When Death is not the end, the IRS steps in: Part 2 of 2
Anderson v. Comm’r, T.C. Memo. 2016-47, 2016 WL 976816 (2016)
Facts: An Alabama court entered a pretrial order in a divorce case, requiring both parties to “[m]aintain status quo as to payment of house note or rent, utilities, food, necessities, fixed credit obligations, ” 2016 WL 976816, at *1. After the order was entered, the husband transferred at least $1,000 each month to the wife “for her spending money and other things that I had previously paid for.” Id.
The husband took an alimony deduction for the amounts paid. When the IRS did not allow the deduction, the husband then appealed to the Tax Court.
Issue: Were the payments alimony for federal tax purposes?
Answer to Issue: Summary of Rationale: The first requirement in the federal definition of alimony states that it must be received under a “divorce or separation ” I.R.C. § 71(b)(1)(A). A “divorce or separation instrument” includes “a decree of divorce or separate maintenance or a written instrument incident to such a decree.” Id. § 71(b)(2)(A). A pretrial order is not a divorce decree, but it is a written instrument incident to such a decree. Thus, the premarital order was a divorce or separation instrument.
The pretrial order directed the husband to maintain the status quo. The husband testified that the payments were intended to cover things he had previously paid for. He was therefore maintaining the status quo, as required by the order, so that the payments were received under a court order. There is no requirement that the divorce or separation instrument list the specific exact amount of support required.
The pretrial order did not specify whether the payments stopped upon death. But the payments occurred periodically, so they were periodic alimony, and Alabama case law stated clearly that periodic alimony ceases upon the death of the payee. Because the payments stopped upon death, they were alimony for purposes of federal tax law.
Lesson: Temporary support, alimony pendente lite, or postseparation support can all constitute alimony under federal tax law, so long as it is clear from the language of the agreement or the order, or from state law if the order is silent, that the obligation terminates upon death of the payee.
Crabtree v. Comm’r, T.C. Memo. 2015-163, 2015 WL 4880959 (2015)
Facts: A separation agreement, incorporated into a Delaware court order, required the husband to pay “unallocated alimony/child support in the monthly sum of $5,232.00 for a continued 8 year period with the provision as long as Mrs. Girard should not remarry or cohabitate.” The agreement was silent on the effect of death of either party.
The husband paid alimony as required. The wife did not report the alimony as income. The IRS assessed a deficiency, and the wife appealed to the Tax Court.
Issue: Did the payments made by the husband constitute alimony?
Answer to Issue: No.
Summary of Rationale: Payments do not constitute alimony for federal tax purposes unless they terminate upon the death of the I.R.C. § 71(b)(1)(D). The agreement was silent on this point, but by requiring payment for an eight-year period, the agreement gave rise to an inference that the obligation did not terminate upon death. The agreement also stated some terminating conditions—remarriage or cohabitation—giving rise to an inference that no other terminating conditions exists. “As a matter of contract interpretation, therefore, we think the better reading of the Divorce Agreement is that Dr. Girard’s payment obligation would not terminate if petitioner were to die during the eight-year term.” 2015 WL 4880959, at *2.
Where an agreement is silent on the death of the payee, payments can still constitute alimony if the payments would terminate automatically by operation of state law. Under Delaware state law, “[u]nless the parties agree otherwise in writing, the obligation to pay future alimony is terminated upon the death of either party.” Del. Code Ann. tit. 13, § 1512(g). But the statute applies only to court-ordered alimony; it does not apply to alimony agreed to in a separation agreement. Stewart v. Stewart, 41 A.3d 401, 405 (Del. 2012).
In addition, under Del. Code Ann. tit. 13, § 1519(b), “[u]nless otherwise agreed by the parties in writing and expressly provided in the decree, the obligation to pay future alimony is terminated upon the death of either party.” This statute applies to all alimony. But the first clause contains an express exception. The provision has not been construed by Delaware case law. The first requirement was met on the facts; it was “otherwise agreed in writing” because the court construed the agreement to provide that support did not terminate. The court recognized that “this understanding was implicit rather than explicit,” Crabtree, 2015 WL 4880959, at *2, but it decided for unclear reasons to “accord principal weight to the statute’s first requirement” that the contrary agreement be written, and to give effectively no weight to the statute’s requirement that a contrary intent be stated expressly in the divorce decree. The court therefore held that the payments were not alimony for federal tax purposes.
Lesson: The tax court was reaching to find that the payments were not alimony. It ultimately ignored statutory language stating that alimony terminates upon death unless a contrary intent is “expressly provided in the decree.” Del. Code Ann. tit. 13, 1519(b).
The clear lesson is that it is unsafe to assume that any obligation for a specific term of years will be treated as alimony for federal tax purposes. When drafting an agreement, if the parties desire that the payments for a fixed term be treated as alimony for federal tax purposes, always include a provision stating expressly that the payments terminate upon death, even if death occurs before the end of the stated term. Otherwise, there is a very real risk that the tax court will refuse to treat the payments as alimony.
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