(a) Facts: The parties entered into a premarital agreement. The agreement provided, among other things, that the wife would receive, upon divorce, a lump sum of $100,000, plus $10,000 for each year the parties were married.
The parties married but divorced after four years. A separation agreement required the husband to pay the wife $140,000, exactly the amount that the above provision would require for a four-year marriage. The agreement further provided:
The parties each acknowledge that this agreement, and each provision of it, is expressly made binding upon the heirs, assigns, executors, administrators, representatives and successors in the interest of each party.
2017 WL 5713945, at *4.
A modified separation agreement then reduced the payment from $140,000 to $117,970.97 on the ground that the husband had already paid $22,029.03 in expenses for the wife. The husband’s total liability, including the expenses, remained at exactly $140,000. The modified agreement was incorporated into a Texas divorce decree.
The husband paid the wife the $117,970.97. On his next tax return, he took an alimony deduction of $170,000. Of this amount, $32,000 was for alimony paid to a prior spouse, and $140,000 was for the payments made to the wife.
The IRS disallowed the deduction above the $32,000 paid to the former spouse, and the husband petitioned for relief in the Tax Court.
(b) Issue: Was the husband entitled to a tax deduction for the $140,000 paid to the wife?
(c) Answer to Issue: No.
(d) Summary of Rationale: The payments to the wife met the first three requirements in § 71(b)(1). They were made under a divorce instrument, the instrument did not say that the payments were not includible in gross income, and the parties were not members of the same household.
The dispositive point was the fourth requirement, which provides that the payments must cease upon the death of the payee. The court found no clear provision on this point within the agreement.
The husband argued that the court should look to the subjective intent of the parties. The court refused to do this. “The definition of alimony for tax purposes turns on fulfillment of the statutory test and not on the intent of the parties to a divorce proceeding.” Id. at *7.
Since the agreement contained no clear provision, the court looked to Texas law. “Under Texas contract law, contractual support payments do not terminate on the death of the former payee spouse absent agreement to the contrary shown by the contract or surrounding circumstances.” Id. at *4. Since the agreement was silent, the right to payment terminated upon the wife’s death, and the obligation was not alimony.
The husband argued that the right to payment could not possibly terminate upon the wife’s death because the wife had not died, and the payment had already been made. The court disagreed:
Petitioner’s contention that under Texas law, he did not have an obligation to pay Ms. Williams in the event of her death because he had already paid her on the date of divorce is irrelevant. In making that contention, petitioner fails to understand the standard articulated by sec. 71(b) and instead relies erroneously upon the fact that he actually made the payment on the date of divorce. The complete termination upon the death of the payee spouse of all payments made as alimony is an indispensable part of Congress’ scheme for deducting a payment as alimony for tax purposes. . . . The fact that payments were, in fact, made simultaneously with the execution of the agreement is irrelevant.
Id. at *5 n.10.
Observation: Interestingly, the court did not view the binding-on-heirs provision as showing a clear intent that the payment obligation survived the payee’s death.
Comment: It was clear, at the time the husband took the alimony deduction and at the time the Tax Court ruled, that the wife had not died and the payment had been made. Nevertheless, a payment is not alimony under § 71(b)(1)(D) unless, if the payee had hypothetically died immediately after the agreement was signed, or the decree entered, and before payment made, the payee would have received nothing. The test is hypothetical, not actual, and it cannot be avoided merely because the payee has not actually died or because the payment was made immediately.
There is more common sense to this result that one might at first think. The central purpose of § 71(b) is to define periodic alimony objectively, in a way that does not force the Tax Court to look at the subjective intent of the parties. The termination-upon-hypothetical-death test is Congress’s main attempt to create an objective requirement. The requirement is logical in itself, as under longstanding common-law principles, periodic alimony terminates upon the death of the payee. If the fact that the payee has not actually died changes the result, then a large number of obligations that are lump-sum alimony or property division are going to be treated as alimony for tax purposes. The hypothetical nature of the test is necessary to distinguish between periodic alimony and other types of payments.