On June 27, 2011, the U.S. Tax Court filed its decision in the case of Grosjean v. Commissioner, an interesting and educational case involving the issue of deductibility of alimony.
The ex-husband taxpayer who alleged that he should have been able to deduct a certain $50,000 payment as alimony lost this case, but, according to the Court’s decision, it could have been worse; he could have had all of the alimony payments he made under his divorce decree disallowed if the IRS had just taken that position in the first place. The IRS are just a bunch of softies? Doubtful. My guess is that the IRS focused on the trees and missed the forest.
I bet the IRS won’t do that again, not with this particular taxpayer in future years, and maybe not with others in similar cases, so pay close attention to the facts of the Grosjean case.
The Grosjeans married in 1997, separated in 2002, and divorced in 2003. During their marriage, they jointly purchased a home subject to a mortgage, and they had twin sons.
The separation agreement, which was incorporated into their divorce decree, provided that Mr. Grosjean would pay both a “maintenance award” to his ex-wife and also a “child support payment.” The child support payment was set at $2,436 per month.
Under the separation agreement, the maintenance award was described as contractual and non-modifiable. In addition, the maintenance award was to be paid until the couple’s twin sons reached the age of 19. The maintenance award was agreed to be the sum of $2,333.46 per month, which represented the house payment on the mortgage on the marital home.
Under the separation agreement, Mrs. Grosjean was supposed to refinance the mortgage on the home within 5 years of the separation agreement (i.e., in 2007) and have Mr. Grosjean’s name eliminated from the loan, although he would continue to make the mortgage payment.
In 2007, Mr. Grosjean paid the monthly mortgage payments as a maintenance award in the amount of $29,583. Additionally, because Mrs. Grosjean was unable to refinance the mortgage at its then principal level, Mr. Grosjean made an additional $50,000 payment to reduce the principal amount of the mortgage.
Mr. Grosjean deducted the full amount of $79,583 as alimony paid in 2007.
The IRS took the position that the $50,000 payment was not alimony and disallowed the claimed deduction.
The Tax Court opinion written by Special Triad Judge Armen is instructive to taxpayers on several fronts.
First, it clearly sets forth the federal tax rules applicable to the payment and receipt of alimony. Section 215(a) of the Internal Revenue Code allows a taxpayer a deduction for alimony payments. Section 71 of the Code provides that alimony received is includible in the recipient’s gross income.
In order to constitute “alimony,” a payment must satisfy four requirements: (1) the payment must be received by or on behalf of a spouse under a divorce or separation agreement; (2) the divorce or separation agreement must not designate the payment as one that is not includable in gross income under Section 71 and not allowable as a deduction under Section 215; (3) the payee spouse and the payor spouse must not be members of the same household at the time the payment is made; and (4) there must be no liability to make a payment for any period after the death of the payee spouse.
In this case, the IRS agreed that the last three of these four requirements were satisfied; the only bone of contention between the IRS and Mr. Grosjean was whether the $50,000 payment was made under the divorce or separation agreement. This brings us to the second major point of instruction in this case.
Second, if a divorced spouse wishes to make a payment to the other spouse that is not otherwise required under the terms of the couple’s separation or divorce agreement, then he should make sure before making the payment that the separation or divorce agreement is properly amended in writing to call for such payment.
The Tax Court noted that a divorce or separation agreement must be made in writing. As the Court noted, a “payment made pursuant to an oral agreement is not a payment made pursuant to a divorce or separation agreement unless there is some type of written instrument memorializing the agreement.”
Third, in drafting a separation or divorce agreement, it is imperative to make sure that payments intended to be treated as alimony payments not be reduced on the happening of a contingency specified in the instrument relating to a child, such as attaining a specific age, marrying, dying, leaving school, or other similar contingency. Otherwise, the payment will be treated as a non-deductible child support payment, rather than a deductible alimony payment.
In this case, in addition to arguing that the $50,000 payment failed to be made pursuant to a written separation or divorce agreement, the IRS also argued that the $50,000 payment was not deductible as alimony because Mr. Grosjean’s maintenance payments under the agreement were tied to conditions related to the couple’s sons (i.e., maintenance payments were to cease when the sons reached the age of 19).
In making its decision, the Tax Court noted that although there had been an Arbitration Award in 2010 finding that the $50,000 was alimony, such award should be disregarded, noting that “state court adjudications retroactively designating payments as alimony and not child support (or vice versa) are generally disregarded for Federal income tax purposes.”
Moreover, since the $50,000 payment was made pursuant to an oral agreement between Mr. and Mrs. Grosjean to allow her to refinance the marital home mortgage rather than pursuant to the terms of a written separation or divorce agreement, the Tax Court determined that the payment failed to meet the first requirement of an alimony payment.
To make matters even more lopsided in favor of the IRS, the Court also agreed with the IRS that the contingency in the separation agreement relating to the maintenance payments and their ceasing to be made upon the couple’s sons reaching the age of 19 disqualified the maintenance payments from being deductible alimony payments.
The Court noted in a footnote that the IRS’s argument as to the nondeductibility of the $50,000 payment as a consequence of the contingency in the separation agreement relating to the age of the couple’s sons would apply equally to all of the maintenance payments made by Mr. Grosjean. However, the IRS failed to contest at trial or on brief the deductibility of the $29,583 in monthly mortgage payments made in 2007.
It is clear from the Court’s opinion that if the IRS had challenged the deductibility of all of maintenance payments, it would have won. So even the taxpayer lost in this case, it could have been worse.