(a) Facts: The parties were divorced in Illinois. The wife remained in the former marital home, and the husband was ordered to pay the mortgage. Upon an eventual sale of the home, the parties were to split the net proceeds.
The home was sold as planned, and the husband paid the wife her one-half of the sale proceeds. He took an alimony deduction for the amount paid. The IRS disallowed the deduction, and the husband petitioned for relief in the Tax Court. The Tax Court held for the IRS, and the husband appealed to the Seventh Circuit.
(b) Issue: Was the husband entitled to an alimony deduction?
(c) Answer to Issue: No.
(d) Summary of Rationale: The payment to the wife met the first three requirements in § 71(b)(1). It was made under a divorce instrument, and the instrument did not say that the payment was not includible in gross income, and the parties were not members of the same household.
The key point was whether the obligation ceased upon the wife’s death. The Tax Court noted that the husband did not dispute that he would have remained liable for the payment even if the wife had died. The payment was therefore not alimony for federal tax purposes.
Contrary to the Tax Court’s finding, the husband did dispute that he would have remained liable for the payment even if the wife had died. Nevertheless, the husband’s position was wrong on the merits. The divorce decree was silent on the point, so the Seventh Circuit looked to Illinois state law. Under that law, both property division payments and lump-sum alimony payments (“maintenance in gross”) survive the death of the payee. The payments at issue fell under one of these two categories:
Illinois law unambiguously provides that the payment at issue would not terminate at Sherris death. Mark was to transfer half of the net gain from the sale. This is a fixed amount and so is categorized either as maintenance in gross or a property settlement.
721 F. App’x at 516. The structure of the parties’ divorce settlement agreement further supported a finding that the payments at issue did not terminate upon death:
The dissolution agreement expressly characterizes as “maintenance” only the payments of a percentage of Marks income to Sherri and adds that they are deductible by Mark under 26 U.S.C. §§ 71(a) and 215. The parties also agreed that Marks maintenance obligation terminates with a change of circumstances listed in 750 ILCS 5/510(c), which includes the death of a party. The proceeds of the sale of the house, however, are addressed in a separate paragraph that does not reference modifiability or taxes, suggesting different treatment was intended. On review of the agreement as a whole, the payment is not alimony.
The husband argued that the home was not marital property, so the obligation imposed by the state court necessarily had to be alimony. This argument missed the point. Under former I.R.C. § 71(b)(1)(D), a payment cannot be alimony unless liability terminates upon death of the payee. Whether the payment was made under the authority of a state alimony statute is not the point. Payments that constitute alimony under state law do not necessarily constitute alimony under federal tax law. The obvious answer to the husband’s concern (if, in fact, the husband was correct that the home was not marital property, and ignoring that separate property can be divided by agreement of the parties) was that the payments were lump-sum alimony, which does not terminate upon the payee’s death and which is therefore not alimony for federal tax purposes. The husband’s argument was not responsive to the way in which federal law defines alimony.
The husband did not rely upon the advice of tax expert, so he was liable for the accuracy-related penalty.
- The federal courts know the difference between a property settlement and an award of alimony.
- Payments that are stated as a percentage of the sale proceeds of an asset, and that are silent upon the consequences of the payee’s death, will almost always be construed to create an unconditional obligation. That obligation will be either division of marital property, contractual division of separate property (if the payment was agreed to by the parties), or lump-sum alimony. None of these obligations is alimony for federal tax purposes.
- It is useless to make broad equitable arguments about whether a payment constitutes alimony under general common-law principles. Alimony is a specifically defined term under the Tax Code. Arguments that do not focus upon the statutory definition are unlikely to succeed.