Divorce—Are Trapped-In Gains Trapped or Not?

Two new cases exemplify the need to know the law in the jurisdiction of your case in a marital dissolution (divorce). In Harvey v. Harvey, the California Appellate Court noted that a tax liability is not taken into account unless the tax is immediate and specific. In this case, the taxes in question related to potential future taxes on trapped-in gains. The court noted that the tax would arise primarily as a result of depreciation that would reverse itself in future years. As a result, the appellate court reversed the trial court’s allowance of the liability as a discount to the value of the business.

However, with the same issue in front of it, the Nebraska Supreme Court came to the opposite conclusion. Experts for both sides in this case allowed some amount for the potential future liability of tax for trapped-in gains. In this case, the Supreme Court never mentioned the issue of immediacy and certainty in allowing the estimated present value of potential future taxes on trapped-in gains.

The answers in these two cases are diametrically opposed. Further, neither case mentions the fact that the Tax Court and some federal appellate courts have allowed some discount or reduction in value for trapped-in gains. After a series of cases, the 5th Circuit Court of Appeals in the Estate of Dunn allowed a dollar-for-dollar deduction for tax on trapped-in gains. In the Jelke case, the 11th Circuit reversed the Tax Court and also allowed a dollar-for-dollar reduction in value for trapped in gains. What might have happened in Harvey if one of the experts had argued for the decisions of the tax and appellate courts? Would the California law still have prohibited the recognition of a liability related to trapped-in gains?

The cases referred to in this blog post can be found in BVLaw with a subscription. What's your opinion on this case? Let us know by emailing our BVLaw editorial team at info@bvresources.com.