The Tax Consequences of the Kardashian Divorce
By Maria Cheung
Reviewed by Jennifer Williams
There are numerous media stories surrounding Kim Kardashian’s failed marriage to former New Jersey Nets basketball player Kris Humphries but the one issue that has particularly interested me is the tax law aspects surrounding the 72 day union. I would like to first preface this blog post by admitting that I am not an expert in the tax field. I am simply a law student who is currently taking a federal income tax course. As soon as Kim announced her decision to file for separation, media outlets started to speculate on the practical and realistic questions such as: “Who keeps the ring? What happens to the presents? And what about all of the money Kim allegedly made off of the wedding?”
Two important pieces of background information to note is that family and tax law (aside from federal tax law) is state specific so the rules in California (where Kim lives) may be a little different from my analysis but the legal foundations are the same. Additionally, Americans pay both federal income tax (presided over by the IRS) and a state tax. For federal income tax purposes, the filing status is determined as of the last day of the tax year, December 31st. Thus, if a couple is a married on December 31st, under the law, the couple was married for the whole year in the eyes of the IRS. If the couple is not married on December 31st, each party must file as a single individual or head of household. Exceptions do apply (depending on the state for state taxes) for same sex marriages, widows and widowers, annulments and married persons who live apart but meet very tailored criteria.
Kim and Kris will now each have to file as single for federal income tax purposes because once a couple legally separates, the couple is considered “unmarried” for federal income tax purposes. In some states, such as Pennsylvania, there is no such thing as a legal separation. However, California does recognize a legal separation so the couple will have to file state taxes separately as well for the 2011 taxable year. Interestingly enough, the question of whether the marriage was fake and simply made for the camera or not does not truly matter. A legally binding marriage is a marriage under tax and family law.
And what does the ring spell out for tax consequences? The engagement ring was 20.5 carats and cost an estimated $2 million. Under the laws of most states, Kim would get to keep the ring because she did fulfill her promise to marry Kris. An engagement ring is considered a promise to marry. If the engagement is broken, the bride will need to return the ring to groom. However, if the wedding actually occurs, the bride can keep the ring, even if the marriage ends. Despite this, according to TMZ, Kim and Kris’s pre-nuptial agreement states that Kim could keep the ring after a divorce if she paid Kris an amount equal to the ring’s original purchase price. Assuming that there is no gain (and because the period of time is so small making a gain quite unlikely), Kris would recognize no capital gain on the sale of the ring back to Kim. Thus, he would not have to pay taxes on the money Kim pays him for the ring. Also, the ring’s selling price would equal the basis (purchase price). If Kim had not contracted to pay Kris for the ring, she would have been entitled to the ring as a matter of law anyways without having to pay anything for it or report it in her tax filings as a capital gain or loss. This is because of a federal income tax statute which states that the basis of any property transferred by a spouse or former spouse if the transfer is incident to divorce is the same as the spouse’s adjusted basis. If however, the ring had gone back to Kris because the wedding had not taken place, he would recognize a capital gain (which he would be taxed on) when he subsequently sold the ring, which most heartbroken grooms usually do.
As for the gifts, according to the rules of common etiquette, Kim should return them because the marriage only lasted for two months. Kim has stated she intends to keep the gifts (subject to any equitable distribution). However, she has publicly stated that she is donating the value of the gifts to charity. For income tax purposes, this will doubly benefit Kim. The gifts are not considered taxable to Kim or Kris since bona fide gifts are generally not taxable, at least to the recipients. Additionally, Kim will get the benefit of a charitable deduction from her adjusted gross income as long as she itemizes it, gets a receipt and makes the donation to a qualified charitable organization. However, the charitable deduction cannot be for more than 50% of her adjusted gross income (which it probably will not be considering she makes around $35 million a year). An argument can be made that many of Kim and Kris’s gifts are not actually gifts, but rather taxable compensation in exchange for promotion. Much of the cost of the $10 million wedding was allegedly offset by discounts and donated items in exchange for Kim’s promotion and endorsements. True gifts are given without expectation of something in return. This is not the case here. Kim’s “gifts” were given with the expectation that these vendors and retailers would gain more business and money by being associated with the wedding. This situation is actually similar to the Academy Award swag that is given out to Award presenters and hosts, which the IRS taxes.
Kris is probably unlikely to receive any type of alimony from Kim despite the fact that there is a NBA lockout and Kim’s shows and brand will most likely continue to thrive (especially as a result of her whirlwind divorce). According to reports, Kim and Kris have an iron-clad pre-nuptial agreement stating that he is not entitled to any form of alimony. However if there was no pre-nup, it is interesting to note that alimony is based on the “reasonable” needs of the parties in accordance with the lifestyle and standard of living that was enjoyed by the parties during the marriage. Kim’s lifestyle probably only enhanced Kris’s. But since the marriage was so short, it is customary in many states for courts to limit the amount of alimony awarded. Some states award one year of alimony for every three years of marriage. If this was the case in California and there was no pre-nup, Kris would be entitled to about 24 days of support. The payment of alimony is deductable to the payor while the alimony would be considered taxable as gross income to the receiver. This applies to court ordered and contractual alimony as well as spousal support. However, voluntary spousal support is subject to different tax consequences.
Even though Kim makes more money than Kris, she has asked the court to require Kris to pay his own attorney’s fees, a request that is likely to be granted. There is no federal income tax benefit to paying for a divorce with the exception that any fees related to tax advice are deductible. While attorney’s fees are generally considered to be personal in nature and not deductible, there is an exception related to tax advice. We will have to wait and see how the divorce and its tax law consequences further play out but one thing is for sure: it is definitely hard to keep up with the Kardashians.