Paul L. Caron

Monday, August 10, 2020

Lesson From The Tax Court: The Unwritten Advantage Of Small Case Procedure

Taxpayers who petition the Tax Court to contest $50,000 or less of a proposed deficiency can elect to have their case heard under the procedures authorized by §7463 and set out in Tax Court Rules 170-174.  Cases decided under these small case procedures are called S-Cases.

The written advantages of S-Cases include a quicker trial date and a more informal trial.  In Adam Jordan Winslow v. Commissioner, T.C. Summ. Op. 2020-22 (Aug. 3, 2020) (Judge Colvin), the Court allowed the taxpayer a highly dubious alimony deduction based on an argument that would probably not have succeeded in a regular case.  To me, the case shows us an unwritten advantage of S-Cases: the Court may be willing to apply the law in a more relaxed fashion when presented with a sympathetic taxpayer.  Details below the fold.

Law: S-Cases and The Las Vegas Rule
Congress enacted §7463 as part of the Tax Reform Act of 1969. 83 Stat. 487, 733.  It appears that the Tax Court had previously had some internal rules allowing for more informal consideration of small tax cases, but the statute allowed the Court to create specific rules of procedure for S-cases.

S-Case rules create relax normal Tax Court procedure in several ways.

First, pleadings are simplified.  Rule 173 says the taxpayer can file a simplified Petition and is not required to submit a Reply in response to the IRS’s Answer.

Second, trial is simplified.  Rule 174(b) instructs that the trial is to be conducted as informally as possible consistent with good order and “any evidence deemed by the Court to have probative value shall be admissible.”  Functionally that means the taxpayers can introduce copies or even ask Chief Counsel to bring copies of documents, and the Court will accept pretty much anything from the taxpayer and evaluate it for what it is worth.

Third, post-trial is simplified.  Rule 174(c) says “neither briefs nor oral arguments will be required in small tax cases unless the Court otherwise directs.”

Fourth, the appeals process is nothing!  Section 7463(b) says that S-Cases “shall not be reviewed in any other court and shall not be treated as a precedent for any other case.” 

I call §7463(b) the “Las Vegas Rule”: what is decided in any S-Case stays in the S-Case.  And that, dear readers, is why taxpayers can sometimes get away with a more relaxed argument that may not succeed in a regular case.

Law: Alimony Deduction
Mr. Winslow’s case involved a disallowed alimony deduction, so a brief review may be useful for those who need a refresher.  Those who don’t can skip right to the Lesson.

For taxpayers who have an obligation to pay money to their ex-spouse under a divorce or separation instrument created before December 31, 2018, may be able to deduct those payments under former §215 if those payments qualify as “alimony” within the meaning of former §71.  See Act of December 2017, 131 Stat. 2054, 2089.

Former §71 required taxpayers receiving alimony to include those amounts in gross income.  Former §215 allowed taxpayers paying alimony to deduct those payments and former §62(a)(10) permitted taxpayers to take the deduction above the line.

So the definition of “alimony” is pretty important.  For today’s lesson, we just need to focus on two of the requirements: (1) the need for a “divorce or separation instrument,” and (2) the need for the payment obligation to terminate on the death of the payee spouse.

(1) Divorce or Separation Instrument. A payment will not be alimony unless it is made pursuant to a “divorce or separation instrument.”  That term was defined in §71(b)(2) but you will now find it over in 121(d)(3)(C) because it is still important for the home sale exclusion. 
A divorce or separate instrument can take one of two forms.  First, it can be a Court Decree, one either granting a divorce or otherwise “requiring a spouse to make payments for the support or maintenance of the other spouse.”  §71(b)(2)(A), (C).   Second, it can be any non-judicial “written instrument” that is either incident to a judicial decree or simply a “written separation agreement” that is not at all connected to a judicial decree.  §71(b)(2)(A), (B).

It’s that second meaning which is important to today’s case, so let’s take a closer look.

The Tax Court has said that a “written separation agreement” has no particular formatting requirements but can be any document or collection of documents that evidences a meeting of the minds.  Thus, when the payor spouse sends a letter and the payee spouse assents to the contents by signing the letter and returning it, that can be a written separation agreement.  Azenaro v. Commissioner, T.C. Memo 1989-224.  Similarly, a letter from the payor spouse that reduces to writing a prior oral agreement for alimony can be a written separation agreement even if the payee spouse does not sign that letter.  Jefferson v. Commissioner, 13 T.C. 1092, 1097-1098 (1949).

The key here is that the writing or writings evidence a meeting of the minds.  Thus, letters which do not show a meeting of the minds between the parties cannot collectively constitute a written separation agreement. Leventhal v. Commissioner, T.C. Memo.2000–92.  Importantly, “[m]ere acquiescence and receipt of a payment by the recipient spouse does not transform a unilateral offer of support into a bilateral written agreement....” LeventhalSee also Harlow v. Commissioner, T.C. Memo 1984-393 (“A unilateral written statement by a party stating that he is willing to pay his spouse certain sums for her support clearly does not meet the statutory requirement of a written separation agreement.”).

(2) Payment Obligation Ends At Death of Payee Spouse. To qualify as alimony the payment obligation must not extend beyond the payee spouse’s lifetime.

The Tax Court will first look to the Divorce or Separation Instrument to fulfill that requirement.  For example, in Webb v. Commissioner, T.C. Memo 1990-540, Mr. Webb obligated himself to make a one-time payment to his wife of $215k, due and payable “on signing this Agreement.”  Mr. Webb deducted the $215k as alimony.  The Tax Court sustained the IRS’s disallowance because the separation agreement did not provide that his obligation to pay the $215,000 ended on the death of his ex-wife.  Mr. Webb argued that this obligation would be satisfied “simultaneously” with the signing of the agreement that created the obligation.  So he asked the Court to ignore the “not payable after death” requirement, pointing out that nothing the in agreement affirmatively required him to pay her the $215k if she died on the spot.  The Court refused to bend the law: “We refuse to embrace such an incongruous, absurd position.”

If the Divorce or Separation Instrument does not fulfill the end on death requirement, the Court will look to see if state law terminates the support obligation.   I cannot find a cite for this proposition, but readers of a certain age will recall that §71 used to contain language requiring language in the divorce or separation instrument itself, but Congress took that language out in, I think, 1984 or 1986.  That implies that some rule outside the scope of the divorce or separation instrument will suffice. 

Facts of the Case:
Mr. Winslow separated from his spouse in November 2014 after which she moved to a different state with their child.  They obtained a Judgment for Absolute Divorce in early 2016.

In December 2014 Mr. Winslow put $5,000 deposited $5,000 into their joint bank account and his spouse withdrew that amount into her separate account.

During 2015, while they were separated but not divorced, Mr. Winslow send his spouse $2,000 per month.  On his 2015 return he deducted that amount as alimony.  The opinion is silent on whether his ex-spouse included it as gross income.

The IRS disallowed the $24,000 deduction and Mr. Winslow petitioner the Tax Court pro-se, asking for S-case designation.

Mr. Winslow was a Marine at all times relevant to the case.  The Marine Corps has a strong policy that it “will not serve as a haven for personnel who fail to provide adequate and continuous support requires for their family members.”  Marine Corps Manual for Legal Administration (Aug. 31, 1999) Chapter 15, ¶15001.1.  Accordingly, it obliges all Marines, upon pain of criminal prosecution, to “comply fully with the provisions of separation agreements and court orders addressing the support of family members.” Id.  The Manual  emphasizes that “the amount of support...should be established by a written agreement between the parties or adjudicated in the civilian courts." ¶15001.2.  Thus, “Final divorce decrees and written agreements in which spousal support is not awarded or mentioned, or is affirmatively waived, eliminates this obligation.”

The Manual also covers situations where there simply is no applicable separation agreement or court order.  For such situations, the Manual sets out “interim financial support standards” and provides that if there is no applicable separation agreement or court order, then “the support standards set forth in this chapter shall be enforced.” ¶15001.1.  See also ¶15002.1(c)(“If neither a court order nor a written agreement exists,” the Marine must follow “the interim financial Support standards of paragraph 15004.”). 

The interim financial support standards are contained in a table in ¶15004.  That table does not distinguish between “spouses” and “children.”  The table simply provides different support requirements depending on “Total Number of Family Members Entitled To Support.”  Paragraph 15001(4) says that the “family members entitled to support” are the Marine’s spouse, biological children, and adopted children. 

As relevant here, ¶15004 requires the Marine to pay half of the Marine’s base housing allowance to support one family member and 2/3rds of the housing allowance to support two family members.  Mr. Winslow’s base housing allowance for 2015 was $2,970.  Two-thirds of that was $1,980.  Rounded, that is $2,000 which is what Mr. Winslow paid each month in 2015.  His spouse accepted the money.

Opinion:  Taxpayer Wins Dubious Alimony Deduction
The first clue that this opinion will be generous to the taxpayer lies in what it does not say.  Normally, a Tax Court decision about deductions starts out with this boilerplate reminder: “Deductions are a matter of legislative grace, and taxpayers have the burden of showing that they are entitled to any deduction claimed.  See Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992).”  See e.g. Hernandez v. Commissioner, T.C. Memo 2018-163.

Here, Judge Colvin omits that reminder.  That is because the opinion seems to flip the usual presumption.  It appears to presume the payments were alimony unless the IRS could explain why they were not.  For example, the opinion’s Analysis section starts out framing the question presented as whether the IRS reasons for disallowing Mr. Winslow’s payments as alimony were correct, instead of addressing Mr. Winslow’s reasons why the payments were alimony.

If Mr. Winslow had been required to show his entitlement, he would have run into two problems: pointing to a written separation agreement, and explaining why the payment obligation ended at the death of the payee spouse.

(1) Was There a Written Separation Agreement?
Judge Colvin found that the following two emails constituted the required “written separation agreement”:

First, Mr. Winslow’s spouse emailed this to him in December 2014:  “Per The Financial Support of Family Members Policy please deposit $3,671.95 into the joint account today, December 15, 2014.  Kindly, [name].”

Second, Mr. Winslow responded that same day with this: “I think your calculations are off. The $5,000 I put into the joint account that you removed and put in your personal account (that I never had access to) covers my obligations through the middle of January. Kindly [name].”

These two email constitute a “written separation agreement” says Judge Colvin, because they showed a meeting of the minds that Mr. Winslow comply with the Marine Corps interim financial support standards.  To even get to that conclusion, Judge Colvin engages in some pretty nimble inferential logic, but it works well enough to show that the emails were probative that both Mr. Winslow and his spouse intended that Mr. Winslow comply with the Marine Corps interim financial support standards.

But one cannot “agree” to abide by the law.  One must abide whether one agrees with it or not.  The emails just show an expectation that Mr. Winslow would comply with what was, to him, a legal requirement---enforced by criminal prosecution---imposed by the Marine Corps to pay $1,980 per month to support his spouse and minor child.  Judge Colvin gives no explanation on why that agreement constitutes a written separation agreement.   That is, the spouse’s first email basically said “Hey, you are supposed to follow the Marine Corps rules!” and Mr. Winslow’s response was “I am following the rules.” Mr. Winslow's subsequent payment of $2,000 per month and his spouse's acceptance of that amount do transform the payments into deductible alimony.  Leventhal.

This shared expectation that Mr. Winslow would follow Marine Corps requirements was nothing like the cases where the Tax Court has found a written separation agreement in an exchange of letters.  In those cases, the letters were far more comprehensive and dealt with many of the other aspects of separation; the alimony amount was only a part of a larger set of issues.  Here, these emails show at most an expectation about one aspect of the separation.  And that expectation is simply that Mr. Winslow would abide by what was required of him. 


(2) Did the Obligation End At Death?
The IRS did not raise this argument, but, again, it should not have had to.  Remember, it was Mr. Winslow’s burden to prove his entitlement to the deduction.  He thus had to show the Court why his obligation to pay $2,000 per month would have ended on the death of his spouse.

All Judge Colvin says about this is that the “terms of the separation agreement did not preclude the monies paid from being included as income or require payments to continue if petitioner died during the separation period.” Op. at 10.  [Note: I think Judge Colvin meant “if petitioner’s spouse died” because the requirement in §71(b) was that the obligation to make payments could not continue “after the death of the payee spouse.”]   That is true, but irrelevant.

If one treats the two emails as “the separation agreement” then to meet the end-at-death requirement they needed to explicitly provide that the payment obligations would end at death.  Silence does not cut it.  The idea that the agreement "did not require payments to continue" is exactly the losing argument Mr. Webb made.  Webb v. Commissioner, supra.  To get the alimony deduction, the taxpayer bears the burden to show that the separation agreement or local law makes the payment obligation die when the payee spouse dies.  The two emails are simply silent about the obligation.

To get even an inferential argument for meeting the end-on-death requirement, one needs to treat the entire Marine Corps Financial Support of Family Members Policy as local law.  Even that is a doubtful proposition.  There are no provisions in the Manual that explicitly state what happens on the death of a spouse.  However, one can infer what happens from the Table in ¶15004.   That sets support amounts by the number of family members the Marine is required to support.  The death of any one of them would logically reduce the number and, hence, reduce the amount of required support.  So one might say the end on death requirement is satisfied by ¶15004.

Again, however, dubious.

(3) Alimony v. Child Support
Judge Colvin determined that not all Mr. Winslow’s $2,000 payments were alimony because that amount was based on his obligation to support two family members.  Here, those two members were his wife and child.

Judge Colvin reasoned that only the amount Mr. Winslow would have been required to send a single family member would be alimony.  In other words, if the child died, his payment obligations would be less.  He would only have to send his single family member half his basic housing allowance, or $1,485.  Therefore, Judge Colvin concluded that of the $2,000, $1,485 was alimony and $515 was non-deductible child support.

Mr. Winslow got another break here.  If one accepts that the Marine Corps Table satisfies the end-on-death requirement, then the proper question is what would happen on the death of his spouse, not the death of the child.  It would be the same reduction in payment obligation: $515.  Thus, the amount of the obligation removed on death of the spouse is the amount that meets the alimony requirement.  That would be $515 per month and not $1,485.

Lesson: The Unwritten Advantage of S-Case Designation
S-Cases are more relaxed on procedure.  This case suggests they may sometimes be more relaxed on substance as well, particularly if the taxpayer can make a good impression.  Here, it appears the taxpayer, a Marine, made a good impression.  When Judge Colvin reprints the emails he relied upon, he is careful to include the closing valedictions used by Mr. Winslow and his spouse.  Each email ended with “Kindly, [name]”  That’s sweet.  These are good people.

One can sympathize with Judge Colvin’s approach to this case.  Taxpayers are often entrapped by tendrils of tax complexity and, gosh, why should two good people have to re-invent the wheel if the Marine Corps Financial Support of Family Members Policy covers their needs?  It is very tempting to read the emails as saying something like: “Hey, I want you to pay me $2,000 per month in support.  Kindly [name]” followed by “Sure.  I am happy to continue paying you $2,000 per month in support during our separation until we work out a more permanent figure in our divorce.  Kindly, [name].”

But that is not what the emails say.  At best (using lots of inferential logic) they reflect an expectation that Mr. Winslow will comply with his employer’s requirements.

In regular cases, the Tax Court has expressed sympathy for taxpayers while being firm that there can be no alimony without a written separation agreement.  See e.g. Keegan v. Commissioner, T.C. Memo 1997-359 where the Court found no written agreement even while noting “We have no doubt that the payments at issue were intended to be in the nature of alimony.” See also Webb v. Commissioner, supra.

When you are in S-case, however, the Court may not be as firm.  It's the Las Vega Rule:  What is said in this opinion stays in this opinion.  It cannot be used as precedent and it cannot be appealed.  It’s a one-off.

Comment:  Whipsaw
Here, Mr. Winslow gets to take his alimony deduction (in generous part).  However, I bet you dollars to donuts that his spouse did not include the amount he gets to deduct in her gross income in 2015.  If the IRS had not identified her 2015 return for audit, it’s now too late.  Even if it had, however, she is quite likely to prevail.  Her arguments that these payments were NOT alimony are far, far stronger that Mr. Winslow’s arguments that they were.  And, remember the Las Vegas rule!  The IRS cannot use what happened in this case to help it in her case.

In fact, if Mr. Winslow's ex-spouse came to you for advice, you now know why she might well want to elect the S-Case procedure, especially if she is also a sympathetic taxpayer. 

Kindly, Bryan Camp

Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School of Law.  He invites readers to return to TaxProfBlog each Monday for a new Lesson From The Tax Court.

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Not the first nor last such occurrence. Reason enough to abolish the "S" case status process. Or have a designated judge (by rotating assignment) review every proposed Summary Opinion.

Posted by: Diogenes | Aug 11, 2020 4:34:27 AM