Payments From Ex-Husband Not Includable in Income as Alimony

LEAH J. RAGAN,
Petitioner
v.
Commissioner of Internal Revenue,
Respondent

United States Tax Court
Washington, DC 20217

ORDER

Pursuant to Rule 152(b), Tax Court Rules of Practice and Procedure, it is

ORDERED that the Clerk of the Court shall transmit with this order to petitioner and respondent a copy of the pages of the transcript of the trial in this case before Judge Ronald L. Buch, at the Hartford, Connecticut remote session, containing his oral findings of fact and opinion rendered at the trial session at which the case was heard. In accordance with the oral findings of fact and opinion, decision will be entered for petitioner.

(Signed) Ronald L. Buch
Judge

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Bench Opinion by Judge Ronald L. Buch

March 11, 2021

THE COURT: The following represents the Court's oral findings of fact and opinion. The oral findings of fact and opinion may not be relied upon as precedent in any other case. This opinion is in conformity with Internal Revenue Code section 7459(b) and Rule 152(a) of the Tax Court Rules of Practice and Procedure. Any section references refer to the Internal Revenue Code or the Treasury regulations in effect during the year at issue, and Rule references are to the Tax Court Rules of Practice and Procedure.

This case was heard pursuant to section 7463. Under section 7463(b), the decision to be entered in this case is not reviewable by any other court, and this opinion may not be treated as precedent for any other case.

Ms. Ragan was divorced in 2003 and has been receiving payments from her ex-husband since then. Through a series of documents including a decision, two amended judgments, and a letter explaining the last amended judgment, the judge presiding over the divorce ordered that the payments made to Ms. Ragan be net of taxes until such time as the divorcing parties resolved how much the payments should be increased to take into account the tax liability that would be imposed on those payments. They never reached agreement. Ms. Ragan did not include the payments in her 2014 income. The Commissioner determined that the payments Ms. Ragan received were taxable. She disagrees.

Section 71 generally treats alimony and separate maintenance payments as taxable to the recipient. An exception is if the divorce or separation instrument provides that the amount is not includible in the income of the recipient. A divorce or separation instrument includes not only a decree but also "a written instrument incident to such a decree." Taking into account the written instruments incident to the divorce decree, the payments to Ms. Ragan were designated as not includible in her income.

BACKGROUND

Leah and Michael Ragan married in 1989 and at some point moved to New Jersey. In 2000, the Ragans separated, and that same year Ms. Ragan filed for divorce in the Superior Court of New Jersey. The case was assigned to Judge Marilyn Herr in the Family Part of the Chancery Division.

On May 22, 2003, Judge Herr finalized the Ragans' divorce. In her decision, Judge Herr awarded Ms. Ragan monthly alimony of $6,279. That decision was rendered orally and appears in a transcript that was served on the previously married parties. Before embarking on a discussion of how much the alimony should be, Judge Herr noted, in the future tense, that alimony "would, of course, be taxable" to Ms. Ragan. However, after discussing the factors leading to her determination of the amount of alimony, Judge Herr ordered that Mr. Ragan pay alimony "net of any taxes." She then left it to the parties to "provide the Court with the tax reserve needed . . . so that [Ms. Ragan's] gross alimony can be calculated accordingly." Judge Herr required the parties to agree on the deductions that each party would take, determine the gross payments needed to reach the net alimony amount she had awarded, and report the tax reserve needed to calculate the gross alimony. But the parties could not reach an agreement, which led Judge Herr to issue several orders amending her original judgment.

The first amendment was entered on June 26, 2003. In it, Judge Herr again referred to the then-current payment to Ms. Ragan as being "net of any taxes" and again urged the parties to reach agreement on the tax reserve so that the gross alimony could be calculated. But that same document again stated that alimony would be taxable to Ms. Ragan. In context, that statement again appears to be referring to the ultimate determination of the alimony after the tax reserve was added to compute the gross alimony.

On September 26, 2003, Judge Herr further amended her judgment through an order issued to enforce Ms. Ragan's rights under the previous decision as amended. In that order, Judge Herr ordered Mr. Ragan to pay the delinquent amount of unallocated alimony, split the total monthly amount of $6,279 into two installments, and changed the enforcement procedures such that two missed payments would result in the issuance of a bench warrant for Mr. Ragan. Notably, Judge Herr, in her own handwritten alteration to the order, referred to the payment to be made to Ms. Ragan as "monthly unallocated support" as distinguished from her prior references to alimony.

Judge Herr further clarified her intent with respect to her September 26, 2003 order by transmitting it with a cover letter that explicitly reference "the enclosed order." In that letter, Judge Herr explained how the modifications she made in her order affected the decision she had previously rendered. Concerning the tax consequences, she noted that she "anticipated that counsel would be able to calculate the income taxes [Ms. Ragan] would pay on this unallocated support and her imputed income and be able to supply that 'taxable' alimony figure." She then explained that "[s]ince you have not calculated the amount [Ms. Ragan] needs to receive as alimony to net $6,279 per month * * * I am simply advising Probation to continue to collect the unallocated non-taxable support for [Ms. Ragan] of $6,279."

Since then, Ms. Ragan has consistently treated the payments as nontaxable support and attempted to resolve the tax reserve amount with her ex-husband. From 2006 to 2016, Ms. Ragan repeatedly contacted Mr. Ragan, both directly and through her lawyer, in attempts to reach agreement as to the tax figure necessary to establish a reserve, per the instructions of Judge Herr. In the early years after her divorce, Ms. Ragan corresponded with Mr. Ragan through their respective counsel reiterating the need to provide the information necessary to establish a tax reserve. Over time, Ms. Ragan began emailing Mr. Ragan directly in an effort to resolve the matter. The parties never reached agreement.

Ms. Ragan filed her 2014 Form 1040, U.S. Individual Income Tax Return, omitting from her income the payments she received pursuant to her divorce instrument. It is Ms. Ragan's understanding that, in that same year, Mr. Ragan deducted his payments to Ms. Ragan as alimony paid.

The Commissioner issued a notice of deficiency to Ms. Ragan, adding the payments she received from Mr. Ragan to her income and determining a corresponding accuracy related penalty. (Since then, the Commissioner has conceded the penalty.)

Ms. Ragan timely filed a petition challenging the Commissioner's determinations. She contends that the payments were nontaxable support pursuant to the terms of the divorce instrument. The Commissioner argues that the payments qualify as alimony under section 71(b), and thus are includable in Ms. Ragan's gross income pursuant to section 71(a).

DISCUSSION

During the year at issue, section 71(a) provided that gross income includes alimony or separate maintenance payments. There are four elements that must be met for payments to fit the definition of alimony or separate maintenance payments as defined in section 71(b)(1). The payments must be received by a spouse under a divorce or separation instrument; that instrument must not designate the payment as not includible in gross income and not allowable as a deduction under section 215; the payee spouse and the payor spouse must not be members of the same household; and the liability to make the payments must terminate after the death of the payee spouse.

There is no dispute as to three of those elements. The Commissioner and Ms. Ragan, however, disagree as to whether the divorce instrument designates the payment as not includible in the gross income of Ms. Ragan.

There is no specific language required to designate a payment made pursuant to a divorce instrument as not includible in gross income. In Estate of Goldman v. Commissioner, 112 T.C. 317, 323 (1999), aff'd without published opinion sub nom. Schutter v. Commissioner, 242 F.3d 390 (10th Cir. 2000), we explained that "we believe the divorce or separation instrument need not mimic the statutory language of the subparagraph (e.g., the instrument need not specifically refer to sections 71 and 215). Rather, in our opinion, the divorce or separation instrument contains a nonalimony designation if the substance of such a designation is reflected in the instrument."

The mere obligation of the payor to bear the ultimate tax cost is not sufficient to classify a payment as being other than alimony or separate maintenance. In Jaffe v. Commissioner, T.C. Memo., 1999-196, 77 T.C.M. 2167 (1999), the divorce instrument stated that the payor "shall be responsible for income taxes due." We held that this language was not sufficient to constitute a designation as nontaxable to the payee under section 71(b)(1)(B). That language merely required the payor be responsible for the taxes (which could, for example, be accomplished through a gross-up) and did not address the payee's excluding the payment from income.

Here, Judge Herr intended for the $6,279 support payments to be net of taxes to Ms. Ragan and excluded from her income. She initially intended to accomplish this by requiring the parties to calculate the amount of a tax reserve, which would have enabled the court to establish a gross alimony amount. When the parties failed to reach agreement as to that tax reserve, Judge Herr altered her initial decision in a September 26, 2003, order. In that order, she specified that the support payments would remain at the net amount. In the cover letter accompanying that order, she explained that because the parties could not agree on the tax issues, the support payments were to be treated as nontaxable. Judge Herr even changed her terminology, referring to the monthly payments as "support" in both the September 26, 2003 order and the transmittal letter.

The language in Ms. Ragan's divorce instrument substantively differs from the contested instrument at issue in Jaffe. The language in the Jaffe instrument delegated the ultimate burden of paying the taxes, using language similar to that found in an indemnification clause. In contrast, Judge Herr designated the tax treatment of the support payments, explicitly referring to them as nontaxable.

The Commissioner argues that we should read Judge Herr's September 26, 2003, order strictly and disregard the attached explanatory transmittal letter. We disagree. The Commissioner's argument is premised on the notion that the cover letter falls outside of the definition of a divorce instrument.

What constitutes a divorce or separation instrument is set forth in section 71(b)(2). A divorce or separation instrument includes a decree of divorce or separate maintenance or a written instrument incident to such a decree, a written separation agreement, or any other decree requiring a spouse to make payments for the support or maintenance of the other spouse. The question before us is whether Judge Herr's transmittal letter constitutes a written instrument incident to a decree.

The Commissioner posits that we should look no further than the judgement of divorce and the amended judgments of divorce. To do so would require that we disregard the clause "written instrument incident to such a decree." That clause requires that we take into account any instrument that supplements a decree. And the term "instrument" is broader than how the Commissioner would have us define it. Black's Law Dictionary defines a written instrument as "[a] written legal document that defines rights, duties, entitlements, or liabilities." It goes on to cite Edward Beal's Cardinal Rules of Legal Interpretation, for the proposition that "[a]n 'instrument' seems to embrace * * * any written or printed document that may have to be interpreted by the Courts." We are confident that Judge Herr would consider her letter transmitting and explaining her order as a written legal document that defines rights and liabilities. So do we. A letter transmitting an accompanying order written by the same judge who wrote the order that explains the rights and obligations of the parties who are subject to that order fits neatly within the definition of a written instrument incident to a decree.

CONCLUSION

The payments received by Ms. Ragan were classified by the judge in the written instruments incident to the divorce decree as nontaxable. Thus, the payments fall outside of the section 71(b)(1) definition of alimony and are not subject to inclusion in Ms. Ragan's gross income.

Decision will be entered for Ms. Ragan.

(Whereupon, at 10:13 a.m., the above-entitled matter was concluded.)