Taxation - Old Tax Code Provision Controls Deductibility
A lump-sum payment made by a man to his ex-wife pursuant to a 1997 agreement that settled their dispute over modification of the alimony portion of their 1976 divorce decree is governed by the version of §71 of the Internal Revenue Code as it stood before its revision in 1984, the U.S. Court of Appeals for the Ninth Circuit held in Johnson v. Commissioner, 9th Cir., No. 04-72322, 3/28/06).
It thus upheld the Tax Court's ruling that as the agreement was a modification of a pre-1984 decree that did not specify that the revision (removing the limitation of deductibility to periodic alimony payments) was to apply, the lump sum was not deductible.
The couple, Stanley and Joyce Johnson, were divorced in Nevada in May 1976. The divorce decree required Stanley to pay alimony to Joyce in amounts ranging from $1,250 per month at the outset to $2,400 per month. In 1993, Stanley filed a motion to terminate the alimony payments, and Joyce filed a countermotion to increase them.
Final Payment
Pending their appeal from the trial court's disposition of the case, in 1997 the former spouses entered into a settlement agreement, under which Joyce would dismiss her counterclaim to increase alimony in return for Stanley's lump-sum payment of $400,000. The agreement specified that the payment "shall be Stanley's final alimony payment to Joyce and constitute total and complete liquidation and discharge of all debts Stanley owes to Joyce." The agreement made no reference to Internal Revenue Code §71, which deals with alimony.
On July 15, 1997, after Stanley made the payment pursuant to the settlement agreement, Joyce's countermotion was dismissed with prejudice. The dismissal order also stated that Stanley had "discharged any and all obligations to pay Joyce alimony" by the terms of the agreement.
No Reference to New Law
On their tax return for 1997, Stanley and his current wife claimed a deduction for the alimony payments from their income in the amount of $424,000. The commissioner disallowed $400,000 of that deduction, and issued a notice of deficiency. The taxpayers petitioned the Tax Court for redetermination.
The Tax Court granted summary judgment for the commissioner, holding that "new section 71 is applicable only to divorce instruments executed after December 31, 1984, or modified after December 31, 1984, where the modified instrument states that the amended version of section 71 will apply." (Section 71 was amended by Congress in 1984 as part of the Deficit Reduction Act. The old §71 provides that payments are only deductible if they are made periodically. However, the language requiring that payments be periodic in order to be deductible is absent in new §71. Accordingly, Stanley's $400,000 payment to Joyce would be deductible if the new law applied, but not if the old law applied.)
Not a Stand-Alone Agreement
On appeal, Judge Arthur L. Alarcón said that the settlement agreement provides that the $400,000 payment was made in contemplation of Stanley's motion and Joyce's countermotion to alter the alimony terms of the 1976 divorce decree, and that the final stipulation and order for dismissal states that Stanley has "no further remaining obligation to pay Joyce any additional alimony, support or other sums whatsoever, Stanley having fully discharged [his obligations under the separate Settlement and Release Agreement]."
It follows, Alarcón continued, that the 1997 agreement, and the $400,000 payment, settled a dispute over the modification of the alimony provisions of the 1976 divorce decree. It was not a separate stand-alone agreement, he explained, but rather a modification of a divorce decree created prior to 1984. Accordingly, he concluded, the parties needed to specify in their agreement that the new law applied pursuant to Deficit Reduction Act §422(e)(2) if Stanley wanted the benefit of the deduction for alimony paid to Joyce.
Since they did not do so, Alarcón held, the Tax Court correctly determined that the taxpayers were not entitled to deduct the lump-sum alimony payment.
Mutually Exclusive
Alarcón also rejected the taxpayers' secondary argument that a portion of the $400,000 payment was deductible pursuant to old §71(c)(2) as a single installment in a set of installments that went back to 1976 and therefore lasted more than 10 years. A lump-sum final payment and a periodic payment, he emphasized, are mutually exclusive concepts.
Further, Alarcón said, the provision in old §71(c) allowing a deduction for installment payments over a period of 10 years was premised on the existence of an obligation to pay a principal sum. Here, he noted, no agreement provided for a principal sum to be paid in installments.
