Cash payments to former spouse not alimony.

In Estate of Goldman, 112 TC 317 (1999), the Tax Court recently ruled that $20,000 monthly cash payments to the taxpayer's former spouse for 20 years were not alimony. The court liberally interpreted Sec. 71(b)(1)(B), which allows election of nonalimony treatment for cash payments that otherwise qualify as alimony. Nonalimony treatment results in the payments being nontaxable to the recipient and nondeductible by the payor. Estate of Goldman is the first case to rule on this issue.

Sec. 71 (a) requires alimony or separate maintenance payments to be included in a recipient's gross income. In turn, Sec. 215(a) allows a payor to deduct alimony paid. Sec. 71(b)(1) specifies that any cash payment is alimony if the following four requirements are satisfied:

1. The payment is received by or on behalf of a spouse or former spouse under a written divorce or separation instrument;

2. The instrument does not designate the payment as being "not includible in gross income under this section and not allowable as a deduction under section 215";

3. Spouses legally separated are not members of the same household; and

4. There is no liability to make the payment or substitute payments (in cash or property) after the death of the recipient spouse.

Sec. 1041(a) states that no gain or loss is recognized on a property transfer between spouses or former spouses if the transfer is "incident to the divorce." Sec. 1041(c) defines transfers "incident to the divorce" as transfers made within one year after the marriage ceases and transfers "related to the cessation of the marriage." Temp. Regs. Sec. 1.1041-1T(b) requires transfers "related to the cessation of the marriage" to occur within six years after the marriage ceases, but this requirement is a rebuttable presumption.

Monte and Sally were married in 1974 and divorced in 1985. They executed a "Property. Settlement Agreement," which a Hawaii divorce court approved. The agreement provided that Monte would pay Sally $4,540,000 in 1985. Also, under "Further Payments for Property Division," Monte agreed to pay Sally $20,000 per month for 240 months beginning in August 1985. The payments would terminate at Sally's death. The agreement stated that Monte and Sally would report all of these property transfers as nontaxable events under Sec. 1041, with no gain or loss recognized. Finally, Sally expressly waived her right to spousal support (which was synonymous with alimony). Relying on the advice of his tax attorney, Monte deducted $240,000 per year as alimony on his 1992-1994 income tax returns. The IRS disallowed these deductions and also assessed the 20% Sec. 6662(a) accuracy-related penalty.

The Tax Court ruled that the payments were a division of marital property, not alimony, because the property settlement agreement contained a non-alimony designation that satisfied Sec. 71(b)(1)(B). A specific reference to Sees. 71 and 215 is not needed to satisfy Sec. 71(b)(1)(B). The court ruled that a divorce or separation instrument contains a nonalimony designation "if the substance of such a designation is reflected in the instrument."

In applying this standard to the agreement, the Tax Court cited the following provisions:

* Repeated "property division" language;

* Sally's waiver of spousal support;

* Explicit directive that the payments were not includible in Sally's income; and

* Requirement that the payments are nontaxable under Sec. 1041.

The court concluded that the agreement clearly indicated that the monthly payments were a division of assets and not spousal support. However, it did not sustain the accuracy-related penalty, because Monte had provided complete and accurate information to his tax adviser and relied on his advice.

Even though the $20,000 in payments were to be made over 20 years, the Tax Court did not raise the six-year presumption of the temporary regulations. Arguably, the payments satisfy the "related to the cessation of the marriage" requirement of Sec. 1041(c). Also, Sec. 71(b)(1)(B) provides nontaxable and nondeductible treatment for nonalimony payments.

Sec. 71(b)(1)(B) allows taxpayers flexibility in determining the tax consequences of cash payments that otherwise qualify as alimony. If a divorce or separation instrument does not address tax consequences, payments are alimony; if the instrument properly indicates the payments are not alimony, they are not. Although Estate of Goldman provides a reasonable, logical approach to Sec. 71(b)(1)(B), the Tax Court's standard, whether the substance of the nonalimony designation is reflected in the instrument, is not a clear standard. Therefore, it is uncertain which language will satisfy Sec. 71(b)(1)(B), short of the statutory language or the redundancies of Monte's and Sally's agreement.

FROM PETER BARTON, J.D., MBA, CPA, PROFESSOR OF ACCOUNTING, UNIVERSITY OF WISCONSIN-WHITEWATER, WHITEWATER, WI (NOT ASSOCIATED WITH DFK INTERNATIONAL)

Philip E. Moore, CPA, MBA Brown, Dakes & Wannall, P.C. DFK International Fairfax, VA