Congress eliminated the deduction for alimony in the December 2017 Reconciliation Act (informally called the Tax Cuts and Jobs Act, or TCJA). The concept is still important, however. First, the legislation grandfathered in alimony payments made pursuant to divorce or separation instruments executed on or before December 31, 2018. So the question of whether a payment qualifies as alimony will thus still be important for many taxpayers for years to come. Second, the definition continues to play an important role in analyzing the support requirements for dependents. See §152(d)(5).
Determining whether payments constitute alimony is not always easy and errors can lead to §6662 penalties for careless taxpayers and their advisors. Jihad Y. Ibrahim v. Commissioner, T.C. Summ. Op. 2022-7 (May 16, 2022) (Judge Weiler), teaches us the importance of the words used in divorce instruments. There, Dr. Ibrahim sought to deduct $50,000 in payments to his ex-wife. He called them as alimony on his return. But the marital separation agreement and the divorce decree did not call them that. The IRS disallowed the deduction as contrary to the plain language in the divorce decree. Despite Dr. Ibrahim’s ingenious arguments, the Tax Court agreed with the IRS and held the taxpayer to his word(s). Details below the fold.
Law: What Constitutes Alimony, Then and Now
To understand today’s lesson, we need to review two concepts: “alimony” and “divorce or separation instrument.”
Before the TCJA, alimony was defined in §71(b)(1). The term “divorce or separation instrument” was defined in §71(b)(2). Then the TCJA repealed §71. It moved the §71(b)(1) definition of alimony over to §152(d)(5)(B) because the concept is still important for determining who is a dependent. Similarly, the TCJA moved the §71(b)(2) definition of “divorce or separation instrument” over to §121(d)(3)(C) to help with determining whether a divorced taxpayer is entitled to an exclusion for gain from the sale of the taxpayer’s residence.
The Pre-TCJA and post-TCJA definitions of alimony are different. Let’s see how.
For purposes of today’s lesson, payments had to meet four basic requirements to constitute deductible alimony. The nuances within each requirement are not relevant for us today.
(1) Cash only. The payments had to be cash, or cash equivalent. Former §71(b)(1).
(2) Per Formal Instrument. The payments had to be made “under a divorce or separation instrument.” Former §71(b)(1)(A). Former §71(b)(2) said the following documents qualified: (a) a judicial decree of divorce or separate maintenance (or a written instrument incident to such decree); (b) a non-judicial written separation agreement; or (c) a judicial decree other than a divorce decree that required a spouse to make payments for the support or maintenance of the other spouse.
(3) End on Death of Payee Spouse. To be deductible alimony, the payor spouse must have had no obligation to continue payments after the death of the payee spouse. Former §71(b)(1)(D). The failure to include language to that effect in divorce documents was a common and sometimes fatal error. See Lesson From The Tax Court: The Perils of Poor Drafting, TaxProf Blog (Dec. 4, 2017). However, courts and the IRS created a rescue rule for badly drafted documents. If the relevant state law provided that the obligation at issue would terminate on the death of the payee spouse, then courts allowed such payments to qualify as alimony. See Hoover v. Commissioner, 102 F.2d 842 (6th Cir. 1996) (explaining history of this requirement).
(4) Not Otherwise Designated. The divorce or separation instrument must not have designated the payments as non-alimony. Again, this was a drafting issue. Courts did not require magic language, but instead look to see whether “the substance of such a designation is reflected in the instrument.” Estate of Goldman v. Commissioner, 112 T.C. 317, 323 (1999). The words need not specifically refer to sections 71 and 215 to designate a payment as non-alimony. See PLR 201706006 (Nov. 7, 2016) (reviewing law). For example, in Steves v. Commissioner, T.C. Summ. Op. 2013-80, the Separation Agreement had this catch-all language: “It is the intent of the parties that all transfers of assets and other monetary awards pursuant to this Agreement, except spousal support payments, are nontaxable transfers between the parties incident to their divorce.” The Court said that language made the payments at issue (for housing expenses) non-alimony even though the specific provision requiring the payments was silent on whether they were to be treated as alimony or not.
The point of this fourth requirement is to allow taxpayers flexibility to decide for themselves whether and when payments would constitute alimony. If they did not want the payments to constitute alimony, they could use any language that clearly showed the payments were not supposed to be alimony. Thus, the language might say the payments were supposed to be something else. Or the instrument could say the payments were not intended be gross income to the payee spouse and/or were not intended to be deductible to the payor spouse. E.g. Estate of Goldman, supra.
Congress changed the definition of alimony in 2017. While Congress cut and pasted the first three requirements from old §71(b)(1) over to §152(d)(5)(b), Congress dropped the fourth requirement. Thus, if an issue about whether payments constitute alimony or child support arises today, it appears that Congress has removed the ability of divorcing couples to specifically designate payments as non-alimony in the relevant divorce or separation instrument. I welcome any comments on whether I’m misreading what Congress has done. If not, then I welcome any explanation readers care to supply on why Congress did that! I’m clueless. I also don’t see where the issue has arisen yet in litigation, so I do not know whether courts will substitute a judicial rule for the now-deleted statutory rule.
In contrast, Congress made no changes to the definition of a divorce or separation instrument when it moved former §71(b)(2) over to §121(d)(3)(C).
Today’s lesson involves the pre-TCJA law. Let’s take a look.
In 2008 Dr. Ibrahim married Ms. Cheryl Edington. Each had been previously married and had children from those prior marriages. He worked as a medical doctor. She worked as a registered nurse. The opinion is silent on the number or ages of the children.
In August 2016 they separated. They then executed a Marital Separation Agreement. The Agreement explicitly provided that neither spouse would pay maintenance to the other (Missouri calls alimony "maintenance"). Further, it provided that “each will be forever precluded from requesting maintenance as part of their decree of dissolution.” Op at 3. Finally, the Agreement did provide that Dr. Ibrahim was to pay Ms. Edington $10,000 ”to assist in Wife’s relocation and legal fees.” Id. This was payable in monthly installments of $300 with the balance due when the divorce decree was final. The initial sum of $10,000 was later raised to $50,000 in a formal amendment to the Agreement.
The divorce decree became final in June 2017. It provided that “neither party shall receive maintenance from the other, and that this judgment with respect to maintenance is not modifiable.” Op. at 4.
Per the Agreement, Dr. Ibrahim faithfully paid Ms. Edington $300 per month. By the time the divorce decree became final in 2017 he had paid $1,200 in 2016 and another $2,000 in 2017. After the divorce decree became final he paid her the balance owed of $46,800.
For some reason, Dr. Ibrahim attempted to deduct the entire $50,000 he had paid on his 2017 return, including his 2016 payments. On audit, the IRS disallowed the entire deduction. The NOD not only proposed to assess roughly $16,000 as a deficiency, it also tagged Dr. I for additional $3,000 as a §6662(a) penalty.
Lesson: Words Matter
Let’s learn our lesson by applying each of the four alimony requirements to Dr. Ibrahim’s payments.
(1) Cash only. No problem. The payments were made by check, a cash equivalent.
(2) Per Formal Instrument. No problem. The payments were made pursuant to the Agreement, and that was incorporated into the final judicial divorce decree as follows: “The parties have entered into a written Marital Separation Agreement that makes full and final disposition of all marital property and provides that neither party shall receive maintenance from the other.” Op. at 4.
(3) End on Death of Payee Spouse. Minor problem. Neither the Agreement nor the divorce decree provided that Dr. Ibrahim’s obligation to pay the $50,000 would terminate on the death of Ms. Edington. However, the governing state law provided that “the obligation to pay future statutory maintenance is terminated upon the death of either party....” Mo. Rev. State. §452.370(3). Of course, for this statute to save the day, the payments would need to maintenance payments in the first place! Thus, if the $50,000 was something other than an obligation to pay future statutory maintenance, then the state law would not rescue the drafting omission.
Thus, whether or not the $50,000 constituted an obligation to pay maintenance (the Missouri state law term for the federal term alimony) is make-or-break, and takes us to the final requirement.
(4) Not Otherwise Designated. Major problem. As Judge Weiler explains: “the agreement, the amended agreement, and the judgment each contain statements indicating that neither Dr. Ibrahim nor Ms. Edington would pay maintenance to the other. We find these statements provide clear, explicit and express direction that neither party shall receive maintenance payments from the other.” Op. at 8 (internal quotes omitted).
Dr. Ibrahim’s attorney came up with two facially clever arguments on why the court should ignore the plain language of the relevant formal instruments and find that the $50,000 was alimony. Neither survives a second look.
First was an argument that the payments must be alimony because “the payments could not possibly be child support and were not an additional division of marital assets.” Op. at 6. Therefore, they must necessarily default to being alimony.
This is an ingenious argument, but totally backwards. Property settlement is the default category, not alimony. Under pre-TCJA rules, payments between divorcing spouses fell into one of three boxes: (1) alimony; (2) child support; or (3) property settlements. The rules for what payments constituted alimony were explicit as I set out above. Similarly explicit were the rules for what constituted child support. See former 71(c)(2) and Treas. Reg. 1.71-1T(c). The statute said that child support payments could be either express or implied. The regulations explained that payments would be implied child support when the amount of payments depended on events directly or indirectly related to the children, such as employment, dying, leaving the household, turning a certain age, etc.
Since the rules for what constituted alimony were explicit, and the rules for what constituted child support were explicit, that meant that anything not constituting alimony or child support would default into the property settlement box. You can actually see that in this case because the state divorce decree itself describes these payment obligations as part of the “full and final disposition of all marital property...” Op. at 4.
Second was a substance-over-form argument. Ms. Edington’s “qualification for maintenance under state law was questionable, and therefore to avoid litigation, [Dr. Ibrahim] agreed...to increase his payment obligation...from $10,000 to $50,000.” Op. at 6. The argument is that, yeah, the payments may have been described as payments for relocation and legal fees, but they were really just a functional substitute for alimony.
Judge Weiler does not explain why that argument fails, but it should be obvious: the words chosen by the parties themselves will control, regardless of whatever secret reasons the parties have for agreeing to the words. Either the words are sufficient to designate the payments as non-alimony or they are not. It is sufficient that the words—again, chosen by the parties themselves—designate the payments as something other alimony, when read from “a reasonable, common sense perspective,” Steves, supra. If they do, then that’s that! Extrinsic evidence of intent is irrelevant.
Here, Dr. Ibrahim agreed to language in all three relevant formal instruments that explicitly designated the payments as something other than alimony.
Judge Weiler holds Dr. Ibrahim to his word(s).
Coda: Judge Weiler also upheld imposition of the §6662(a) and (b)(2) penalty for substantial understatement. Dr. Ibrahim asserted he had substantial authority for his position. If true, that would be a good defense to penalties. See §6662(d)(2)(B). But to have substantial authority you must first have some authority. A bemused Judge Weiler points out that Dr. Ibrahim “has not identified the authorities in support of his position.” Op. at 12. I too would be really hard-pressed to find any authority at all! After all, even his substance-over-form argument conceded that the initial $10,000 was not alimony. And what authority is there for deducting the payments made in 2016 on the 2017 return? I sure hope Dr. Ibrahim did not have to pay his attorney for the time it took to assert that defense.
Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School of Law. He invites readers to return each Monday for a new Lesson From The Tax Court.