As I mentioned, I noticed that you had referred to the transfer of a specific asset, but didn’t focus on that because I thought the discussion had move from the taxation of community income to the transfer of assets incident to divorce, which is governed by Internal Revenue Code Section 1401.
I assume that you received the Restricted Stock Units (RSUs) as compensation for services rendered to a corporation in your capacity as an independent contractor filing a Form 1040, Schedule C. When the RSUs vested, you received (or will receive) a Form 1099-NEC from the corporation for the self-employment income, will include the ordinary income from vesting in your 2023 Schedule C and received the related shares.
Transferring an asset “incident to divorce” – which results in no income to the recipient spouse and no deduction to the paying spouse - is not an issue. Your transfer to your former spouse of 50% of shares received on the vesting of the RSUs would qualify as “incident to divorce” because it is “related to the cessation of marriage.” See Reg. Sec. 1.1041-1T(b) Q&A 7:
“A transfer of property is treated as related to the cessation of the marriage if the transfer is pursuant to a divorce or separation instrument, as defined in section 71(b)(2), and the transfer occurs not more than 6 years after the date on which the marriage ceases.”
The issue is whether or not, in your case, the income resulting from the vesting of the RSUs qualified as community income. Assuming that the income from the vesting of the RSUs qualifies as community income, Internal Revenue Code Section 1402(a)(5) is clear that you are liable for 100% of the self-employment tax even though your former spouse is liable for 50% of the income tax on that income. A divorce decree drafted under state law does not override the Internal Revenue Code. Federal law preempts state law (Supremacy Clause: U.S. Constitution, Article VI, Paragraph 2).
If your former spouse rendered no services to your Schedule C business, there is no basis for treating the transfer of shares to your former spouse as independent contractor compensation deductible on your Schedule C.
The income arose over two years after the divorce. IRS Publication 555 (“Community Property”) refers to “income received” during marriage. However, an article on a law firm’s website indicated that, in the case of deferred compensation, it’s when the income is earned that governs. Apparently, RSUs may or may not be “deferred compensation” depending on the terms of the RSU plan, but I didn’t research that issue.
Interpreting community property laws is outside the scope of a CPA’s practice. As a CPA, I can only tell you the tax consequences once a lawyer has determined the extent (if any) to which the income is community income. In the case of community income, self-employment tax is governed by Internal Revenue Code Section 1402(a)(5). A transfer of assets is governed by Section 1041.
