Tax Court Denies Alimony Deduction Due to Substitute Payments

 

Scott E. Vincent
Vincent, Fontg & Chartier LLC
Kansas City

The Tax Court recently found payments to a former spouse were not deductible as alimony due to alternate payments that would be substituted for the alimony in the event of the former spouse's death. Okerson v. Commissioner, decided September 9, 2004, provides a good current outline of the alimony rules along with a clarification of the statutory definition.

Background

The initial divorce court decree in Okerson required that the taxpayer pay his ex-spouse 113 monthly payments of alimony totaling $117,000 in connection with the divorce. The court decree stated that this alimony would terminate if the ex-spouse died before the $117,000 was paid in full. In that event, the taxpayer would then be required to continue making the monthly payments toward the education of the parties' children until the children completed four years of college. Two years later, the court decreed that the taxpayer make 42 additional monthly payments totaling $33,500 to his ex-spouse's attorney as additional alimony to be deductible to the taxpayer and taxable income to his ex-spouse. The subsequent decree similarly stated that this additional alimony would terminate if the ex-spouse died before the $33,500 was paid in full, but that the taxpayer would then be required to continue making the monthly payments to the ex-spouse's attorney until the $33,500 was paid in full.

The taxpayer claimed all these amounts as deductible alimony during the years in question. During the time the tax case was pending, the taxpayer obtained a further order from the divorce court restating that it intended for federal income tax purposes that all of the $117,000 and the $33,500 be alimony deductible by the taxpayer and includable in his ex-spouse's income, and that these amounts had been paid in full.

Court's Analysis

The Tax Court first outlined the statutory requirements for a taxpayer to deduct payments as alimony. The payments must be includible in the ex-spouse's gross income, which requires that the following requirements be met: LK:NON: IRC-FILE S215(A) LK:NON: IRC-FILE S215(B) (1) the payments are made in cash, (2) the payments are received under a divorce or separation instrument, (3) the divorce or separation instrument does not provide that the payments are not reportable as alimony, (4) the spouses reside in separate households at the time the payments are made, (5) the spouses do not file a joint return, and (6) the payor spouse's liability for the payments, or for making other payments in substitute of those payments, does not continue for any period after the payee spouse's death.

In this case, the court focused only on this last requirement that the payor spouse's liability for the payments and for any substitute payments must cease as of the payee spouse's death. The court first noted that this determination is made by looking first to the terms of the applicable divorce documents, which are dispositive of the issue if clearly making the determination. The taxpayer in this case argued that the court should also consider the state court's clear intent to allow the taxpayer to deduct the $117,000 and $33,500 as alimony, and also emphasized that these amounts were in fact paid in full during the ex-spouse's lifetime so that the taxpayer never made any of the post-death payments called for in the divorce decrees.

The court rejected the taxpayer's reliance on the intent of the state court that the payments be treated as alimony. Further, the court rejected the taxpayer's argument that no post-death payments were ever made. Instead, the court concluded that an objective statutory analysis made strictly on the divorce documents should apply for alimony determinations, based in part on a conclusion that

[t]his will make it easier for the Internal Revenue Service, the parties to a divorce, and the courts to apply the rules to the facts in any particular case and should lead to less litigation..Congress has mandated through section 71(b)(1)(D) LK:NON: IRC-FILE S71(B)(1)(D) that payments qualify as alimony for Federal income tax purposes only when the payor's liability for those payments, or for any payments which may be made in substitute thereof, terminates upon the payee spouse's death. Petitioners fail this requirement in that both of the decrees state specifically and unequivocally that petitioner's obligation to pay alimony will terminate upon the death of Okerson but that petitioner will then be liable to start making corresponding payments in substitute of the alimony payments. The complete termination upon the death of the payee spouse of all payments made as alimony or in substitute thereof is an indispensable part of Congress's scheme for deducting a payment as alimony for Federal income tax purposes, and it is something that may not be overcome simply because the payor may establish an intent that the payments be deductible by the payor spouse as alimony.

After concluding that the alimony determination in this case would be based on a strict application of the statutory test (and not on the intent of the parties to a divorce proceeding or of the court overseeing that proceeding), the court quickly determined that the divorce decrees in this case provided for substitute payments following the ex-spouse's death, and therefore defeated the taxpayer's attempt to deduct them as alimony. The court further rejected the taxpayer's reliance on the fact that none of the substitute payments were ever made (because the ex-spouse survived the payment terms).

Conclusion

The Tax Court determined that the taxpayer's obligation to make substitute payments in the event of his ex-wife's death prevented the payments from qualifying as alimony. It was irrelevant that his ex-wife survived the entire payment period and that he never had to actually make any substitute payments. The court was not persuaded by the fact that the state court had later modified the couple's divorce instruments to further clarify that the payments were intended to be deductible alimony. The Tax Court applied a strictly objective test based on statutory requirements to determine whether the payments were alimony and did not consider the parties' stated intent.

The decision in Okerson is an important reminder that the precise structure of the payments to be made pursuant to a divorce decree requires special scrutiny. In this case, even the parties' efforts to clarify their and the divorce court's intent were not sufficient to overcome the strict statutory framework that must be applied in this context. Of course, the Tax Court's reversal of the parties' intent in their divorce decree also shifted the tax burden between the parties and substantially altered the economic terms of the divorce.

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