Divorce Court Cannot Change History by Re-Characterizing Payments as Deductible Alimony

alimony

Divorce Court Cannot Change History by Re-Characterizing Payments as Deductible Alimony

Generous exes who pay more alimony than they are required to might get an unwelcome surprise when they file their income tax returns: the IRS will deny their retroactive alimony deduction claim. The U.S. Tax Court, in Baur v. Commissioner, T.C. Memo 2014-117, held that a taxpayer could not deduct alimony payments that exceeded the taxpayer’s contractual obligation.  The taxpayer was also charged with accuracy-related penalties.

The taxpayer, Mr. Baur, and his former wife were married in 1982 and had three children, AB, JB, and SB.  In February 2009, the spouses were divorced in Illinois, and executed a Marital Settlement Agreement.  Pursuant to paragraph 2.1 of their settlement agreement, Mr. Baur was required to pay $3,750 per month ($45,000 per year) as “unallocated maintenance and child support,” plus 45% of his net bonuses.  This obligation reduced to $1,800 per month ($21,600 per year) when the youngest children were emancipated.

In 2010, Mr. Baur paid $45,000 in unallocated payments to his ex-wife. He received an $8,000 bonus in April 2010. He paid 45% to his ex-wife ($3,618) but not until 2011.  On his 2010 federal income tax return, Mr. Baur deducted alimony of $41,695.  When his return was examined, Mr. Baur claimed that his deduction should have been $45,000 instead. The IRS sent a deficiency notice, disallowing $26,143 and allowing $15,552 of the alimony deduction.

(Note: The IRS’s allocation is not explained and does not correspond to the proportions of alimony (48%) and child support (52%) in the “unallocated” contractual obligation.  Curiously, the disallowed amount ($26,143) exceeds the child support portion ($23,400) of the contractual obligation.)

Reacting to the IRS deficiency notice, the Illinois court issued a corrective order in 2012 that characterized the entire $4,500 per month as “maintenance” for the ex-wife.  The 2012 order stated that the entire amount was intended to be tax-deductible.  The 2012 order stated that any contrary language in its earlier 2009 order (which had adopted the settlement agreement) was a mere scrivener’s error. The 2012 order vacated the paragraph of the 2009 order that would modify the obligation when the youngest children were emancipated.

At this point, the U.S. Tax Court reviewed the case. The taxpayer took the position that $45,000 was tax-deductible alimony; and the IRS took the position that only $17,981.89 was deductible.  More specifically, the IRS argued that the underlying settlement agreement (that reduced the taxpayer’s unallocated obligation when the children were emancipated) was not rescinded, and the divorce court’s 2012 order could not have any retroactive effect on the characterization of the payments that had been made in 2011.   TheTax Court reviewed Sections 71 and 215 of the Internal Revenue Code, which deal with alimony.  The Court also reviewed Commissioner v. Lester, 366 U.S. 299 (1961), which deals with the allocation of payments that include alimony and child support.  Most importantly, the Tax Court quoted Gordon v. Commissioner, 70 T.C. 525 (1978), which deals with the retroactive effect of divorce court orders.

The U.S. Tax Court concluded that the Illinois court’s 2012 order was ineffective to change history.  The Tax Court rejected the notion that the 2009 order had contained a scrivener’s error, because the 2009 order matched the parties’ settlement agreement.  The 2009 order that reduced an “unallocated” alimony and child support order when the children reached age 18 was consistent with the settlement agreement.  Therefore, the Tax Court held that the 2012 order could not retroactively make the 2011 payments tax-deductible.