of-interest releases. The same consideration should extend to other family members who, as a result of the divorce, may have competing interests (see AICPA Code of Professional Conduct Rule 102, Integrity and Objectivity , especially Interpretation 102-2.03, Conflicts of Interest ). Rule 102 provides examples of situations in which an AICPA member’s objectivity could be impaired. One is “a member has provided tax or personal financial planning (PFP) services for a married couple who are undergoing a divorce, and the member has been asked to provide the services for both parties during the divorce proceedings” (see also the sidebar, “Divorce Issues Checklist”).

DIVISION OF MARITAL ASSETS

For wealthy couples, particularly, the distribution of property often is the most important aspect of a divorce or separation agreement. Unless they meet the requirements of Sec. 1041 or Sec. 2516, property transfers included in a divorce decree are subject to income taxes or gift taxes, respectively.

Property acquired by the spouses during their marriage (e.g., family home, retirement plan assets) generally qualifies as marital property. With the exception of qualified retirement plan assets covered under the Employee Retirement Income Security Act (ERISA), state laws ultimately govern the division of marital assets in a divorce, and state laws differ radically on who gets what when the marriage ends. The division of assets differs according to whether the divorce takes place in an equitable distribution (common law) state or in a community property state. Currently, nine states (listed below) are community property states, and the remaining 41 are common law states.

EQUITABLE DISTRIBUTION STATES

In the 41 equitable distribution states, the courts decide what is a fair, reasonable, and equitable division of assets. A court may decide to award a spouse anywhere from none to all of the property value. The courts focus on factors such as how long the marriage lasted, what property each party brought into the marriage, the earning power of each spouse, the responsibilities of each spouse in raising their children, the amount of retraining needed to make a spouse employable, the tax consequences of the asset distribution, and debt allocation. If the couple signed a prenuptial agreement or an agreement during the marriage, they have more control over how the property is divided. Additional aspects of an equitable distribution that should not be overlooked include:

• Every asset acquired during the marriage and not covered by an agreement is subject to division.
• The name on the asset title or the source of the money used to acquire assets is not controlling.
• The parties to the divorce have the burden of identifying and proving the existence of assets.
• One spouse may prove to the satisfaction of the court that the other spouse transferred assets with divorce in mind and have an equal amount of assets awarded to him or her.
• Each spouse is responsible for any debts incurred during the marriage.

Thus, equitable distribution is considered a fair, but not necessarily equal, distribution of marital property.

COMMUNITY PROPERTY STATES

Community property is a form of concurrent ownership between a husband and wife created by statute in nine states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin (Alaska also allows a full or partial community property election). Community property laws, however, also are important for individuals residing in non-community-property states because property acquired in community property states and brought into non-community-property states ordinarily remains community property for state law and tax purposes. In addition, the separate property of each spouse brought into a community property state remains separate property, as long as it is properly segregated and identifiable. However, some states, such as California, may treat the property as community property for purposes of division during a divorce if it would have been community property had it been acquired in the community property state (see Cal. Fam. Code §125). The earnings of the divorcing couple are considered community property and thus are equally divided between the spouses. The same is true for assets bought by one spouse during marriage with funds earned during marriage.

Separate property in community property states may include property owned before marriage and, in some states, property acquired during the marriage with proceeds from the sale of separately owned assets. State law also may permit each spouse to inherit or receive by gift property that will not become community property.

FULL DISCLOSURE REQUIRED TO DIVIDE MARITAL ASSETS

Almost all states require the parties to disclose all material information needed to allow them to negotiate and agree upon a division of marital property. For example, California law states that because married couples are subject to the fiduciary rules imposed on persons in a confidential relationship (Cal. Fam. Code §721), this creates an obligation for a spouse to “make full disclosure to the other spouse of all material facts and information regarding the existence, characterization, and valuation of all assets in which the community has or may have an interest” (Cal. Fam. Code §1100(e)).

To ensure clients comply with the full-disclosure requirement, tax advisers should recommend that the divorcing couple inventory all property, including intangible assets such as advanced degrees, goodwill, and patents, that can result in substantially increased income in future years. Consideration of intangible assets in property settlements is becoming more important as courts express an increased willingness either to classify the intangibles as property subject to distribution or to require spouses to pay for reimbursement.

SEPARATION AGREEMENT AND DIVORCE DECREE

If the parties present their separation agreement to the court and the court issues a decree dissolving the marriage, the court may incorporate the agreement in the divorce decree, usually referred to as a merger. According to Section 306(d)(1) of the Uniform Marriage and Divorce Act (UMDA), merger occurs when the decree sets forth the terms of the separation agreement and orders the parties to perform its terms as an enforceable contract with enforcement as a judgment. Section 306(e) of UMDA provides for enforcement as a judgment, as well as contract remedies, if the separation agreement is in the divorce decree. A court order that specifically modifies an original divorce or separation instrument relates to the ending of the marriage and thus is incident to the divorce (with tax implications described later), even if it is issued many years after the divorce.

TRANSFERS DURING MARITAL DIFFICULTIES

A transfer of property by one spouse during a period of marital strife, whether or not divorce is imminent, might not be considered made unconditionally and is subject to additional scrutiny. All states give each spouse certain legal rights to share in the family’s assets if there is a divorce, but the scope of those rights varies significantly from state to state. In most states, the nondonor spouse may have set aside—as a fraudulent transfer—a gratuitous transfer of property made after the marriage has begun to deteriorate. Any unwritten custody arrangements where one spouse transfers property to a custodian for safekeeping with the understanding of a future repossession is highly suspect when the other spouse has no knowledge of the transfer.

TRANSFERS OF PROPERTY: ASSET DISSIPATION

The judicial doctrine of fraud on marital rights or dissipation of marital assets is an attempt to balance the transferor’s right to freely transfer his or her own property against the need to protect the legal entitlement of the transferor’s spouse to property. In most states, the law invalidates lifetime transfers if they are made with intent to deprive the transferor’s spouse of marital property rights, or if the transfers are made under circumstances where it would be unfair to permit them to stand.

To determine whether a spouse has attempted in a divorce situation to remove assets from the claims of the other spouse, courts look at all the relevant factors including:

• Whether consideration is involved;
• Size of the property transferred versus the transferring spouse’s total wealth;
• Time elapsing between the transfer of property and the divorce;
• Relations between the spouses at the time of transfer;
• The source of the property transferred; and
• Whether the transfer is revocable or illusory (i.e., the transferring spouse retains rights in or powers over the transferred property).

TAX CONSIDERATIONS

It is usually important that any property transfers between the divorcing spouses occur under circumstances that do not produce taxable gain or gift tax liability. Since no estate tax marital deduction is allowed for transfers to a former spouse, the transferor also will not want the transfer to be includible in his or her taxable estate.

Taxable gain. Under the general rule of Sec. 1041(a), a transfer of property to a former spouse incident to divorce will not cause the recognition of gain or loss. A transfer of property is incident to a divorce if the transfer occurs within one year after the date on which the marriage ceases or is “related to the cessation of the marriage,” which requires that the transfer:

• Is pursuant to a divorce or separation instrument, and
• Occurs not more than six years after the date on which the marriage ceases.

A divorce or separation instrument includes a modification or an amendment to the decree or instrument (Temp. Regs. Sec. 1.1041-1T(b), Q&A-7).

Transfer taxes. A transfer of marital property rights under a property settlement agreement that was incorporated into a divorce decree is not subject to gift tax. In Harris , 340 U.S. 106 (1950), the Supreme Court held that in such a case, the transfer would be pursuant to a court decree, not a “promise or agreement” between the spouses as required under gift tax law. However, subsequent decisions have limited the application of this rule to transfers that occur after the entry of a divorce decree.

If a transfer is not made under a property settlement agreement incorporated into a divorce decree, it may still not be subject to gift tax under Sec. 2516. Sec. 2516 provides that transfers of property or interests in property in settlement of marital property rights are treated as made for full and adequate consideration if the transfers are made pursuant to a written agreement and the divorce occurs within a three-year period beginning one year before the spouses enter into the agreement. Note that under Sec. 2516, the property transfer does not have to occur during the three-year period; the transfer may be made any time later, as long as it is “pursuant” to an agreement entered into during the three-year period.

Example. On Jan. 19, 2006, Mr. and Ms. Smith signed a separation and property settlement agreement to address contractual issues arising from the cessation of their marriage. The Smiths divorced in 2007. As part of the agreement, Mr. Smith transferred certain property to Ms. Smith. The agreement also provided:

Each party accepts the provisions herein made for him or her in lieu of and in full and final settlement and satisfaction of any and all claims or rights that either party may now or hereafter have against the other party for support or maintenance or for the distribution of property. However, each party has relied upon the representations of the other party concerning a complete and full disclosure of all marital assets in accepting the property settlement, and it is understood and agreed that this provision shall not constitute a waiver of any marital interest either party may have in any property owned but not fully disclosed by the other party as to existence or fair market value at the time this agreement is executed. Moreover, the failure of either party to disclose property shall constitute a material breach of this agreement, which shall give rise to whatever remedies at law or in equity may be available to the other party.

At some time after the parties signed the agreement, Ms. Smith began asking Mr. Smith whether all assets had been disclosed. She also hired an attorney to pursue claims arising from nondisclosure of assets. In 2011, Mr. Smith realized that he had inadvertently failed to disclose to Ms. Smith stock options ($16 million fair market value) that a court would consider marital assets. According to the terms of the agreement, Ms. Smith had not waived her marital interest in the stock options. Pursuant to a settlement (or an amendment to the original agreement), Mr. Smith paid Ms. Smith $6 million in 2011 in settlement of the claim that she had made regarding her interest in this property.

In considering this issue, Mr. Smith expressed concern that the transfer to Ms. Smith would exhaust his unified transfer tax credit and create a taxable gift transfer. However, because Mr. Smith made the payment pursuant to a written agreement relative to their marital and property rights, and Mr. and Ms. Smith divorced within the three-year period beginning one year prior to the signing of the agreement, under Sec. 2516, Mr. Smith was not subject to gift tax on the transfer and did not have to use his unified transfer tax credit.

Alimony. Sec. 71(b)(1) defines alimony as a transfer of cash made under a divorce or separation instrument to a spouse or former spouse under the following conditions:

• The divorce or separation instrument does not designate the payment as anything other than alimony (not for child support).
• The payments do not continue after the death of the recipient.
• The provisions of the instrument do not preclude a deduction by the payor spouse and the recognition of income by the payee spouse.
• Spouses who are legally separated under a decree of divorce or separate maintenance do not live in the same household when the transfer is made.

Certain payments to third parties on behalf of the spouse—for example, mortgage payments—qualify as payments in cash.

Alimony does not include child support payments (which are generally nondeductible by the payor and not included in the recipient’s gross income), noncash property settlements, payments that are part of the community income of the payee, payments to maintain the payor’s property for use by the payee, or the value of such use. If the parties are married at the end of the tax year and file a joint return, payments made during the year do not qualify as alimony.

Generally, alimony is deductible by the payor and included in the recipient’s gross income. Thus, there is inherent tension between property settlement and alimony. The payor may want a low property settlement and high alimony amounts for the tax deduction. The payee spouse, however, wants the reverse—that is, a property settlement not includible in income rather than taxable alimony.

To make property payments deductible, the payor spouse may try to disguise the payments as alimony. For example, the payor may make large “alimony” payments shortly after the divorce, followed by smaller alimony payments in subsequent years. Sec. 71(f) prohibits excessive front-loading of alimony payments and requires the payor spouse to recharacterize (or “recapture”) part of the alimony payments as nondeductible property transfers if there is excessive front-loading. Tax advisers can help their divorcing clients by reviewing any nonuniform payment schedule to make sure it does not violate the anti-front-loading rules.

ENSURING SAFETY

In planning for the division of assets and the obligations of the parties, safeguards can be put into place to avoid failed expectations. For example, parties may contractually decide that new life insurance is needed to fulfill the payor’s alimony and child support payment obligations in the event of death. The parties may contract to leave the ex-spouse as beneficiary (hanging beneficiary) on life insurance policies and retirement plans to ensure that the ex-spouse receives his or her bargained-for interests. If the beneficiary is designated as “my current spouse” and the owner spouse remarries, the ex-spouse no longer receives his or her interest when death or retirement occurs.

Safeguards also may be needed when a payor spouse has cyclical income business interests or illiquid business interests; the spouses may agree that an alimony trust or maintenance trust (Sec. 682 trust) is the best solution. An alimony trust can protect the payee (ex-spouse) from the death or financial insolvency of the payor before all of the payments have been made.

EMERGING WHOLE

Spouses in divorce situations must disclose all property, and this property must be distributed to the proper party. When fraud, errors, or omissions occur, a CPA needs to be capable of helping his or her client avoid the negative tax consequences of transfers or payments made in connection with the divorce. The client’s objective is to emerge from the divorce economically whole while minimizing taxes.  

Divorce Issues Checklist

Among the many tax practice resources the AICPA makes available to Tax Section members (see Resources box at the end of this article) is an eight-page checklist of tax considerations for CPAs representing clients who are divorcing or recently divorced. Some of its points are:

• Determine which party to represent and prepare a new engagement letter, privacy disclosure notice, power of attorney, and similar documents.
• Consider obtaining conflict-of-interest releases where indicated.
• Review any prenuptial agreement.
• Consider the effect of joint liability for any taxes owed.
• Determine responsibility between spouses for payment of taxes, allocation of estimated tax payments, tax refunds, carryovers, and potential recapture.
• Consider the need for (or, if completed, obtain a copy of) a qualified domestic relations order for any individual retirement accounts and other retirement plans.
• If there are children with investment income, reevaluate “kiddie tax” implications.
• For a property settlement, obtain or prepare a schedule of assets with tax considerations for each asset.
• Consider the effect of divorce on insurance coverage, beneficiary designations, mortgages and other debts, financial and estate planning, etc.

Source: Divorce Issues Checklist , AICPA Tax Section.

EXECUTIVE SUMMARY

CPAs can provide forensic services and/or tax advice concerning identification and division of marital property for a client going through a divorce. Since divorcing spouses are likely to have competing interests, however, CPAs providing these services should take care to avoid conflicts of interest.

In the nine community property states, property is owned concurrently between spouses. In the rest, referred to as common law states, courts must determine an equitable distribution of the spouses’ property between them.

Property transfers by a spouse during a period of marital strife may be subject to heightened judicial scrutiny in an equitable distribution of property. A court may invalidate transfers made to deprive the other spouse of assets by fraud or dissipation.

A transfer incident to divorce from one spouse to the other generally will not result in taxable gain or loss. However, divorcing couples should be made aware of requirements in the Code and regulations for a transfer to be considered incident to divorce. Similarly, alimony typically entails tax planning.

Ray A. Knight ( [email protected] ) is a visiting professor of accountancy, and Lee G. Knight ( [email protected] ) is the Hylton Professor of Accountancy, both at Wake Forest University in Winston-Salem, N.C.

To comment on this article or to suggest an idea for another article, contact Paul Bonner, senior editor, at [email protected] or 919-402-4434.

AICPA RESOURCES

Publications

• Divorce Issues Checklist , available to AICPA Tax Section members with many other tax practice guides and other resources at tinyurl.com/b7k4g98 after logging in. To join the Tax Section, see below.
• Divorce: The Accountant as Financial Expert (#091055)
• Forensic Accounting for Divorce Engagements: A Practical Guide, Third Edition (#091029)

CPE self-study

• Family Law (#154110)
• Forensic Accounting: Fraudulent Reporting and Concealed Assets (#731958)

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Tax issues to consider when a partnership interest is transferred.

By Colleen McHugh - Co‑Partner‑in‑Charge, Alternative Investments

There can be several tax consequences as a result of a transfer of a partnership interest during the year. This article discusses some of those tax issues applicable to the partnership.

Adjustments to the Basis of Partnership Property Upon a transfer of a partnership interest, the partnership may elect to, or be required to, increase/decrease the basis of its assets. The basis adjustments will be for the benefit/detriment of the transferee partner only.

• If the partnership has a special election in place, known as an IRS Section 754 election, or will make one in the year of the transfer, the partnership will adjust the basis of its assets as a result of the transfer. IRS Section 754 allows a partnership to make an election to “step-up” the basis of the assets within a partnership when one of two events occurs: distribution of partnership property or transfer of an interest by a partner.
• The partnership will be required to adjust the basis of its assets when an interest in the partnership is transferred if the total adjusted basis of the partnership’s assets is greater than the total fair market value of the partnership’s assets by more than $250,000 at the time of the transfer.

Ordinary Income Recognized by the Transferor on the Sale of a Partnership Interest Typically, when a partnership interest is sold, the transferor (seller) will recognize capital gain/loss. However, a portion of the gain/loss could be treated as ordinary income to the extent the transferor partner exchanges all or a part of his interest in the partnership attributable to unrealized receivables or inventory items. (This is known as “Section 751(a) Property” or “hot” assets).

• Unrealized receivables – includes, to the extent not previously included in income, any rights (contractual or otherwise) to payment for (i) goods delivered, or to be delivered, to the extent the proceeds would be treated as amounts received from the sale or exchange of property other than a capital asset, or (ii) services rendered, or to be rendered.
• Property held primarily for sale to customers in the ordinary course of a trade or business.
• Any other property of the partnership which would be considered property other than a capital asset and other than property used in a trade or business.
• Any other property held by the partnership which, if held by the selling partner, would be considered of the type described above.

Example – Partner A sells his partnership interest to D and recognizes gain of $500,000 on the sale. The partnership holds some inventory property. If the partnership sold this inventory, Partner A would be allocated $100,000 of that gain. As a result, Partner A will recognize $100,000 of ordinary income and $400,000 of capital gain.

The partnership needs to provide the transferor with sufficient information in order to determine the amount of ordinary income/loss on the sale, if any.

Termination/Technical Termination of the Partnership A transfer of a partnership interest could result in an actual or technical termination of the partnership.

• The partnership will terminate on the date of transfer if there is one tax owner left after the transfer.
• The partnership will have a technical termination for tax purposes if within a 12-month period there is a sale or exchange of 50% or more of the total interest in the partnership’s capital and profits.

Example – D transfers its 55% interest to E. The transfer will result in the partnership having a technical termination because 50% or more of the total interest in the partnership was transferred. The partnership will terminate on the date of transfer and a “new” partnership will begin on the day after the transfer.

Allocation of Partnership Income to Transferor/Transferee Partners When a partnership interest is transferred during the year, there are two methods available to allocate the partnership income to the transferor/transferee partners: the interim closing method and the proration method.

• Interim closing method – Under this method, the partnership closes its books with respect to the transferor partner. Generally, the partnership calculates the taxable income from the beginning of the year to the date of transfer and determines the transferor’s share of that income. Similarly, the partnership calculates the taxable income from the date after the transfer to the end of the taxable year and determines the transferee’s share of that income. (Note that certain items must be prorated.)

Example – Partner A transfers his 10% interest to H on June 30. The partnership’s taxable income for the year is $150,000. Under the interim closing method, the partnership calculates the taxable income from 1/1 – 6/30 to be $100,000 and from 7/1-12/31 to be $50,000. Partner A will be allocated $10,000 [$100,000*10%] and Partner H will be allocated $5,000 [$50,000*10%].

• Proration method – this method is allowed if agreed to by the partners (typically discussed in the partnership agreement). Under this method, the partnership allocates to the transferor his prorata share of the amount of partnership items that would be included in his taxable income had he been a partner for the entire year. The proration may be based on the portion of the taxable year that has elapsed prior to the transfer or may be determined under any other reasonable method.

Example – Partner A transfers his 10% interest to H on June 30. The partnership’s taxable income for the year is $150,000. Under the proration method, the income is treated as earned $74,384 from 1/1 – 6/30 [181 days/365 days*$150,000] and $75,616 from 7/1-12/31 [184 days/365 days*$150,000]. Partner A will be allocated $7,438 [$74,384*10%] and Partner H will be allocated $7,562 [$75,616*10%]. Note that this is one way to allocate the income. The partnership may use any reasonable method.

Change in Tax Year of the Partnership The transfer could result in a mandatory change in the partnership’s tax year. A partnership’s tax year is determined by reference to its partners. A partnership may not have a taxable year other than:

• The majority interest taxable year – this is the taxable year which, on each testing day, constituted the taxable year of one or more partners having an aggregate interest in partnership profits and capital of more than 50%.

Example – Partner A, an individual, transfers his 55% partnership interest to Corporation D, a C corporation with a year-end of June 30. Prior to the transfer, the partnership had a calendar year-end. As a result of the transfer, the partnership will be required to change its tax year to June 30 because Corporation D now owns the majority interest.

• If there is no majority interest taxable year or principal partners, (a partner having a 5% or more in the partnership profits or capital) then the partnership adopts the year which results in the least aggregate deferral.

Change in Partnership’s Accounting Method A transfer of a partnership interest may require the partnership to change its method of accounting. Generally, a partnership may not use the cash method of accounting if it has a C corporation as a partner. Therefore, a transfer of a partnership interest to a C corporation could result in the partnership being required to change from the cash method to the accrual method.

As described in this article, a transfer of a partnership interest involves an analysis of several tax consequences. An analysis should always be done to ensure that any tax issues are dealt with timely.

If you or your business are involved in a transfer described above, please contact your Marcum Tax Professional for guidance on tax treatment.

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The Taxing Side of Divorce: Partnership Tax Returns as Discovery Tools

The Partnership Tax Return – Form 1065

Returns and return information of a partnership or LLC may be disclosed to any person who was a member of the partnership during any part of the period covered by the return. Both general and limited partners are entitled to request and receive partnership returns and return information. On December 20, 2007, IRC §6103(e)(10) was enacted, limiting the disclosure of certain information attached to partnership returns. The information to be disclosed cannot include any supporting schedule, attachment, or list of a person other than the individual making the request for access. A requesting partner can no longer receive any Forms K-1 or other attachments that include identifying information of other partners or other individuals. He or she can receive only the Form K-1 for his or her interest in the partnership.

Special attention should be paid to the information reported on partnership returns when the divorcing partner owns a significant or controlling interest in the partnership. A controlling partner will presumably have the ability to dictate how income and expense items are classified and reported on the return. A minority partner, especially one with a very small percentage interest, usually has little or no input in the financial reporting process.

Page 1 Form 1065 – Beyond the Numbers

There is important information to be gleaned before looking at the numbers.

Boxes A & B identify the business activity of the partnership and the product or service provided. Box E provides the date the partnership was formed. If it is a new partnership, you may want to inquire as to the original capital required of the divorcing partner. Box H identifies the method of accounting. Accrual-based accounting is considered to provide the most accurate picture of the partnership’s financial results. If the partnership reports on a cash basis, does the divorcing partner have the ability to defer receipt of income or accelerate payment of expenses resulting in decreased earnings in the year of divorce? Box J provides the number of partners holding ownership interests at any time during the year. Changes in the number of partners may allow for the discovery of partner interest valuations or other partnership agreements.

Page 1 Form 1065 – Numbers Worth a Second Look

Ordinary income or loss from other partnerships, estates, and trusts is reported on Line 4. An entry on this line indicates that the partnership owns an interest in another entity. Inquire as to the nature and purpose of the ownership. You may want to request a copy of the other entity’s tax returns.

Other income is reported on Line 7. There should be a statement attached to the return that identifies the source of this income. Compare the entries year by year to determine if this is recurring income or a one-time occurrence.

Salaries and wages reported on Line 9 should not include any payments to partners. Are the amounts paid commensurate with the nature and volume of the partnership? If not, further investigation may be warranted. Inquire as to the reason and determine if there are family members receiving wages.

Guaranteed payments on Line 10 are the equivalent of salaries paid to partners. You may want to request a breakdown of these payments among the partners for each year. If the divorcing partner’s guaranteed payments have decreased in relation to the other partners in the year of the divorce, there may be a tacit agreement to make increased guaranteed payments to him or her once the divorce is finalized. Request a copy of the Partnership Agreement to determine if these payments comply with the agreement.

Rent expense reported on Line 13 should always be investigated. Is the partnership paying fair market rent? It is possible that the rent is either above or below market rates if paid to a related party? Inquire as to the ownership of the property being rented. It may be that the divorcing partner has an interest in the property.

Retirement plan expenses are reported on Lines 18. Request a copy of the summary plan description (SPD) for any plan maintained by the partnership. This will enable you to determine if the divorcing partner is covered by a defined contribution plan, a defined plan, or both. Also request the most recent statement of benefits for the divorcing partner.

Partners may be able to deduct personal expenses on Line 20 – Other Deductions. Carefully examine the schedule of these expenses attached to the return and request the details of any expenses that may be personal in nature.

The name and contact information of the tax preparer is provided at the bottom of Page 1 of the return. Request authorization to contact the preparer with any questions you may have about specific items or to review additional workpapers. If the divorcing partner is a minority owner, this permission may be denied.

Page 2 Form 1065 – Beyond the Numbers

Do not dismiss Page 2 merely because it does not contain any numbers. There is valuable information contained within these questions.

The answer to Question 3b – “Did any individual or estate own, directly or indirectly, an interest of 50% or more in the profit, loss, or capital of the partnership?” – will identify if there is a controlling partner. If there is a controlling partner, Form 1065 Schedule B-1 must be attached to the return.

The following questions 4a and 4b may reveal other assets of significant value.

aI At the end of the year, did the partnership own directly 20% or more, or own, directly or indirectly, 50% or more of the total voting power of all classes of stock entitled to vote on any foreign or domestic corporation? bI At the end of the year, did the partnership own directly an interest of 20% or more, or own, directly or indirectly, an interest of 50% or more in the profit, loss, or capital in any foreign or domestic partnership (including an entity treated as a partnership) or in the beneficial interest of a trust?

Page 3 Form 1065 – Beyond the Numbers

Similar to Page 2, there may be clues to additional assets contained in the answers to some of the questions.

If “yes” is checked in Box 13, the partnership either distributed property received in a like-kind exchange or contributed that property to another entity. This should spur further investigation into the nature of the property involved in the like-kind exchange, to whom it was distributed, and if contributed to another entity, the ownership of such entity. It may reveal another asset of the divorcing partner.

Likewise, if the answer to Box 14 is “yes,” the partnership distributed either a tenancy-in-common or other undivided interest in partnership property to a partner. Investigation into the details of the distribution may be warranted.

Finally, the IRS requires the name and contact information of the Designation of Tax Matters Partner. Is this the divorcing partner? If so, it may indicate that he or she has significant influence over the tax treatment of income and expense items.

Page 4 Form 1065 – Numbers Worth a Second Look

The partners’ distributive shares of income, loss, and other items are reported on Page 4. Amounts reported here represent the sum of all items “passed through” to the partners. The individual shares allocated to each partner are reported on Form 1065 Schedule K-1 to be discussed later.

Net income or loss from rental real estate is reported on Line 2. Although rental properties often generate taxable losses, they can be a source of additional cash flow to the partnership and partners. Adding back depreciation, a non-cash expense should give a rough estimate of the activity’s cash flow. If the partnership interest is being valued, the property should be appraised.

An entry on Line 12 – Section 179 Deduction indicates that the partnership purchased a capital asset during the year and elected to expense the cost rather depreciate it. This will, of course, reduce the net income reported on the return.

Line 19 Distributions

Page 5 Form 1065 – Numbers Worth a Second Look

The partnership balance sheet at the beginning and the end of the year is shown on Page 5 of the return.

Investments reported on Line 4 (U.S. government obligations) and Line 5 (tax-exempt securities), are stated at their original cost to the partnership. These assets may, in fact, be worth more (or less) than the value shown.

Always review the attached schedules, which provide the detail behind Line 6 – Other Current assets and Line 13 – Other Assets. You may find non-operating assets that add value to the partnership interest.

Loans to partners are shown on Line 7. Are these legitimate loans or merely a vehicle to provide the partners tax-free income? Inquire as to the interest rate and terms of repayment of these loans. If the divorcing partner received a loan from the partnership, were the proceeds used for marital purposes or is it possible that the funds are in a previously undisclosed account?

Loans from partners are reported on Line 19. If the divorcing partner has made a recent loan to the partnership, inquire as to the reason for the loan and when it will be paid back. It may be that the partner was merely parking marital funds in the partnership pending the finalization of the divorce. Whatever the reason for the loan, it should be considered a marital asset.

Schedule M-1 is a reconciliation of financial statement income and tax basis income. If the partnership is a cash basis taxpayer, a review of the reconciling items may give a more accurate picture of the true profit or loss of the partnership.

Schedule M-2 summarizes the partnership activity during the year and the impact on the partners’ capital accounts from the beginning of the year to the end of the year. The impact on individual partners’ capital accounts is detailed on their respective K-1s as will be discussed later.

Form 1065 Schedule K-1 – Numbers Worth a Second Look

In addition to providing the individual partner’s share of each element of partnership income or deduction, Schedule K-1 provides information regarding the nature of the interest, the partner’s percentage ownership interests, distributions, and capital. Remember, the partnership agreement may stipulate that an unequal percentage of profit or loss is to be allocated to a partner regardless of the amount of his or her capital contribution.

Part II – Item G will tell you if the divorcing partner is a general partner or a limited partner. As a limited partner, he or she would have little, if any, control over the operations of the partnership or the timing and amount of distributions.

Item J shows the partner’s profit percentage, loss percentage, and capital percentages as of the beginning of the year and the end of the year. If there are significant changes in these percentages, particularly in the year of divorce, make sure there is a valid reason and that it is not merely “divorce planning.”

Item L provides a reconciliation of the partner’s capital account, including any capital contributions or withdrawals made during the year. While the capital account is not necessarily a true reflection of the value of the interest, it is a starting point.

Other deductions are reported on Line 13 and identified by codes prescribed by the IRS. Certain items reported here may play a role in settlement negotiations.

Code M. Any amounts paid during the tax year for insurance that constitute medical care for the partner and his or her family. Code O. The partnership reports any dependent care benefits received by the partner. This may be a consideration in determining the amount of child support to be paid or received by the divorcing partner. Code R. Payments made on behalf of the partner to an IRA, qualified plan, simplified employee pension (SEP), or a SIMPLE IRA plan. If there is a Code R entry, inquire as to the nature of the plan, the current balance, and expected contribution in the year of divorce.

Actual distributions made to the partner are reported on Line 19. Code A denotes distributions of cash and certain marketable securities. The marketable securities are included at their Fair Market Value on the date of distribution. The partnership may distribute all or none of the income or, in many cases, only an amount necessary to pay the tax on the pass-through income.

Comparing the level of distributions in relation to taxable income over a three to five year period should reveal any significant changes in the year of divorce. A significant decrease in the amount distributed in the year of divorce may indicate that the distribution is merely being deferred until the divorce is finalized.

If you have reason to believe the returns you have been provided may not be the actual returns filed, you can request tax returns (and amended returns) directly from the IRS using Form 4506 or 4506 T (for transcripts only).

• High-Stakes Marital Dissolution

Dividing A Business In A Divorce: Pay Attention To The Tax Implications

Transferring Property Tax-Free

When dividing a business in a divorce, you can generally divide most assets. This is including cash and business ownership interests, between you and your soon-to-be ex-spouse without any federal income or gift tax consequences. When an asset falls under this tax-free transfer rule, the spouse who receives the asset takes over its existing tax basis (for tax gain or loss purposes) and its existing holding period (for short-term or long-term holding period purposes).

For example, let’s say that, under the terms of your divorce agreement, you give your house to your spouse in exchange for keeping 100% of the stock in your business. That asset swap would be tax-free. And the existing basis and holding periods for the home and the stock would carry over to the person who receives them.

Tax-free transfers can occur before the divorce or at the time it becomes final. Tax-free treatment also applies to post-divorce transfers. This is as long as they’re made “incident to divorce.” This means transfers that occur within:

• A year after the date the marriage ends.
• Six years after the date the marriage ends if the transfers are complete pursuant to your divorce agreement.

Future Tax Implications of Dividing a Business in a Divorce

Eventually, there will be tax implications for the receiving tax-free assets in a divorce settlement. The ex-spouse who winds up owning an appreciated asset generally must recognize taxable gain when it’s sold, unless an exception applies. This is specifically when the fair market value exceeds the tax basis.

What if your ex-spouse receives 49% of your highly appreciated small business stock? Thanks to the tax-free transfer rule, there’s no tax impact from the family business transfer of ownership or shares. Your ex will continue to apply the same tax rules as if you had continued to own the shares. This is including carryover basis and carryover holding period. When your ex-spouse ultimately sells the shares, he or she will owe any capital gains taxes. You will owe nothing.

Note that the person who winds up owning appreciated assets must pay the built-in tax liability that comes with them. From a net-of-tax perspective, appreciated assets are worth less than an equal amount of cash or other assets that haven’t appreciated. That’s why you should always take taxes into account when dividing a business in a divorce and negotiating your agreement.

In addition, the IRS now extends the beneficial tax-free transfer rule to ordinary-income assets, not just to capital-gains assets. For example, say you transfer business receivables or inventory to your ex-spouse in divorce. These types of ordinary-income assets can also get a tax-free transfer. When the asset is later sold, converted to cash or exercised (in the case of non-qualified stock options), the person who owns the asset at that time must recognize the income and pay the tax liability.

Avoid adverse tax consequences

Like many major life events, divorcing a small business owner can have major tax implications. For example, you may receive an unexpected tax bill. This generally happens if you don’t carefully handle dividing a business in a divorce regarding qualified retirement plan accounts and IRAs. And if you own a business, the stakes are higher. Our team of professional CPA experts can help you minimize the adverse tax consequences of settling your divorce under today’s laws.

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Q1. Under what circumstances did a partnership terminate under prior law (through December 31, 2017)?

A1. Before enactment of the Tax Cuts and Jobs Act (TCJA), a partnership was considered terminated if either:

• No part of the partnership’s activities continued to be carried on by any of its partners in a partnership. For example, the partnership ceases its activities and liquidates.
• A sale or exchange of 50 percent or more of the total interests in the partnership’s capital and profits occurred within a twelve-month period. This was considered a technical termination.

Q2. What changes made by the TCJA relate to partnership terminations?

A2. The TCJA eliminated the rule for technical terminations for partnerships or entities treated as partnerships for tax years beginning after December 31, 2017. So, a partnership may now only terminate by cessation of partnership activities and liquidation, or when the partnership’s business activities no longer continue in partnership form.  

Example 1 – Pre-TCJA

AB partnership was formed on January 1, 2005. On that date, the partnership purchased and placed in service rental real estate properties. On January 5, 2017, sales and exchanges of greater than 50 percent interests in capital and profits occurred within a 12 month period, causing a technical termination.   All of AB’s depreciable assets are considered contributed to a new partnership on January 6, 2017.  The new partnership keeps the same name and taxpayer ID. A Treasury regulation [Reg. § 1.708-1(b)(3)] states that the partnership’s tax year closes for all partners on the date a terminating event takes place. The partnership would file a final return for the short period ending on the partnership termination date, January 5, 2017. The new partnership would file a short-period return beginning January 6, 2017.

Example 2 – Post-TCJA

Assume AB partnership was formed on the same date above and purchased the same assets. But, assume that on January 5, 2018, sales and exchanges of greater than 50 percent of interests in capital and profits occurred within a 12-month period. No technical termination occurred, since the TCJA repealed technical terminations for tax years beginning after December 31, 2017.  The partnership would not file a short-period return for tax year 2018.

Income Allocation

Q3. how is income allocated when a partner leaves the partnership.

A3. When a partner sells or exchanges their entire partnership interest, the partnership’s tax year ends for that partner. The partnership allocates its income or loss for the year between the transferor and transferee partners based on the sale date. If a partner transfers less than their entire interest, the partnership tax year doesn’t close for the selling partner unless the partnership actually terminates.  Still, the partnership must allocate income or loss in a way that recognizes the partners’ varying interests during the tax year. In these situations, the partnership’s distributive share items are allocated among the partners whose interest changed in one of two ways: the interim closing method or the proration method. The proration method can only be used if agreed to by the partners in writing. 

Regulations under IRC Section 706 gives allocation rules for the following situations:

• when a partner’s interest in a partnership varies during the year due to a disposition of the entire interest, such as a partner’s death or the sale or exchange of liquidation of a partner’s interest, or
• when a disposition is less than the entire interest, including the admission of a new member.

Q4. If a partnership wants to trigger a technical termination as under prior law, may it voluntarily do so?

A4. Generally, no. But, a fiscal year partnership whose tax year began after January 1,2017, and on or before December 31, 2017, may be subject to the technical termination rules for its final fiscal period beginning in 2017.     

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• The Intersection of Business in Marital Divorce Cases: Business Issues That Often Arise in Family Law Proceedings 

When divorcing couples hold ownership interests in private companies as part of their marital estate, they will have to address a number of business issues related to these interests in their divorce settlement. Planning ahead to address these issues may help to avoid surprises and also lead to a less contentious discussion of their settlement options. This post, therefore, focuses on critical issues that divorcing couples will need to address in their divorce settlement negotiations if they have ownership interests in private companies.

Valuing a Private Company Interest Requires Current, Detailed Information

By definition, the stock of private companies is not traded in public markets. As a result, the process of determining the current market value of a private company will require assistance from an experienced business valuation expert. To provide a valuation report, the expert will need to analyze the company’s financial performance, review sales transactions of similar companies that have recently taken place in the industry and determine the value multiple used in the industry. This analysis, and the number of variables the expert is required to consider, can lead to wide variances in values when the spouses retain opposing experts.

Given the potential for a wide divergence in valuation opinions reached by the experts, spouses going through a divorce that involves private company ownership are advised to consider three things. First, the spouses will want to take steps to obtain the most up-to-date financial information regarding the company to provide to their experts because valuations can fluctuate greatly over time. Second, the scope of the information provided to the experts should be fairly broad and include documents that reflect recent valuations, offers for purchase made to the business, and previous sales of company stock or units. Our previous post focused on this specific issue. 

Finally, if one spouse is transferring his or her interest in the business to the other spouse in the settlement, the transferring spouse may want to negotiate to include a lookback provision in the settlement agreement. This provision provides that if the business is sold within a set period after the divorce settlement (often within a year) for a price higher than the value used in the settlement, the transferring spouse will receive a “true up” payment. The acquiring spouse is not required to agree to this lookback provision but may be willing to do so as part of the negotiations. 

Personal Goodwill May Play a Major Factor in Valuation

Another important issue related to the valuation of a business is the role that personal goodwill plays in the divorce setting. Personal goodwill is defined as:

“… [an] intangible asset arising as a result of name, reputation, customer loyalty, location, products, and similar factors not separately identified.”

The International Glossary of Business Valuation Terms

In the family law context, personal goodwill that results from a business, which is known as enterprise goodwill, can be divided between the spouses in a divorce. But personal goodwill that belongs to an individual owner/operator in the business is not divisible, and instead, it is the separate property of the spouse to whom it belongs.

“Personal goodwill is the goodwill that is attributable to an individual’s skills, abilities,    and reputation.”

See Texas Pattern Jury Charge, 203.2. Personal goodwill arises in personal services businesses, such as law firms, accounting or medical practices, sales companies or financial services firms. The percentage of personal goodwill can be such a large part of the total value of the business that it is often one of the most hotly contested issues in a divorce proceeding. Indeed, in some cases, personal goodwill can amount to 60% or more of the total value of the business. 

For this reason, personal goodwill tends to play an outsize role in the divorce negotiations as it may substantially reduce the value of the business to be divided in the divorce proceeding.  The spouse who is subject to the application of the discount based on the personal goodwill determination may therefore want to consider the following factors before accepting the opposing expert’s personal goodwill discount. Personal goodwill is a function of reputation and prominence, and a number of areas that are discussed below can be investigated to determine if this discount should be as robust as may be claimed. 

• First, most companies have a succession plan, and it should be obtained and analyzed as it may show that the spouse who is claiming the goodwill discount is not viewed as being crucial to the company or its succession plan.
• Second, whether the company maintains a key life insurance policy on the spouse claiming the discount should be determined. The absence of this policy suggests the company does not consider the spouse claiming the discount to be invaluable to the business.
• Third, the total headcount of the business should be examined. The more people who work at the business, the more an argument can be made that the value of the business is attributable to others at the company, and not as much to the spouse who is claiming the discount. 
• Finally, the expert for the spouse challenging the goodwill discount will need to evaluate the connection of the company’s clients to the spouse who is claiming the discount. It may be that many or most of the company’s clients are not tied to the spouse, and that the company’s reputation is largely independent of the personal goodwill of the spouse. 

The issues noted above are for the valuation expert to address, but the spouse who is challenging the goodwill discount may have knowledge about the business that will impact the analysis that applies to the calculation of the discount.

The Transfer of a Spousal Ownership Interest Raises Business Issues

In a previous post we reviewed key business issues that often arise when a spouse’s interest in a company is transferred to the other spouse as part of the divorce settlement. In this scenario, we refer to the spouse who is acquiring the full interest in the business as the acquiring spouse, and the spouse who is transferring the business interest is referred to as the transferring spouse.

The following important concerns should be part of the parties’ negotiations and final settlement documents:

• The parties should make it clear in the divorce settlement that the transferring spouse does not retain any ownership interest or other rights of any kind after the divorce from or related to the business. This includes a transfer of all rights to receive dividends, distributions, royalties, reimbursements or payments of any kind directly from or related in any way to the business.
• The transferring spouse should obtain a full, broad release not just from the acquiring spouse, but also from the company to prevent the acquiring spouse from directing the company to pursue any claims of its own after the divorce settlement has been completed.
• The transferring spouse should also seek an indemnity from the business in the divorce for any claims that are made by third parties after the divorce is final. This indemnity is particularly necessary when the transferring spouse previously worked in the business for some period.
• Finally, the acquiring spouse should consider whether it is necessary to obtain a noncompete restriction from the transferring spouse. If there is any potential for the transferring spouse to compete against the business after the divorce, this noncompete restriction may be valuable, but it will also likely require that the acquiring spouse provide some consideration to the transferring spouse. Even if a noncompete restriction is not obtained, the acquiring spouse should require the transferring spouse to sign a confidentiality agreement.

In some divorces, the business issues are the most difficult ones to resolve. This is more often the case when the couples have accumulated ownership interests in private companies during the marriage, and these interests must be divided as part of the divorce proceeding. Once it becomes clear that a marital divorce is going to take place, planning ahead to address these business issues will help lessen conflicts and allow for the necessary negotiations to take place relating to the ownership of interests in private companies. This type of planning includes gathering financial and governance records related to the business, meeting with the business valuation expert to discuss the valuation process, and discussing with counsel the key business terms that will be included in the final divorce settlement.

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• Treasury and IRS release guidance on partnership “basis shifting” transactions

Guidance documents related to certain “basis-shifting” transactions involving partnerships and related parties

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The U.S. Treasury Department and IRS today released three guidance documents related to certain “basis-shifting” transactions involving partnerships and related parties.  

As explained in the related IRS release— FS-2024-21 (June 17, 2024)—the basis shifting transactions targeted in the new guidance generally fall into three groups:

• Transfer of partnership interest to related party:  In this transaction, a partner with a low share of the partnership’s “inside” tax basis and a high “outside” tax basis transfers the interest in a tax-free transaction to a related person or to a person who is related to other partners in the partnership. This related-party transfer generates a tax-free basis increase to the transferee partner’s share of “inside” basis.
• Distribution of property to a related party:  In this transaction, a partnership with related partners distributes a high-basis asset to one of the related partners that has a low outside basis. After this, the distributee partner reduces the basis of the distributed asset and the partnership increases the basis of its remaining assets. The related partners can arrange this transaction so that the reduced tax basis of the distributed asset will not adversely impact the related partners, while the basis increase to the partnership’s retained assets can produce tax savings for the related parties.
• Liquidation of related partnership or partner:  In this transaction, a partnership with related partners liquidates and distributes (1) a low-basis asset that is subject to accelerated cost recovery or for which the parties intend to sell to a partner with a high outside basis. and (2) a high-basis property that is subject to longer cost recovery (or no cost recovery at all) or for which the parties intend to hold to a partner with a low outside basis. Under the partnership liquidation rules, the first related partner increases the basis of the property with a shorter life or which is held for sale while the second related partner decreases the basis of the long-lived or non-depreciable property, with the result that the related parties generate or accelerate tax benefits.

The guidance generally only impacts partnerships when partners are related parties. For purposes of the guidance, partners and other persons would be considered as related if they have a relationship described in section 267(b) (without regard to section 267(c)(3)) or section 707(b)(1) immediately before or immediately after a transaction.  However, the guidance would impact certain transactions not involving related parties – including where a party is tax-exempt, foreign (in certain cases) or has a tax-attribute precluding the recognition of gain (in certain cases).

Notice 2024-54 announces forthcoming regulations

To address these transactions, the Treasury Department and IRS today released Notice 2024-54 announcing two sets of upcoming regulations:

• The first set would require partnerships to treat basis adjustments arising from covered transactions in a way that would restrict them from deriving inappropriate tax benefits from the basis adjustments. The notice further announces that the covered transactions governed by these regulations would involve basis adjustments under sections 732, 734(b) and/or 743(b).
• The second set would provide rules to ensure clear reflection of the taxable income and tax liability of a consolidated group of corporations when members of the group own interests in partnerships. According to the guidance, regulations would apply a single-entity approach to partnership interests held by various members of a consolidated group.  

The notice states that the Treasury Department and IRS intend to propose that the first set of regulations apply to tax years ending on or after June 17, 2024. That is, once finalized, the regulations would govern the availability and amount of cost recovery deductions and gain or loss calculations for tax years ending on or after June 17, 2024, even if the relevant covered transaction was completed in a prior taxable year. The effective date for the second set of regulations will be proposed in the upcoming proposed regulations.  

Proposed regulations identifying certain partnership basis shifting transactions as transactions of interest

In addition, the Treasury Department and IRS today released proposed regulations  (REG-124593-23) that would identify certain partnership related-party basis adjustment transactions and substantially similar transactions as transactions of interest (TOI), a type of reportable transaction.

The TOIs generally involve positive basis adjustments of $5 million or more under section 732(b) or (d), 734(b), or 743(b), for which no corresponding tax is paid. The transactions would include either a distribution of partnership property to a partner that is related to one or more other partners in the partnership, or the transfer of a partnership interest in which the transferor is related to the transferee, or the transferee is related to one or more of the partners. In these transactions, the basis increase allows related parties an opportunity for decreasing their taxable income through increased cost recovery deductions or through decreasing their taxable gain (or increasing their taxable loss) on the subsequent transfer of the property in a transaction in which gain or loss is recognized in whole or in part.

The proposed regulations are proposed to apply as of the date of publication of final regulations in the Federal Register. However, taxpayers and their advisors should note that they may be required to report transactions that occurred prior to the date of publication of the final regulations.

Comments on the proposed regulations, as well as requests to speak and outlines for topics to be discussed at a public hearing (scheduled for September 17, 2024, at 10:00 AM ET), are due by August 19, 2024. If no outlines are received by that date, the public hearing will be cancelled. 

Revenue Ruling 2024-14 clarifies application of economic substance doctrine to partnership basis-shifting transactions

Finally, the Treasury Department and IRS today released Rev. Rul. 2024-14 clarifying when the economic substance doctrine may apply to disallow tax benefits associated with basis-shifting transactions involving partnerships and related parties.

In particular, Rev. Rul. 2024-14 announces that the economic substance doctrine will be raised in cases when related parties:

• Create inside/outside basis disparities through various methods, including the use of certain partnership allocations and distributions
• Capitalize on the disparity by either transferring a partnership interest in a nonrecognition transaction or making a current or liquidating distribution of partnership property to a partner
• Claim a basis adjustment under sections 732(b), 734(b), or 743(b) resulting from the nonrecognition transaction or distribution

Read another related IRS release— IR-2024-166  (June 17, 2024)

The purpose of this TaxNewsFlash  is to provide a high-level summary of these guidance documents. Another TaxNewsFlash will be released shortly providing initial analysis and observations on the guidance.

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The IRS Takes Aim at Basis Adjustments in Partnership Transactions

Trevor R. Allen Edward E. Gonzalez Kathleen (Kat) Saunders Gregor Sarah Beth Rizzo Jeff A. Romero Paul Schockett Matt Dinger

On June 17, 2024, the IRS issued three pieces of guidance addressing certain “basis-shifting” transactions in the context of related-party partnerships:

• In new proposed regulations, the IRS identified several transactions as “transactions of interest,” which would require taxpayers and material advisors to report such transactions to the IRS. 1
• Notice 2024-54 describes two sets of forthcoming proposed regulations that would have the effect of (i) suspending the basis-adjustment benefits of certain transactions in the related-party partnership setting and (ii) disallowing basis-adjustment benefits where related partners are members of the same consolidated group.
• Revenue Ruling 2024-14 applies the economic substance doctrine to three specific transactions in the related-party partnership setting, concluding that each transaction lacks economic substance, disallowing the intended tax benefit and imposing penalties.

Certain aspects of the guidance, if finalized, could apply to disallow deductions this year, even if the related-party partnership transaction occurred in prior years, and would apply without regard to a taxpayer’s intent. These and other key provisions and takeaways are described below.

In a press release accompanying the guidance, the IRS announced the formation of a new group within the Office of Chief Counsel that will handle issues surrounding partnerships and other pass-through entities, with a focus on “closing loopholes.” 2 Regarding the transactions addressed in the proposed guidance, the press release provides that “[c]urrently, the IRS has tens of billions of dollars of deductions claimed in these transactions under audit.” As previously reported, 3 the IRS has significantly ramped up enforcement activity in the partnership and pass-throughs area. This guidance shows that basis-shifting transactions are an early priority of this new group.

Transactions of Interest – Proposed Regulations Under Section 6011

Proposed Treasury Regulations Section 1.6011-18(c) describes four “basis-shifting” transactions in the related-party partnership setting identified as transactions of interest (requiring reporting by taxpayers and material advisors). The first three transactions involve current or liquidating distributions by a partnership to a “related partner” that result in a basis increase to property distributed to the partner or retained by the partnership under IRC section 732 or 734. 4 The fourth transaction involves a transfer of a partnership interest to a related partner in a nonrecognition transaction that results in a basis increase to partnership property under IRC section 743. 5 Finally, “substantially similar” transactions — e.g ., transactions that involve tax-indifferent (rather than related) partners or transfers of partnership interests to related transferees in recognition transactions that exceed the $5,000,000 threshold — would also be reportable transactions. 6

The comment period for the proposed regulations ends on August 19, 2024, and a public hearing has been scheduled for September 17, 2024.

• Although the proposed regulations are not yet effective (and will be effective only after finalization), reporting by participating partners, partnerships and material advisors may nevertheless be required for transactions occurring before that date. This is because a partner or partnership is treated as “participating” in a transaction of interest both in the taxable year in which the basis-adjusting transaction occurs and in any taxable year in which the tax return of the partner or partnership, as applicable, reflects the tax consequences of the basis increase. 7
• Increased audit scrutiny of these and similar transactions involving partnerships has already begun, meaning the IRS is likely developing theories for challenging tax benefits arising from existing ( i.e ., already completed) transactions that might be reportable at a later date — partnerships and partners might benefit from a risk assessment of existing transactions now, particularly in light of the reasoning set forth in Revenue Ruling 2024-14, discussed below.

Suspension of Benefits and Implications for Consolidated Groups – Notice 2024-54

Notice 2024-54 outlines two sets of forthcoming proposed regulations intended to address the basis-shifting transactions described above in the related-party partnership setting (defined in the notice as “covered transactions”):

• Proposed regulations under IRC sections 732, 734(b), 743(b) and 755 (the “Proposed Related-Party Basis Adjustment Regulations”) are intended to disallow the benefit of the basis adjustment in covered transactions. The proposed regulations would generally disallow recovery of the basis increase through depreciation or amortization, and would also prohibit taking such basis increase into account upon a future disposition of the property.
• Proposed regulations under section 1502 (the “Proposed Consolidated Return Regulations”) would address the interplay between the consolidated return rules and the rules of subchapter K. Short on any specific details, Notice 2024-54 provides that the forthcoming proposed regulations would “apply a single-entity approach with respect to interests in a partnership held by members of a consolidated group” and that such an approach is intended to “prevent direct or indirect basis shifts among the members of the group” resulting from the covered transactions described above. 8
• Treasury and the IRS have requested comments regarding the approaches to addressing distortions of income from related-party partnership basis shifting transactions by July 17, 2024.
• The Proposed Related-Party Basis Adjustment Regulations explicitly recognize that they could cover a host of transactions that are neither abusive nor lacking in economic substance as they are meant to apply mechanically regardless of taxpayer intent. 9 In addition, the rules would apply to suspend positive basis adjustments only, even if the related-party transaction also had the effect of reducing basis in other depreciable property.
• Similar to the proposed reportable transaction regulations described above, the Proposed Related-Party Basis Adjustment Regulations could apply retroactively to transactions that occurred before June 17, 2024, as long as the basis increase from such transactions is reflected on a tax return after the effective date. 10
• Although Notice 2024-54 describes the Proposed Consolidated Return Regulations as intended to prevent direct or indirect basis shifts among consolidated group members, the implications of this guidance are potentially much broader. If, as the notice suggests, a true “single-entity approach” were applied with respect to partnership interests held by consolidated group members, this could severely restrict the use of partnerships wholly-owned within consolidated groups. The applicability date for the Proposed Consolidated Return Regulations will be contained in future guidance.

Economic Substance Analysis – Revenue Ruling 2024-14

Revenue Ruling 2024-14 sets forth three situations involving basis-adjustment transactions in the related-party partnership setting and analyzes these transactions under the economic substance doctrine. In each situation, through the use of partnership distributions and/or related-party transfers of partnership interests, members of a controlled group shift basis from partnership property that is not depreciable or amortizable to depreciable or amortizable property held by the partnership or by a related partner, resulting in increased deductions or reduced amounts of gain (or increased loss). In each situation, (i) partnership contributions, distributions and allocations had been previously undertaken “with a view to creating a disparity” between inside and outside basis, (ii) the stated business purpose of the transactions at issue involved “cleaning up intercompany accounts, reducing administrative complexity and achieving other administrative efficiencies” and certain cost savings, and (iii) the cost savings resulting from the transaction were insubstantial relative to the reduction in aggregate federal income tax liability.

After discussing the relevant code provisions, Revenue Ruling 2024-14 concludes that, in each situation, the transactions at issue failed both the objective and subjective prongs of the economic substance doctrine as codified at IRC section 7701(o), i.e ., the transactions neither changed in a meaningful way (apart from federal income tax effects) the taxpayer’s economic position nor was there a substantial nontax business purpose for entering into the transactions. As a result, the ruling concludes that any resulting basis increases must be disregarded, and that the taxpayers are subject to a 20% penalty on any underpayment resulting from such a basis increase (increased to 40% for nondisclosure).

• While the first two pieces of guidance describe new rules, Revenue Ruling 2024-14 states the IRS’s current position with respect to certain basis-shifting transactions in the related-party partnership context.
• Notably, the IRS relies on IRC section 7701(o) and not Treasury Regulation section 1.701-2, the partnership anti-abuse rules. This reflects a broader and questionable trend by the IRS to expand the application of IRC section 7701(o) in contexts not traditionally considered to be subject to the economic substance doctrine or where another anti-abuse provision or doctrine already exists. Additionally, Revenue Ruling 2024-14 applies the economic substance doctrine without any consideration of its relevancy to the transactions at issue.

______________

1 REG-124593-23.

2 IR-2024-166, June 17, 2024.

3 See Armando Gomez, Kathleen (Kat) Saunders Gregor, Emily Lam, “ The Informed Board: The IRS Is Coming for Partnerships and High Net Wealth Individuals ,” Skadden Publications, Fall 2023.

4 Prop. Treas. Reg. § 1.6011-18(c)(1)(i)-(iii).

5 Prop. Treas. Reg. § 1.6011-18(c)(2).

6 Prop. Treas. Reg. § 1.6011-18(d).

7 Prop. Treas. Reg. § 1.6011-18(e)(5). In addition, taxpayers and material advisors may also be required to disclose a transaction of interest occurring in any taxable year for which the period of limitations remains open. See Treas. Reg. § 1.6011-4(e)(2)(i).

8 Notice 2024-54 § 5.01.

9 Notice 2024-54 § 4.01.

10 Notice 2024-54 § 6.01.

This memorandum is provided by Skadden, Arps, Slate, Meagher & Flom LLP and its affiliates for educational and informational purposes only and is not intended and should not be construed as legal advice. This memorandum is considered advertising under applicable state laws.

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Nike jeopardizes fc barcelona relationship with huge error, reports as.

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Nike has run the risk of jeopardizing its improving relationship with FC Barcelona with a huge error ... [+] reported on by AS.

Nike has run the risk of jeopardizing its improving relationship with FC Barcelona, with a huge error reported on by AS .

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On his podcast, Barca president Joan Laporta confessed to heading an attempt to cancel his club's arrangement with its kit sponsor, which he believed was in breach of contract.

"They have tried to improve the contract, but they have made efforts that are not enough because we know that the market pays more," Laporta explained, amid talk that Puma could be a future partner to provide the La Liga giants' kits.

Relevo revealed how a judge then ruled Barca must honor its agreement with Nike, which runs until 2028, and it wasn't long until reports from the likes of MARCA spread of a 10-year extension which would be worth over $1 billion.

That also reportedly comes with a much-needed signing-on fee exceeding $107 million, which would help the Catalans significantly in their quest to return to the 1:1 rule under Financial Fair Play limits and perhaps even head to the transfer market this summer.

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Furthermore, additional money could be forthcoming in bonuses whereas Barca have been previously penalized for not performing well domestically or on the continent.

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Meanwhile, however, AS sheds light on a development that has caused tension between Nike and Barca.

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At the moment, Barca therefore misses out on being able to capitalize on the tourists that visit its city in summer and take home a jersey as a souvenir.

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• Crime, justice and law
• Family justice system
• Family Court Statistics Quarterly: January to March 2024
• Ministry of Justice

Guide to Family Court Statistics

Published 27 June 2024

© Crown copyright 2024

This publication is licensed under the terms of the Open Government Licence v3.0 except where otherwise stated. To view this licence, visit nationalarchives.gov.uk/doc/open-government-licence/version/3 or write to the Information Policy Team, The National Archives, Kew, London TW9 4DU, or email: [email protected] .

Where we have identified any third party copyright information you will need to obtain permission from the copyright holders concerned.

This publication is available at https://www.gov.uk/government/statistics/family-court-statistics-quarterly-january-to-march-2024/guide-to-family-court-statistics

1. Introduction

Family Court Statistics in England and Wales are published every quarter, presenting the key statistics on activity in the family court system. This document aims to provide a comprehensive guide to the family court system, focusing on concepts and definitions published in Ministry of Justice statistics. It also covers statistical publication strategy, revisions, data sources, data quality, and dissemination. There is also a separate Quality Statement released alongside this guide.

The key areas covered in this guide are:

A high-level background to the family court system, focusing on the topics featured in the Family Court Statistics Quarterly (FCSQ) bulletin.

Information on the frequency and timings of the bulletin and its revisions policy.

Details of the data sources and any associated data quality issues.

Major legislation in the period covered by the bulletin.

A glossary of the main terms used within the publications.

A list of relevant internet sites on the Family Court system.

2. Background to the Family Court statistics

Family law is the area of law that deals with:

Public law – local authority intervention to protect children;

Private law – parental disputes concerning the upbringing of children;

Matrimonial cases – divorces, annulments and separations;

Financial Remedy (formerly known as ‘ancillary relief’) – financial provisions after divorce or relationship breakdown;

Domestic violence remedy orders;

Forced marriage protection orders;

Female genital mutilation protection orders;

The Mental Capacity Act; and

The Single Family court (also known as ‘the Family Court’) was implemented on 22 April 2014. Proceedings are issued by the Family Court and are allocated to a level of judge according to their type and complexity. The Single Family court aims to enable magistrates, legal advisers and the judiciary to work more closely together.

Previously, family cases were dealt with at Family Proceedings Courts (which were part of magistrates’ courts), at county courts or in the Family Division of the High Court.  These cases are now dealt within the Family Court and the High Court and most cases affecting children are dealt with under the Children Act 1989.

The Designated Family Judge (DFJ) has a role in leading the Family Court and managing its workload in distinct areas across England and Wales (called DFJ areas. Each DFJ area has a Designated Family Centre which is the principal family court location for each DFJ area. This is the location where all family applications from that DFJ area are sent to for initial consideration.

Family cases still need HM Courts & Tribunals Service (HMCTS) staff to administer them through the Family Court. What may have changed is how family work is received, distributed and listed within the DFJ areas. For example, in some areas more family work may be heard at the Designated Family Centre, with allocation and listing being managed from that location, with some other work taking place elsewhere.

3. Public Law

Data quality note Please note that there are several public law data series affected by HMCTS Reform and have been removed from Quarter 1 2022. Please see the data quality notice in the most recent bulletin for further details.

Public law cases are those brought by local authorities or an authorised person (currently only the National Society for the Prevention of Cruelty to Children) to protect the child and ensure they get the care they need. In these proceedings, the child is automatically a party and is represented by a Children’s Guardian appointed by the Children and Family Court Advisory and Support Service (Cafcass). The Children’s Guardian is an independent person who is there to promote the child’s welfare and ensure that the arrangements made for the child are in his or her best interests.

A range of different orders can be applied for. The main types of order are a care or supervision order which determines whether the child should be looked after or supervised by the local authority, and an emergency protection order which allows an individual or local authority to take a child away from a place where they are in immediate danger to a place of safety. The majority (two thirds) of Public law applications are for care orders.

The Public Law Outline flowchart provides more information about the main court processes for Children Act Public Law cases.

Following the publicity surrounding Baby P case [footnote 1] , the number of children involved in public law applications made by local authorities increased . Figures remained steady until 2015, after which there was a steady increase, such that prior to the pandemic, in 2019 there were around 30,000 individual children involved in public law applications.

Cafcass also publishes (England only) data on the number of care applications .

Case level care order figures are currently not produced by the MoJ and so comparisons between the two datasets cannot be made at this time.

3.1 Timeliness of Public Law Care and Supervision applications

In the interests of the child, courts try to minimise the length of time it takes for a case to be resolved. However, many factors can affect how long the case takes, such as the type of order applied for, the number of parties involved and how complex the child’s situation is. In general, there is a wide spread of case durations with many straight-forward cases being completed fairly quickly, more complicated cases taking longer and a few very complex ones taking a long time.

The care and supervision timeliness measure presented in this bulletin considers cases that began with a care or supervision application and measures the time from the application until the first of seven disposal types for each individual child. The seven valid disposal types for the purposes of this measure are a care order, a supervision order, a residence order, a special guardianship order, the application withdrawn, an order refused or an order of no order.

The bulletin presents the average, or ‘mean’, case duration, which can be quite heavily influenced by a few very long durations. We therefore also present the median timeliness in the accompanying tables, which is the length of time within which a definitive disposal was reached for half of all children involved which is less affected by cases with very long durations.

4. Private Law

Private law cases are court cases between two or more private individuals who are trying to resolve a dispute. This is generally where parents have split up and there is a disagreement about who the children should live with and have contact or otherwise spend time with. A range of different types of court order can be applied for, including “Section 8” orders (referring to the relevant section of the Children Act 1989), parental responsibility, financial applications and special guardianship orders. The vast majority of private law applications are for Section 8 orders, which include a child arrangements order determining who the child should live with and when and who a child should have contact with or spend time with.

The Private Law Outline flowchart provides more information about the main court processes for Children Act Public Law cases.

Cafcass also publishes (England only) data on the number of private law cases started .

Figure 1 compares both Cafcass and MoJ figures and shows that the trends are similar (for 2018-2020, MoJ figures have been higher on average, increasing gradually from 9% higher in 2014 to 18% in 2022, and 16% in 2023).

The difference between MoJ and Cafcass figures is mainly due to Cafcass only receiving section 8 cases [footnote 2]   from the courts. Other differences between the datasets include the following:

Section 8 cases where all of the issues are dealt with on the day (called ‘urgent without notice’ applications) should not be sent to Cafcass

Section 8 cases which are not listed within the Private Law Programme (PLP) and do not have a first hearing dispute resolution appointment (FHDRA) should also not be sent to Cafcass

Certain non-section 8 cases can be sent to Cafcass if the subject child is a party to ongoing proceedings (and a Cafcass officer has been appointed as the children’s guardian) or the court is directed to do so by a judge or legal advisor

This accounts for the discrepancy between the two datasets which cannot be accurately matched as it is impossible to identify the various situations described above from administrative data sources (particularly the ‘urgent without notice’ applications).

Figure 1: Comparison of the number of private law cases received, as recorded by Cafcass and MoJ (England only), January to March 2011 to January to March 2024

4.1 Timeliness of Private Law Cases

The private law timeliness measure presented in the quarterly bulletin considers cases that began with a private law application and measures the time from case start date until a final order has been issued in the family court.

As with public law, it presents the average, or ‘mean’, case durations, which can be quite heavily influenced by a few long durations, and therefore the median timeliness which is the length of time within which a definitive disposal was reached for half of all the cases is also presented.

4.2 Disposal of public and private law applications

There are four ways in which an application can be disposed of:

withdrawn applications – applications can only be withdrawn by order of the court.

order refused – in public law proceedings, an order is refused if the grounds are not proved and the court has dismissed the application. In private law proceedings, the court may refuse to make an order or make an order of no order.

order of no order – this is made if the court has applied the principle of non-intervention under section 1(5) of the Act. This means that the court shall not make an order unless it would be better for the child to make an order.

full order made – the type of order made may not be the same as the type of application that was originally applied for. An order is made in favour of one of the parties (Local Authority, parent or other guardian) however this aspect of the case outcome is not recorded on the central case management system (FamilyMan).

If a child arrangement order is breached, a party may apply to the court for an enforcement order to be made. Since December 2008, contact orders (and subsequently child arrangement orders) routinely contain a warning notice stating the consequences if a party fails to keep to the requirements of the order. For earlier orders, the party seeking enforcement must first apply to the court to have a warning notice attached to the order, and the relevant party informed that a notice has been attached. The enforcement order generally requires the person who has breached the order to undertake unpaid work, although if a party has suffered financial loss as a result of the breach they may apply for financial compensation. If other types of order are breached, it is possible for a party to apply for committal, so the breach is dealt with as contempt of court; however, this is very rare.

4.3 Mediation

Mediation can be particularly beneficial where there will be a continuing relationship following dispute resolution – such as in family cases. Family mediation can help reduce hostility and improve chances of long-term co-operation between parents and couples, for example in agreeing arrangements for their children and financial matters.

Before applying to the Family Court, people will need to prove they’ve considered mediation first. They can do this:

by showing they are exempt from having to consider mediation, for example, if domestic violence is involved; or

by proving to the judge that they have been to a ‘mediation information and assessment meeting’ (MIAM) with a family mediator but that mediation is not suitable for them.

This was enacted in the Children & Families Act 2014 .

The Legal Aid Agency publishes figures on the number of publicly funded mediations:

https://www.gov.uk/government/collections/legal-aid-statistics

5. Legal representation

Legal representation status as published within family court statistics reflects whether details of an applicant’s/respondent’s legal representative has been recorded or left blank within FamilyMan, the family court case management system. A blank field is assumed to indicate that no legal representative has been used.

Table 10 suggests that for almost half of the divorces not involving financial remedies disposed, neither party had legal representation. However, further analysis showed that these were uncontested cases and almost all of them did not have a single hearing. Therefore, parties recorded as without legal representation are not necessarily self-representing litigants in person .

To provide a better proxy for litigants in person, a new table was produced which gives the number of parties in cases with at least one hearing, by their legal representation status (Table 11).

There was a revision to the methodology used to produce Tables 10 and 11 [footnote 3] – specifically to account for the issue in public law cases where applicants would generally be public bodies (mostly local authorities) with access to their own legal resources, but who would previously have been shown as an ‘unrepresented’ party. This was amended such that they are now shown as represented parties in the above tables, and this changed the percentage of applicants with legal representation in public law cases with at least one hearing from around 20% to 99%. The overall trends seen in the mean time to disposal of public law cases by representation type however (Table 10) have not changed.

Please note that the majority of the work done in the Court and Tribunal Service Centre in divorce (see section on Core Case Data) are online applications from unrepresented parties.

5.1 Legal representation and its relationship with timeliness

Different types of cases tend to take different lengths of time to complete – in general public law cases for children take longer than private law cases and divorce cases tend to be quite lengthy due to set time limits, whereas domestic violence cases are usually completed in a fairly short time due to their nature. Another factor that may influence how long a case takes is whether one or both parties had a legal representative or alternatively represented themselves. This may also be affected by whether the parties consent to the application or are contesting it which in turn may reflect the complexity of the case.

5.2 Legal Aid, Sentencing and Punishment of Offenders (LASPO) Act 2012

This created the Legal Aid Agency, an executive agency of the Ministry of Justice, on the 1st April 2013, following the abolition of the Legal Services Commission. The implementation of the Act also made changes to the scope and eligibility of legal aid, removing some types of case from the scope of legal aid funding, and only allowing other cases to qualify if they meet certain criteria. Funding is no longer available for private family law, such as divorce and disputes over arrangements for children. Family law cases involving domestic violence, forced marriage or child abduction will continue to receive funding.

Full details of the LASPO Act .

The removal of legal aid for many private law cases resulted in a change in the pattern of legal representation, and Figure 4 of the FCSQ bulletin shows how this changed over time. Around the time that the LASPO reforms were implemented, there was a marked increase in the number and proportion of cases where neither party were represented, with an equivalent drop in the proportion of cases where both parties were represented. In 2023, neither the applicant nor respondent had legal representation in 39% of private law disposals, an increase of 20 percentage points from 2013. Correspondingly, the proportion of disposals where both parties had legal representation dropped by 14 percentage points over the same period.

The Legal Aid Agency (LAA - formerly the Legal Services Commission) collects statistics on those applying for legal aid, and figures on the number of applications received and certificates granted by various Family categories have been published in their annual and quarterly statistical reports.

6. Matrimonial cases

There are two ways to legally end a marriage or a civil partnership. An individual can apply for a divorce which will give them a final order (previously known as a decree absolute), ending a valid marriage or civil partnership – this occurs in the vast majority of cases. Alternatively, an individual can apply for a decree of nullity, which declares that the marriage or civil partnership itself is void, specifically no valid marriage or civil partnership ever existed; or voidable, specifically the marriage or civil partnership was valid unless annulled. No application can be made for divorce within the first year of a marriage or a civil partnership. An alternative to divorce is a decree of judicial separation or a decree of separation of civil partners, but this does not allow them to remarry or enter into a civil partnership. Figure 2 shows the main court processes for divorce or dissolution cases.

The Office of National Statistics also publishes statistics on the number of divorces occurring each year in England and Wales .

Figure 2: The main court processes for divorce cases

During 2014 and 2015, a number of centralised divorce centres were introduced in England and Wales, with the vast majority of uncontested decree nisi applications being considered by Legal Advisers (rather than district judges) at those centres. Some have since closed and the majority of divorce cases are now handled digitally by the Courts and Tribunal Service Centres (CTSCs). Further details on court closures can be provided upon request.

Following the Children and Families Act 2014, couples divorcing are no longer required to provide information on children as part of the divorce process. We therefore removed this information from the accompanying relevant csv file to avoid misleading conclusions being made.

6.1 New divorce legislation – Divorce, Dissolution and Separation Act 2020

New legislation came into effect from 6th April 2022, following the Divorce, Dissolution and Separation Act 2020. The key changes include:

• Ability for either a joint or sole application for divorce, civil partnership and judicial separation
• Removal of the Facts (i.e. no grounds for divorce, civil partnership or separation)
• Some timeliness changes (i.e. the respondent in a sole application has 14 days to respond not 7 days, and also there is an inclusion of a mandatory 20 week period from issue to conditional order)
• Ability to change from joint to sole application at the conditional (CO) and final order (FO) stages

There are also several terminology changes:

• A petition is now an application;
• A petitioner is now an applicant;
• A decree nisi is now a conditional order;
• A decree absolute is now a final order.

As a result of these changes, the main divorce table in FCSQ (Table 12) has a filter added so that users can separate out old and new divorce cases and a new table (Table 12b) has been added to expand on data available under the new divorce legislation.

6.2 Digital system

Following a testing phase, those citizens seeking to apply for divorce could do so via an online service which was rolled out across England and Wales from 1 May 2018 in stages. It offers prompts and guidance to assist people in completing their application, and uses clear, non-technical language. This digital system runs alongside the existing paper application.

Cases which were started between May 2018 and January 2019 would only have the petitions (applications) submitted online. This means whilst petitions may have been issued online, subsequent steps would have been via paper using the existing non-digital processes.

From January 2019 the online service developed in stages to cover the remaining aspects of the divorce process, with the full process rolled out nationally in September 2019.

7. Financial remedy (formerly ‘ancillary relief’) – financial disputes post-divorce/separation

During a divorce, a marriage annulment, a judicial separation, or the dissolution of a civil partnership there may still be a need for the court to settle disputes over money or property. The court can make a financial remedy order, formerly known as ‘ancillary relief’. These orders include dealing with the arrangements for the sale or transfer of property, maintenance payments, a lump sum payment or the sharing of a pension. Orders for financial provision other than for ancillary relief are not dependent upon divorce proceedings and may be made for children.

The Child Maintenance and Other Payments Act 2008 led to the creation of the Child Maintenance Enforcement Commission (CMEC) which replaced the Child Support Agency (CSA), although the CSA retained its existing caseload. The Act also removed the requirement for all parents in receipt of benefit to go through the CMEC even if they could reach agreement. Parents who were not on benefits were previously allowed to come to courts for consent orders. This change  likely increased the number of parties that came to court for maintenance consent orders.

If an order is breached, several options are open to the aggrieved party to seek enforcement of the order. For money orders, proceedings can be instituted in the family court where a variety of remedies such as attachment of earnings may be available. However, if arrears of more than one year are owed, the person seeking payment must first get the court’s permission to make an enforcement application.

Please note that data in Table 16 previously looked at financial remedy disposals, (which includes orders made and dismissals) by remedy type. However, during to differing ways of requesting these on the application (some request all types, either to have an order made or to be dismissed, others just request the type they require the order for), it has been deemed that the quality of this data is not suitable for publication in a National Statistics bulletin. Work is ongoing to collect robust data on orders made and this will be reported on when available.

Within Table 14 a split is given between contested and uncontested financial remedy applications. Where the first application lodged in a financial remedy case is for a consent order the case is considered to be uncontested, otherwise the case is considered to be contested.

8. Domestic violence remedy orders

Part IV of the Family Law Act 1996 provides single and unified domestic violence remedies in the family court and the High Court, with the vast majority carried out in the former. Figure 3 shows the main court processes for domestic violence remedy cases.

A range of people can apply to the court: spouses, cohabitants, ex-cohabitants, those who live or have lived in the same household (other than by reason of one of them being the other’s employee, tenant, lodger or boarder), certain relatives (for example, parents, grandparents, in-laws, brothers, sisters), and those who have agreed to marry one another.

Two types of order can be granted:

a non-molestation order, which can either prohibit particular behaviour or general molestation by someone who has previously been violent towards the applicant and/or any relevant children; and,

an occupation order, which can define or regulate rights of occupation of the home by the parties involved.

In July 2007, section 1 of the Domestic Violence, Crime and Victims Act 2004 came into force, making the breach of a non-molestation order a criminal offence. A power of arrest is therefore no longer required on a non-molestation order but instead it includes a penal notice. The court may also add an exclusion requirement to an emergency protection order or interim care order made under the Children Act 1989. This means a suspected abuser may be removed from the home, rather than the child.

Where the court makes an occupation order and it appears to the court that the respondent has used or threatened violence against the applicant or child, then the court must attach a power of arrest unless it is satisfied that the applicant or child will be adequately protected without such a power. If there is no power of arrest attached to the order, and the order is breached, this is dealt with as contempt of court. The court may then impose a fine or make a committal order whereby the person who breached the order is imprisoned or put on remand until the next hearing.

Figure 3: The main court processes for domestic violence remedy cases

9. Forced marriage protection orders

Applications for a Forced Marriage Protection Order (FMPO) can be made at 15 designated locations of the family court. This court, as well as the High Court, is able to make Forced Marriage Protection Orders to prevent forced marriages from occurring and to offer protection to victims who might have already been forced into a marriage.

From 16 June 2014, it is an offence to force a person to marry against their will, or to breach a FMPO. As a result, courts no longer need to attach a power of arrest to an FMPO, and so are no longer included in the relevant table.

From October-December 2018, there is a marked increase in the number of FMPOs made compared to the number of applications. Often there are multiple orders granted per case, where one application covers more than one person, and an order is granted for each person covered in the application. Extensions and increased provision of previous orders can also be granted as new orders, without the need for a new application to be submitted.

10. Female genital mutilation protection orders

Female Genital Mutilation Protection Orders (FGMPOs) are intended to safeguard girls who are at risk of FGM at home or abroad, or who are survivors. They came into effect on 17 July 2015.

11. Adoption

Data quality note Please note that there are several public law data series affected by HMCTS Reform and have been removed from Quarter 4 2022. Please see the data quality notice in the most recent bulletin for further details.

Prior to making an adoption application, a placement order is generally made to place a child with prospective adopters. If the placement is being made by an adoption agency, by a High Court order, or by the child’s parent, the placement period is 10 weeks before an adoption application can be made. For a step-parent, the placement duration is six months, while for local authority foster parents, it is usually one year. In other cases, the courts generally require the child to have been living with the prospective adopters for three out of the preceding five years. An application for adoption can be made to the family court in the area in which the child is living.

An adoption order made by a court extinguishes the rights, duties and obligations of the natural parents or guardian and vests them in the adopters. On the conclusion of an adoption the child becomes, for virtually all purposes in law, the child of its adoptive parents and has the same rights of inheritance of property as any children born to the adoptive parents. Figure 4 shows the main court processes for adoption cases.

Until 2012, the Office for National Statistics (ONS) published adoption figures annually.

Figure 4: The main court processes for adoption cases

12. The Mental Capacity Act

The Mental Capacity Act 2005 provides a statutory framework to empower and protect vulnerable people who are not able to make their own decisions. It makes it clear who can take decisions, in which situations, and how they should go about this. It enables people to plan ahead for a time when they may lose capacity.

The Act created two new public bodies to support the statutory framework, both of which are designed around the needs of those who lack capacity.

The Court of Protection

The Public Guardian, supported by the Office of the Public Guardian (OPG)

12.1 The Court of Protection

The Court of Protection makes specific decisions, and also appoints other people (called deputies) to make decisions for people who lack the capacity to do this for themselves. These decisions are related to their property, financial affairs, health and personal welfare. The Court of Protection has powers to:

make declarations about a person’s capacity to make a particular decision, if the matter cannot be decided informally;

make decisions about serious medical treatment, which relate to providing, withdrawing or withholding treatment to a person who lacks capacity;

make decisions or orders about the personal welfare and property and affairs of people who lack capacity to make such decisions themselves;

authorise deprivation of liberty in relation to a person’s care and residence arrangements;

appoint a deputy to make ongoing decisions for people lacking capacity to make those decisions in relation to their personal welfare or property and financial affairs;

make decisions about a Lasting Power of Attorney or Enduring Power of Attorney, including whether the power is valid, objections to registration, the scope of attorney powers and the removal of attorney powers.

Most applications to the court are decided on the basis of paper evidence without holding a hearing. In around 95% of cases, the applicant does not need to attend court. Some applications such as those relating to personal welfare, objections in relation to deputies and attorneys, or large gifts or settlements for Inheritance Tax purposes may be contentious and it will be necessary for the court to hold a hearing to decide the case.

Following the introduction of new forms in July 2015, applicants must make separate applications for ‘property and affairs’ and ‘personal welfare’, resulting in the almost complete absence of ‘hybrid deputy’ applications since Q4 2015.

Applications relating to deprivation of liberty increased following the Supreme Court decision on 19 March 2014 [footnote 4] whereby it was considered a person could be deprived of their liberty in their own home, sheltered accommodation etc., and not just the nursing homes and hospitals which were previously covered.

In Re X and others [2014] EWCOP25 , the Court of Protection set out a new streamlined process to enable courts to deal with deprivation of liberty cases in a timely and just fashion. Half of applications for deprivation of liberty were made under this process.

NHS Digital publishes official statistics on the Mental Capacity Act 2005, Deprivation of Liberty Safeguards data collection . This includes any application to local authorities reported to NHS Digital that was received, processed or considered to be “active” in any way during the year.

12.2 Deprivation of Liberty (High Court)

In July 2022 the President of the Family Division launched the national deprivation of liberty court. Based at the Royal Courts of Justice, it deals with all new applications seeking authorisation to deprive children of their liberty under the inherent jurisdiction and ran for a pilot phase initially.

These applications differ to deprivation of liberty applications made under the Court of Protection (referenced above), with the distinction of being processed under the High Court. Applications processed under the High Court are specifically in relation to children and cover information included on the C66 application form – the form used to apply for an order under the High Court inherent jurisdiction in relation to children.

Data collected on deprivation of liberty (High Court) applications began in FCSQ from quarter 3 2023. Prior to this, Nuffield Family Justice Observatory reported on data during the pilot phase from July 2022 to June 2023 on a monthly basis. For information relating to trends prior to implementation in FCSQ, please see their last publication, National deprivation of liberty court: Latest data trends – June 2023 with links to previously published information.

12.3 Office of the Public Guardian

The Office of the Public Guardian (OPG), an agency of the Ministry of Justice, was established in October 2007, and supports the Public Guardian in registering Enduring Powers of Attorney (EPA), Lasting Powers of Attorney (LPA) and supervising Court of Protection (COP) appointed Deputies.

The OPG supports and promotes decision making for those who lack capacity or would like to plan for their future, within the framework of the Mental Capacity Act 2005. The role of the Public Guardian is to protect people who lack capacity from abuse. The Public Guardian, supported by the OPG, helps protect people who lack capacity by:

setting up and managing a register of LPAs and EPAs;

setting up and managing a register of Court appointed Deputies, supervising Court appointed Deputies, working with other relevant organisations (for example, social services, if the person who lacks capacity is receiving social care);

receiving annual financial reports from all primary Deputies under their supervision; and

dealing with cases, by way of investigations, where concerns are raised about the way in which Attorneys or Deputies are carrying out their duties.

The Power of Attorney (PoA) data provided by the Office of the Public Guardian for publication focuses on registrations, whereas previous receipts data provided data on all PoAs received (some of which would ultimately be withdrawn or rejected due to errors). Data on receipts may be introduced in future releases.

13. Probate

When a person dies, somebody has to deal with their estate (money property and possessions left) by collecting in all the money, paying any debts and distributing what is left to those people entitled to it. Probate is the court’s authority; given to a person or persons to administer a deceased person’s estate and the document issued by the Probate Service is called a Grant of Representation . This document is usually required by the asset holders as proof to show the correct person or persons have the Probate Service’s authority to administer a deceased person’s estate.

Grants of representation are known as either:

Probate – when the deceased person left a valid will and an executor is acting,

Letters of administration with will – when a person has left a valid will but no executor is acting, or

Letters of administration – usually when there is no valid will.

These different types of grants of representation appoint people known as personal representatives to administer the deceased person’s estate.

When a Probate is contested, the Chancery Division of the High Court deals with the matter. See the Guide to Civil and Administrative Justice Statistics for more information on the Chancery Division.

Grants of representation can be applied for digitally (and handled by the Courts and Tribunals Service Centre) or via the traditional paper route. The CTSC have trained substantial numbers of new staff and now has now got a broad multi skilled team who can process probate applications more quickly and accurately than previously.  

Timeliness measures for grants of representation are provided in FCSQ from application submission and document receipt. Document receipt occurs after payment has been made and all accompanying paperwork has been received by HMCTS. As such, it does not reflect the entire case journey from when an application is submitted by the user to when a grant is received. Instead these figures reflect the timeliness from when HMCTS staff are able to start working on the case. The aspects not included in these timeliness measures include (but are not limited to); time taken to scan and upload documents to the management system (for paper items), and check that these items are of good enough quality to proceed. For digital applications the receipt is instant but no work can start until the Will is sent to HMCTS.

Please note that the HMCTS database which collects information on probate changed in May 2019. However, due to the transition between the old and new systems, it was not possible to provide the breakdown by grant type and applicant type for quarter 2 of 2019 (and as such, for 2019 as a whole).

14. Data Sources and Data Quality

14.1 data sources.

The data on family related court cases is principally sourced from the court administrative system, FamilyMan, used by court staff for case management purposes. It contains good quality information about a case’s progress through the family courts.

For earlier years, FamilyMan provided data for county courts and for the Family Proceedings Courts which share premises and administrative systems with county courts; data for other Family Proceedings Courts was provided on electronic summary returns submitted to HMCTS Business Information Division on a monthly basis. Figures prior to 2007 for Family Proceedings Courts were weighted estimates based on data from a subset of courts. There are known data quality problems with these, which are likely to be an undercount. Starting at the end of 2009, an upgrade to the administrative system in all county courts and Family Proceedings Courts was rolled out nationally. This upgrade was completed in December 2010 following a staggered rollout. Therefore, the majority of the family court case data now comes from the FamilyMan system.

Whilst the Ministry of Justice’s divorce statistics are sourced directly from the main court system (FamilyMan originally, Core Case Data more recently), the ONS data used to be compiled from ‘D105’ forms used by the courts to record decrees absolute. There were small differences between the number of divorces as recorded by the two sets of statistics, and attempts were made to understand these differences and reconcile where possible. A joint statement was subsequently produced by the MoJ and ONS on the differences in these divorce statistics, which can be found at Annex C of the CSQ bulletin for Q1 2012 .

Core Case Data

In September 2016, a commitment was made to modernise courts through the HMCTS Reform programme . As a result, data transitions from the existing case management systems to the new Core Case Data (CCD) as different areas are addressed. Like FamilyMan, CCD is an administrative data system set up for case management purposes.

Probate figures from Q2 2019 onwards are extracted from CCD, which was implemented in May 2019. Earlier data was extracted from HMCTS’s OPT system, which utilised data from ProbateMan – a similar administrative system to FamilyMan.

Divorce has undergone reform, and data for digital cases is available directly via CCD whilst paper cases are bulk scanned in, and financial remedy case data has also migrated to CCD. Published statistics use a combination of both data systems, from June 2021 (for divorce) and March 2022 (for financial remedy).

A similar process will take place as other areas are reformed for public law, private law (including domestic violence remedy, FGM and forced marriage cases) and adoption. This section will be updated accordingly.

Other Data Sources

Information on Forced Marriage Protection Orders (FMPOs) and Female Genital Mutilation Protection Orders (FGMPOs) are sourced from the HMCTS Performance database (OPT) . This is a regularly updated, web-based management information system which enables aggregation to national level of returns from individual courts. It is based on systems similar to FamilyMan, that is court administrative systems used for case management.

Mental Capacity Act figures are provided directly to MoJ from the Court of Protection (CoP) and the Office of the Public Guardian (OPG) from their data management systems. Information about Lasting Power of Attorney records (LPAs) is managed by OPG’s Sirius case management system, whilst deputyships are extracted from the Caserec system. Sirius is the first case management system in government developed using Government Digital Service principles; it is built with open source technologies, cloud hosted and maintained by teams in OPG.

A number of published breakdowns of OPG data are derived from recorded variables, as opposed to being recorded directly themselves. These are:

Gender of donor is inferred from the donor’s title. Cases within the “other” category relate to titles which cannot clearly be categorised as male or female (i.e. Dr, Professor etc), and where titles have additional characters/errors (i.e. Mrs., Mr’ etc).  Possible non-binary also appear in this category as it is unclear if these are non-binary titles or mistakes in spelling of a male/female title (i.e. Mx.);

Age of donor is calculated from the recorded date of birth and date of registration, and split into several bands. The ‘Other’ age is where the date of birth is recorded but we are unable to infer accurately (e.g. over 120 years old, has a negative age, under 18 years old).

Location of donor is inferred from the donor’s recorded address and classified into NSPL (ONS National Statistics Postcode Lookup) categories for country, region and local authority breakdowns.

14.2 Counting Rules

Here are some main points to consider when interpreting the family court statistics:

A disposal which occurs in one quarter or year may relate to an application which was initially made in an earlier period. Additionally, an application of one type may lead to an order of a different type being made.

As well as an order made, a disposal can be a refused order, withdrawn application, or order of no order.

There are several ways to analyse and count the data on family cases. By case – where each case number in FamilyMan is only counted once. By application or disposal - where each application or disposal is only counted once. Please note counting applications or disposals by type will not sum to the overall total as an application or disposal may include more than one type. By the number of children involved - the data on Public law and Private law proceedings is also analysed by the number of children which are subject to an application or disposal - for example, if two children are the subject of a single case then the children would be counted separately in those statistics. Different types of orders may be made in respect of different children involved in a case.

Breakdowns of many of the summary figures presented in FCSQ, such as splits by case type or by Designated Family Judge (DFJ) area, are available in the Comma Separated Value (csv) files that accompany the bulletin.

Symbols and conventions

The following symbols have been used throughout the tables in this bulletin:

.. = Not applicable

• = Not available

14.3 Data Quality

Family court statistics are published in compliance with the Ministry of Justice quality strategy, principles and processes for statistics , which states that information should be provided as to how the bulletin meets user needs.

Five principles (relevance, accuracy, timeliness, accessibility and clarity, comparability and coherence) are outlined. The Data Quality statement which accompanies this guide addresses how each are addressed in the FCSQ publications.

15. Accredited official statistics status

Accredited official statistics are called National Statistics in the Statistics and Registration Service Act 2007. These accredited official statistics were independently reviewed by the Office for Statistics Regulation in January 2019. They comply with the standards of trustworthiness, quality and value in the Code of Practice for Statistics and should be labelled ‘accredited official statistics’.

It is the Ministry of Justice’s responsibility to maintain compliance with the standards expected for accredited official statistics. If we become concerned about whether these statistics are still meeting the appropriate standards, we will discuss any concerns with the Authority promptly. Accredited official statistics status can be removed at any point when the highest standards are not maintained, and reinstated when standards are restored.

The continued accreditation of these statistics as Accredited Official Statistics was confirmed in January 2019 [footnote 5] following a compliance check by the Office for Statistics Regulation. The statistics last underwent a full assessment against the Code of Practice in 2010 [footnote 6] when this information was previously published as part of the Court Statistics Quarterly collection.

Accreditation can be broadly interpreted to mean that the statistics:

meet identified user needs;

are well explained and readily accessible;

are produced according to sound methods, and

are managed impartially and objectively in the public interest.

Once statistics have been accredited as Accredited Official Statistics, it is a statutory requirement that the Code of Practice shall continue to be observed.

15.1 Revisions

In accordance with Principle 2 of the Code of Practice for Statistics, the Ministry of Justice is required to publish transparent guidance on its policy for revisions .

The three reasons specified for statistics needing to be revised are;

changes in sources of administrative systems or methodology changes

receipt of subsequent information, or

errors in statistical systems and processes.

Each of these points, and its specific relevance to the FCSQ publication, are addressed below.

Changes in source of administrative systems/methodology changes

The data within this publication come from a variety of administrative systems. This technical document will clearly present where there have been revisions to data due to changes in methodology or administrative systems. In addition, statistics affected within the publication will be appropriately footnoted or additional text included to explain and quantify the impact of said changes.

As the data underlying Family Court Statistics Quarterly (FCSQ) are extracted from a live administrative database, figures are subject to revision in future publications. For tables that use information from the FamilyMan or CCD systems, data are extracted for the full timeseries within each bulletin. Minimal changes (i.e. a handful of cases) may be observed in earlier years, whilst larger changes are seen in the most recent quarters as cases progress further through the system. This is especially relevant for case progression tables (Tables 8-10).

Receipt of subsequent information

The nature of any administrative system is that data may be amended or received late. For the purpose of FCSQ, late or amended data of any previously published periods will be incorporated to reflect the up to date ‘live’ FamilyMan or CCD databases, as described in the revisions section above.

Errors in statistical systems and processes

Occasionally errors can occur in statistical processes; procedures are constantly reviewed to minimise this risk. Should a significant error be found, the publication on the website will be updated and appropriate notifications documenting the revision will be made.

16. Users of the statistics

Official statistics are used by a wide range of individuals and organisations, and their value lies in their wide and informed use. The main users of these statistics are Ministers and officials in central government responsible for developing policy regarding family justice. Other users include the central government departments, and various voluntary organisations with an interest in family justice. The data also feeds into statistics produced by the Office for National Statistics, such as public-sector productivity and the Domestic Violence in England and Wales bulletin .

We routinely consult with policy and operational colleagues to refresh our understanding of core uses for the data, promote the release and provide support to known users.  We seek comments from external users and maintain dialogue with public users via a dedicated email account that is included in this guide and in every bulletin and accompanying data visualisation tool for feedback on the commentary and any additional wider feedback or queries.

17. Legislation coming into effect in the reporting period

The legislation described below relates mainly to legislation that came into force since 2000. It is only a brief summary of the sections that may have affected the published statistics. Details of all legislation that has come into force in the intervening period can be found on the government website .

The coverage of the statistics in this publication may have been affected by the following legislation:

Adoption and Children Act 2002

Civil Partnership Act 2004

Domestic Violence, Crime and Victims Act 2004

Forced Marriage (Civil Protection) Act 2007

Legal Aid, Sentencing and Punishment of Offenders Act 2012

Crime and Courts Act 2013

Children and Families Act 2014

Anti-social Behaviour, Crime and Policing Act 2014

Divorce, Dissolution and Separation Act 2020

Domestic Abuse Act 2021

17.1 Adoption and Children Act 2002

The Adoption and Children Act 2002 was implemented on 30 December 2005, replacing the Adoption Act 1976. It made amendments to the law in relation to the adoption of children. The first stage of the Act deals with Local Authorities duties to provide an adoption service and support services. The second stage relating to inter-country adoptions and the third stage relates to Adoption Support Services. Changes to parental responsibility and the adopted children register were also made. The key changes resulting from the new act were the:

alignment of adoption law with the Children Act 1989 to ensure that the child’s welfare is the most important consideration when making decisions;

provision for adoption orders to be made in favour of unmarried couples;

the introduction of Special Guardianship Orders, intended to provide permanence for children for whom adoption is not appropriate.

17.2 Civil Partnership Act 2004

The Civil Partnership Act 2004 grants civil partnerships in the United Kingdom with rights and responsibilities identical to civil marriage. Civil Partners are entitled to the same property rights as married opposite-sex couples, the same exemption as married couples with regard to social security and pension benefits, and also the ability to get parental responsibility for a partner’s children, as well as responsibility for reasonable maintenance of one’s partner and their children, tenancy rights, full life insurance recognition, next-of-kin rights in hospitals, and others. There is a formal process for dissolving partnerships akin to divorce.

17.3 Domestic Violence, Crime and Victims Act 2004

The Domestic Violence, Crime and Victims Act 2004 concentrates upon legal protection and assistance to victims of crime, particularly domestic violence.

17.4 Forced Marriage (Civil Protection) Act 2007

The Forced Marriage (Civil Protection) Act 2007 seeks to assist victims of forced marriage, or those threatened with forced marriage, by providing civil remedies. The Act created the forced marriage protection order (FMPO). A person threatened with forced marriage can apply to court for a forced marriage protection order. The court can then order a range of appropriate provisions to prevent the forced marriage from taking place, or to protect a victim of forced marriage from its effects, and may include such measures as confiscation of passport or restrictions on contact with the victim.

The subject of a forced marriage protection order can be not just the person to whom the forced marriage will occur, but also any other person who aids, abets or encourages the forced marriage. A marriage can be considered forced not merely on the grounds of threats of physical violence to the victim, but also through threats of physical violence to third parties (for example, the victim’s family), or even self-violence (for example, marriage procured through threat of suicide.) A person who violates a forced marriage protection order is subject to contempt of court proceedings and may be arrested.

17.5 Legal Aid, Sentencing and Punishment of Offenders Act 2012

Following the introduction of the Legal Aid, Sentencing and Punishment of Offenders Act 2012 on 1 April 2013, the scope of services funded as part of civil legal aid changed. For family law, the general position is that Public law proceedings and the representation of children remain in scope under Part 1, Schedule 1 of LASPO. However, most private family law cases involving children or finance remain in scope only where there are issues concerning domestic violence or child abuse and specific evidence fulfilling the requirements of regulation 33 or 34 of the Procedure Regulations is provided in support of this.

17.6 Crime and Courts Act 2013

The Crime and Courts Act 2013 established the single Family Court, replacing the previous three-tiered system under which cases were heard in family proceedings courts, Country Courts and the High Court. 

17.7 Children and Families Act 2014

The Children and Families Act 2014 made a number of changes affecting Public law family cases. In particular, it introduced a 26 week time limit for completing care and supervision cases. It gave the family court the discretion to extend cases by up to 8 weeks at a time should that be necessary to resolve proceedings justly.  The Act also removed the need to review interim care orders and interim supervision orders as frequently, allowing the courts to set interim orders in line with the timetable for the case.  In relation to Private law matters, the Act introduced a ‘child arrangements order’, replacing residence and contact orders.  It also removed the requirement for the court to consider arrangements for children as part of the court processes for divorce and dissolution of a civil partnership. 

17.8 Anti-Social Behaviour, Crime and Policing Act 2014

The Anti-Social Behaviour, Crime and Policing Act 2014 came into force on 16 June 2014 and made it an offence to force a person to marry against their will, or to breach a FMPO.

17.9 Divorce, Dissolution and Separation Act 2020

The Divorce, Dissolution and Separation Act 2020, which amends existing laws relating to divorce to allow for no-fault divorce in England and Wales. It came into effect from 6th April 2022.

17.10 Domestic Abuse Act 2021

The Domestic Abuse Act 2021 has created a single domestic abuse protection order to unify the current civil law protection orders. Most of the provisions in the Act came into force during 2021 and 2022.

18. Directory of Related Internet Websites on the Family Court

The following list of web sites contains information in the form of publications and/or statistics relating to the family justice system that may be of interest.

Ministry of Justice This site provides information on the organisations within the justice system, reports and data, and guidance.

Ministry of Justice Statistical and Research publications :  Most of the publications can be viewed online.

Attorney General’s Office : Provides information on the role of the department including new releases; updates; reports; reviews and links to other law officer’s departments and organisations.

Welsh Assembly Government : Gives information on all aspects of the Welsh Assembly together with details of publications and statistics.

Scottish Government : Gives information on all aspects of the Scottish Executive together with details of publications and statistics.

UK National Statistics Publication Hub : This is the UK’s home of official statistics, reflecting Britain’s economy, population and society at national and local level. There are links to the Office for National Statistics and the UK Statistics Authority.

Children and Family Court Advisory and Support Service (CAFCASS) : A non-departmental public body set up to promote the welfare of children and families involved in family court.

The Nuffield Foundation has established a Family Justice Observatory that will support the best possible decisions for children by improving the use of data and research evidence in the family justice system in England and Wales.

19. Glossary

19.1 application.

The act of asking the court to make an order. For divorce cases (previously a petition), an application for a conditional order.

19.2 Child Arrangements Order

A child arrangements order regulates the arrangements for who a child is to live with, spend time with or otherwise have contact with when parents separate. It effectively combines residence and contact orders and reduces the feeling that one parent has more say in the upbringing of the child because they have a residence order.  The order contains a warning notice about failure to comply with the order and will be subject to enforcement in the same way as a contact order is currently. The child arrangements order replaced residence orders and contact orders from 22 April 2014.

19.3 Conditional Order (previously Decree Nisi)

This is the first order made in divorce proceedings and is given when the court is satisfied that there are reasonable grounds for granting the divorce. It is used to apply for a decree absolute.

19.4 Convention Adoption

An adoption carried out under the terms of The Hague Convention on Protection of Children and Co-operation in Respect of Intercountry Adoption. This is an international treaty designed to protect children from child trafficking and requires signatory countries to establish safeguards to ensure that any inter-country adoption is in the child’s best interests.

19.5 Decree Absolute

This is the final order made in divorce proceedings that can be applied for six weeks and one day after a decree nisi has been given. Once this is received, the couple are no longer legally married and are free to remarry. Under the new divorce law, this is known as the final order.

19.6 Decree Nisi

This is the first order made in divorce proceedings and is given when the court is satisfied that there are reasonable grounds for granting the divorce. It is used to apply for a decree absolute. Under the new divorce law, this is known as the conditional order.

19.7 Deputyships

A Deputy (OPG) is legally responsible for acting and making decisions on behalf of a person who lacks capacity to make decisions for themselves. The Deputy order sets out specific powers in relation to the person who lacks capacity.

19.8 Dissolution

The legal termination of a marriage by a decree of divorce, nullity or presumption of death or of a civil partnership by the granting of a dissolution order.

19.9 Digital divorce

Where a divorce has been dealt with digitally by a Courts and Tribunal Service Centre at all stages of the divorce process.

19.10 Divorce

This is the legal ending of a marriage.

19.11 Enduring Power of Attorney (EPA)

An EPA is a legal document that allows someone (the ‘donor’) to appoint one or more people (known as ‘attorneys’) to make decisions about their property or money, at a time in the future when they either lack the mental capacity or no longer wish to make those decisions themselves. EPAs were replaced by lasting powers of attorney on 1st October 2007. Only EPAs made and signed before this date can still be used.

19.12 Final Order (previously Decree Absolute)

This is the final order made in divorce proceedings that can be applied for six weeks and one day after a conditional order has been given. Once this is received, the couple are no longer legally married and are free to remarry.

19.13 Financial Remedy

Formerly known as Ancillary Relief. This refers to different types of order used to settle financial disputes during divorce proceedings. Examples include: periodical payments, pension sharing, property adjustment and lump sums, and they can be made in favour of either the former spouse or the couple’s children.

19.14 Judicial Separation

This is a type of order that does not dissolve a marriage but absolves the parties from the obligation to live together. This procedure might, for instance, be used if religious beliefs forbid or discourage divorce.

19.15 Lasting Power of Attorney (LPA)

An LPA is a legal document that allows someone (the ‘donor’) to appoint one or more people (known as ‘attorneys’), that they trust to make decisions on their behalf, at a time in the future when they either lack the mental capacity or no longer wish to make those decisions themselves.

19.16 Non-molestation Order

This is a type of civil injunction used in domestic violence cases. It prevents the applicant and/or any relevant children from being molested by someone who has previously been violent towards them. Since July 2007, failing to obey the restrictions of these orders has been a criminal offence for which someone could be arrested.

19.17 Nullity

This is where a marriage is ended by being declared not valid. This can either be because the marriage was void (not allowed by law) or because the marriage was voidable (the marriage was legal but there are circumstances that mean it can be treated as if it never took place).

19.18 Occupation Order

This is a type of civil injunction used in domestic violence cases. It restricts the right of a violent partner to enter or live in a shared home.

19.19 Order

The document bearing the seal of the court recording its decision in a case. Some examples of orders are below:

Care orders

A care order brings the child into the care of the applicant local authority and cannot be made in favour of any other party. The care order gives the local authority parental responsibility for the child and gives the local authority the power to determine the extent to which the child’s parents and others with parental responsibility (who do not lose their parental responsibility on the making of the order) may meet their responsibility. The making of a care order, with respect to a child who is the subject of any section 8 order, discharges that order.

Supervision orders

A supervision order places the child under the supervision of the local authority or probation officer. While a supervision order is in force, it is the duty of the supervisor to advise, assist and befriend the child and take the necessary action to give effect to the order, including whether or not to apply for its variation or discharge

Emergency Protection Orders

An emergency protection order is used to secure the immediate safety of a child by removing the child to a place of safety, or by preventing the child’s removal from a place of safety. Anyone, including a local authority, can apply for an emergency protection order if, for example, they believe that access to the child is being unreasonably refused.

19.20 Petition (for divorce)

An application for a decree nisi or a judicial separation order. Under the new divorce law, this is known as the application.

19.21 Private Law

Refers to Children Act 1989 cases where two or more parties are trying to resolve a private dispute. This is commonly where parents have split-up and there is a disagreement about who their children should live with and who their children should have contact with, or otherwise spend time with and when.

19.22 Public Law

Refers to Children Act 1989 cases where there are child welfare issues and a local authority, or an authorised person, is stepping in to protect the child and ensure they get the care they need.

Section 8 orders: Under the Children Act 1989, Section 8 orders refer to child arrangement orders (contact and residence), prohibited steps and specific issue orders.

20. Contacts

Enquiries about this guide should be directed to the Data and Analysis: Courts and People division of the MoJ:

Carly Gray, Head of Access to Justice Data and Statistics

Email: [email protected]

General information about the official statistics system of the UK is available from www.statistics.gov.uk

Press enquiries should be directed to the Ministry of Justice press office:

Tel: 020 3334 3536

https://web.archive.org/web/20081208061525/http://www.haringey.gov.uk:80/index/news_and_events/latest_news/childa.htm   ↩

Under the Children Act 1989, Section 8 orders refer to child arrangement orders (contact and residence), prohibited steps and specific issue orders.  ↩

As from the publication of the January to March 2017 bulletin.  ↩

P v Cheshire West and Chester Council and P and Q v Surrey County Council [2014] UKSC 19  ↩

https://www.statisticsauthority.gov.uk/correspondence/compliance-check-on-court-statistics/   ↩

https://www.statisticsauthority.gov.uk/publication/statistics-on-court-activity/   ↩

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Partnership terminations triggered by a change in form

• Partnership & LLC Taxation
• Formation, Transfers & Termination

A partnership terminates under Sec. 708(b)(1) when the business of the partnership is no longer carried on in partnership form. This can occur because the partnership elects out of partnership status, incorporates, or has only one partner remaining (for example, as the result of a sale or the death of a partner). Note that a partnership will also terminate if no part of any of its business, financial operations, or ventures continues to be carried on.

The partnership form no longer exists (for most purposes) if the partners elect not to be treated as a partnership. The Code permits limited classes of partnerships to elect out of taxation under the partnership rules (or out of selected portions of the partnership rules). The election out of partnership status is available only if the income of the partners can be adequately determined without computing the partnership's income and the arrangement is (1) an investing partnership, (2) an operating agreement, or (3) a securities syndicate (Sec. 761(a); Regs. Sec. 1. 761 - 2 ).

The partnership form also ceases to exist if a transfer of partnership interests occurs and only one partner remains. For example, a partnership terminates when a 60% partner acquires the interests of two other partners who each have a 20% interest in the partnership (Regs. Sec. 1. 708 - 1 (b)(1)). The partnership is terminated as of the sale date of the partnership interests. (However, a special rule applies upon the death of a partner in a two - person partnership. See the discussion below.) After the sale of the interests, the business is no longer carried on in a partnership form but rather is conducted as a proprietorship or branch (if the owner is a corporation, another partnership, or a multimember limited liability company (LLC)). A business can also cease to be a partnership if its assets are transferred to a trust or the business is incorporated.

Two - person partnerships necessitate careful planning to avoid inadvertent terminations. For example, a partnership will terminate if a buy - sell agreement is triggered upon the death of either partner. While such a buy - sell agreement may be appropriate for transfer of the partnership interest and income tax planning, the partners may not intend that the sale result in the termination of the partnership with its potentially adverse effects.

A termination can be avoided if the deceased partner's interest is transferred directly to a beneficiary or the estate of the deceased partner. If the successor in interest shares in the partnership profits after the death of the deceased partner, the partnership does not terminate (Regs. Sec. 1. 708 - 1 (b)(1)(i)). This rule applies even if the parties are engaging in negotiations to purchase or retire the interest held by the deceased partner's successor in interest.

Similarly, if one partner in a two - person partnership dies, the partnership is not terminated until the deceased partner's entire interest is liquidated (Regs. Sec. 1. 736 - 1 (a)(1)(ii)). Thus, the surviving partner is deemed to be operating a partnership for income tax purposes (though clearly not qualifying for such classification for state law purposes) as long as the partnership continues to make payments for his interest or as a share of partnership income to the deceased partner's successor in interest.

A practitioner should consider making the following recommendations to clients regarding two - person partnerships to ensure continuation of the partnership after the death of one of the partners:

• The partnership agreement or the liquidation agreement should indicate the interest of the deceased partner is to be retired by a series of liquidating payments made by the partnership. Ideally, the agreement should state the payments are made under Sec. 736;
• Upon the partner's death, the partnership books should reflect the elimination of the deceased partner's interest in capital and the establishment of a payable to the partner's successor in interest. All subsequent payments made to retire the interest should reduce the payable;
• Partnership returns should be filed as long as payments are being made to the deceased partner's successor in interest; and
• All payments for the deceased partner's interest in the partnership should be made from the business account of the partnership and not from the personal account of the remaining partner.

In some circumstances, it may not be desirable for the partnership to continue after a partners' death or retirement. For example, the remaining partner may want to terminate the partnership to avoid the costs of filing a tax return, complying with state filing requirements, and paying state license fees.

Based on the holding in McCauslen , 45 T.C. 588 (1966), and Rev. Ruls. 67 - 65 and 99 - 6 , when a partnership terminates because a sale of partnership interests results in a single partner, the selling partner follows the normal rules for recognizing gain or loss on the sale of the partnership interest. But for the remaining (purchasing) partner, the partnership is deemed to have distributed all its assets to its partners in liquidation. The purchasing partner takes a carryover basis in the assets deemed distributed to him or her and is treated as purchasing the assets that were deemed distributed to the selling partner for an amount equal to the purchase price of the partnership interest. The purchasing partner's holding period for the assets deemed purchased begins on the day immediately following the date of sale. The holding period for the assets with a carryover basis (those deemed distributed to the purchasing partner) includes the partnership's holding period for those assets. The purchasing owner recognizes gain and assigns basis under the general rules that apply to liquidating distributions.

Example 1. Two-person partnership terminates after one partner sells interest to the other: J and B are equal partners in H Investors Partnership ( HIP ). J wants to liquidate his interest in HIP , so B decides to buy him out for $100,000.

J treats the transfer of his partnership interest as a sale. Accordingly, the difference between the sales price of J' s interest and his basis is generally capital gain. If Sec. 751 hot assets are held by the partnership, the hot - asset rules in Sec. 751 may result in J' s realizing ordinary income.

B is treated as if HIP had made a liquidating distribution of all its assets to J and B and, following the distribution, B purchased the assets deemed distributed to J . B' s basis in the assets acquired by the deemed purchase of J' s assets is the purchase price of $100,000. B' s holding period for the assets deemed acquired from J begins on the day immediately following the date of sale. B must recognize gain on the deemed distribution of assets to her under the general rules (for example, gain would be recognized if B is deemed to receive cash in excess of the basis of her partnership interest). B' s holding period for the assets deemed distributed includes the partnership's holding period for the assets.

Example 2. Partnership terminates at the sale of all partnership interests to one new partner: Assume the same facts as in Example 1, except a third party, A , purchases the interests in HIP owned by both B and J . J and B report gain or loss under the rules that generally apply to the sale of partnership interests. A , however, must determine the basis and holding period of HIP' s assets as if HIP had made a liquidating distribution of its assets to J and B and, immediately following the distribution, A had acquired the assets from the partners. A' s basis in the assets is his purchase price, and his holding period begins on the day immediately after the date of sale.    

This case study has been adapted from PPC's Tax Planning Guide — Partnerships , 33d Edition (March 2019), by William D. Klein, Sara S. McMurrian, Linda A. Markwood, Sheila A. Owen, Twila A. Bollinger, William R. Bischoff, and Cheryl McGath. Published by Thomson Reuters/Tax & Accounting, Carrollton, Texas, 2019 (800-431-9025; tax.thomsonreuters.com ).

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