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Enron still causing trouble

Leslie v. Comm’r, 725 F. App’x 597 (9th Cir. 2018) (unpublished)

(a) Facts: A husband and wife signed a separation agreement to settle a California divorce case.  In a section entitled “Spousal Support,” the agreement awarded the wife $7,000 per month, stating expressly that it would end upon either party’s death.

The agreement further awarded the wife 10% of an attorney’s fee that the husband might receive in the future for representing the plaintiff in a class-action suit against Enron.  The agreement provided:

Ms. Leslie’s ten percent (10%) interest in the Enron fee is a spousal support award from a contingent liability, the amount of which could not be definitely set at the time of this agreement, since Mr. Georgiou cannot be certain of the amount of fees that he will receive from the Enron litigation. This ten percent (10%) distribution to Ms. Leslie is taxable to Ms. Leslie and deductible to Mr. Georgiou as spousal support.

Leslie v. Comm’r, T.C. Memo. 2016‑171, 2016 WL 4921026, at *5 (2016) (emphasis added) (case discussed in the 2017 version of this outline).

The husband ultimately received an attorney’s fee of $55 million, and he paid the wife her share in installments as the fee came in.  The final installment was due in 2009, and the husband paid that installment into a joint bank account in both parties’ names.  The wife “credibly testified that she had no control over [the account].  She was not given any checks to sign from the account, and her impression of the payment was that it wasn’t yet legally hers.”  Id. at *7.

On most of the relevant tax returns, which were filed late, the wife reported the attorney’s fee payments as alimony.  On her 2009 tax return, however, the wife did not treat that installment as alimony.

The IRS assessed various deficiencies, some not related to domestic relations, and the wife sought relief in the Tax Court.  The Tax Court held that the wife’s share of the Enron fee was taxable as alimony but that the 2009 payment was not taxable until the wife actually had control over the money.  The wife appealed to the Ninth Circuit, obviously raising only the first question (since she prevailed on the second question).

(b) Issues: Was the wife’s share of the Enron fee taxable as alimony?

(c) Answer to Issue: Yes.

(d) Summary of Rationale: Once again, the key point was whether the payments terminated upon the wife’s death.  The agreement was silent, but the Tax Court held yes:

Under California law, “[e]xcept as otherwise agreed by the parties in writing, the obligation of a party under an order for the support of the other party terminates upon the death of either party or the remarriage of the other party.” Cal. Fam. Code sec. 4337 (West 2013). “A written agreement to waive section 4337 ‘must be specific and express.’” Johanson v. Commissioner, 541 F.3d 973, 977 (9th Cir. 2008) (quoting In re Marriage of Thornton, 115 Cal. Rptr. 2d 380, 383 (Ct. App. 2002)), aff’g T.C. Memo. 2006‑105. The parties here have not produced any such agreement. The mere failure to include language terminating support upon death is not enough to constitute a waiver. Id. By operation of California law, then, payments from the Enron settlement would have terminated upon Leslie’s death.

Id. at *6.  The Ninth Circuit summarily affirmed:

We agree: § 71(b) plainly applies to the payments at issue. The payments were received “under a . . . separation instrument.” § 71(b)(1)(A). The separation instrument designated the payments as “taxable to Ms. Leslie and deductible to Mr. Georgiou as spousal support.” See § 71(b)(1)(B). Leslie and Georgiou were “not members of the same household at the time such payment[s] [were] made.” § 71(b)(1)(C). And finally, by operation of California law, the liability to make the payments would have ended upon Georgious death. § 71(b)(1)(D); see Cal. Fam. Code § 4337.

725 F. App’x at 597-98.

The trial court was unimpressed by the wife’s argument that the court should look to the parties’ subjective intention whether the payment constituted alimony.  This is simply not what the statute says.  The Ninth Circuit agreed:

When a statute has a plain meaning, it is that meaning we apply. Hughes Aircraft Co. v. Jacobson, 525 U.S. 432, 438, 119 S.Ct. 755, 142 L.Ed.2d 881 (1999). Courts, moreover, “do not resort to legislative history to cloud a statutory text that is clear.” Ratzlaf v. United States, 510 U.S. 135, 147-48, 114 S.Ct. 655, 126 L.Ed.2d 615 (1994). We therefore decline Leslie’s invitation to reject the statute’s plain meaning.

Id. at 598.

Comment: The parties did not do a very good job of drafting an agreement that actually accomplished their stated intent.  Language providing that a payment shall be taxed as spousal support is not legally binding.  The issue is whether the payments meet the objective language of § 71(b)(1), not whether the parties subjectively intended that the obligation be taxed as support.  The federal courts have stated this point over and over again; taxpayers have been very slow to get the message.

The safe way to make certain a payment constitutes alimony is to make certain all four factors in § 71(b)(1) are met.  The agreement should have stated expressly that the Enron fee payments would terminate upon the wife’s death.  That language would have removed all doubt as to whether the payments met the tax law definition of alimony.

That having been said, the federal courts will sometimes try to uphold the intent of the parties where that can be done within the confines of the § 71(b) factors.  The fact that the payments were described as spousal support gave the courts an opening to apply California law stating generally that spousal support terminates upon death.  But do not assume that every federal court will be willing to do this.  The safe option is to state expressly that any payment that is intended to be alimony for federal tax purposes terminates when the payee dies.

 Observation: The more interesting part of the Leslie case is the holding, made by the Tax Court in a portion of the opinion not appealed to the Ninth Circuit, that the payments were not income until the wife actually controlled the money.   The IRS’s argument that the wife had received alimony in 2009, when she had to file an action in state court to obtain control over the money, seems extremely weak.  Indeed, it is possible that the wife never obtained control over the 2009 installment at all.  “There is nothing in the record that clearly shows if and when Leslie got this money.”  2016 WL 4921026, at *19 n.8.

The fact that the wife appealed the first issue, however, tends to suggest that she probably did not acquire control over the money until some point after 2009.  If she never controlled the money, she never received alimony, and the first issue would not be relevant.  Assuming that she eventually controlled the money, it was taxable income to her in the year that she acquired that control, not in the year in which the husband claimed to make the payment.