A state family court or divorcing spouses by settlement can provide that payments, otherwise qualifying for the alimony deduction, shall nonetheless be non-deductible and not includible in the income of the recipient spouse; but, conversely neither the state court by decree nor the spouses by settlement can make alimony deductible / taxable unless the payments satisfy the requirements of Internal Revenue Code (Code) Section 71 (b (1)).  See Code Section 215(a) and (b).

The Section 71(b) (1) requirements are:

1. The payment must be made in cash to or on behalf of the recipient spouse.
2. The payment must be made pursuant to a divorce or separation instrument which is defined in Section 71(b) (2) to mean:
   1. A Decree of divorce or separate maintenance or a written instrument incident to such a decree.
   2. A written separation agreement, or,
   3. A decree not described above requiring a spouse to make support or maintenance payments to the other spouse.
3. The qualifying instrument does not designate the payments as non-taxable / non-deductible under section, an
4. There is no liability to make the payments for “any period after the death of the recipient spouse, and no liability to make substitute payments (in cash or property) for alimony after the recipient’s death.

The case of Nye v. Commissioner TC Memo 2013-66 (7/15/13), involved interpreting the last requirement as applied to a lump sum paid in settlement of an alimony obligation that met all of the other requirements of Section 71(b).

The facts in Nye which were not in dispute are:

• The parties divorced in Florida in 1990.  The original final judgment of divorce incorporated a marital settlement agreement that provided, in part:
  • Former husband (FH) would pay to former wife (FW) permanent alimony of $3,600 per month plus $150 per month for medical insurance to end on the death or remarriage of FW or death of FH.
• In 2006, FW filed a petition for modification seeking to modify the final judgment of divorce to increase her alimony payments.
• Prior to the final hearing on the modification petition, the former spouses entered into a mediated settlement agreement on 12/7/07 that provided:
  • FH, in lieu of future alimony, would pay to FW a lump sum of $350,000 to settle the dispute over the modification.
  • FH would pay alimony arrears and stay current on the $3,600 plus $150 until the lump sum was paid.
  • FW would quit claim deed the former marital residence to FH.
• The court entered its final judgment on the modification, after the $350,000 payment and deed transfer were made, on 2/4/08.
• The judgment did not state that the payments were non-taxable/ non-deductible under section 215.
• Both the settlement agreement and court’s judgment were silent as to whether the payment obligation would survive the death of the FW prior to the funds being transferred.
• FH and his new wife filed a joint return for 2008 and deducted $350,000 as alimony.
• IRS disallowed all but $3,750 of the deduction ($3,600 and $150 payments made in January of 2008).
• IRS also determined an accuracy related penalty under section 6662(a) (20%).

Tax Court discussion of the applicable law:

Since the settlement and judgment were silent on whether the lump sum payment would survive the death of the FW (i.e., could be enforced by the personal representative of her estate), the court looked to Florida State law in deciding that issue.

The Tax Court cited Van Boven v. First Nat’l Bank in Palm Beach, 240 So. 2d 329 (Fla. DCA, 1970).  Van Boven had almost identical facts to Nye, except that the FW in Van Boven died after the settlement agreement had been signed but before the former husband completed his lump sum alimony settlement payment obligation under the agreement (which were to have been made in installments) and before the trial court had entered its final judgment on modification.  The executor of FW’s estate in Van Boven was then substituted as a party to the modification and filed a petition asking the court to enter its final judgment on modification incorporating the partially executed settlement agreement.  The trial court entered the judgment finding that the lump sum payment was not alimony, which under Florida law would not survive death, but a lump sum of money “in lieu of all claims of alimony.”     On appeal the District Court of Appeal held that the lump sum payments required were, in fact, lump sum alimony. Had no settlement agreement been executed, the trial court could not enforce or modify such payments after the death of the payee spouse.  But, the parties had entered into a lawfully binding contract.

Thus, the Tax Court, then looked to whether contract rights and obligations survive the death of one of the contracting parties under Florida law.  Although the Florida DCA dismissed the petition for modification in Van Boven, it did so, “without prejudice to any rights which (the executor of FW’s estate) may have under either of the written contracts (i.e., the Van Boven original marital settlement agreement and the Van Boven modification settlement agreement).”  The court also cited Frissell v. Nichols, 114 So. 431, 4, 34 (Fla, 1927); and, Hiers v. Thomas, 458 So 2d 322, 323 (Fla, DCA, 1984) in finding that under Florida law contract rights survive the death of one of the parties to the contract.

Thus, the ultimate finding of the Tax Court in Nye was that FH’s payment of $350,000 did not satisfy the requirements for it to be treated as alimony under Sec. 71(b) (1) because under Florida law the contract obligation to pay the $350,000 would have survived the death of the FW.

The Tax Court also upheld the accuracy related penalty because it found that the FH had conceded the issue by not averring error to the Commissioner’s determination and even had he not conceded the issue, he had argued only that the IRS position was incorrect but presented no alternative argument that he had reasonable cause for taking the position that the lump sum payment was deductible.

COMMENT:

Mr. Nye could have sought to have the agreement state that the payment shall not survive the death of the FW.    Of course, FW might not have signed.  More likely, no one thought to address the alimony definition when the agreement was drafted.  How would such a statement be viewed if the funds transfer is made simultaneous with the signature of the agreement?  In that instance, there would be no possibility of death before payment.

Caveat:  This is also an example of the danger of using the forensic accountant or CPA for tax advice where federal law depends on state law. The latter determination is strictly legal.

RESOURCE

I have authored a monogram (74 pages, 8 ½ x 11), “Representing Divorcing Clients,” aimed at professionals but also informative and helpful to parties going through a divorce.  The monogram covers many tax issues that come up in divorce cases.   Order a copy by sending your check for $94 (includes tax and shipping via US First Class Mail) made payable to Steinberg & Associates PA.  Be sure to include a proper shipping address.

© 2013 by Robert S. Steinberg, Esquire
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