Determination of what is alimony is known to be a contentious issue in taxes, especially because Congress in 1984 created a full independent federal definition by which payments are tested for classification as tax alimony, regardless of the intent of the parties or what state law may call a payment. In the case of Leslie v. Commissioner, TC Memo 2016-171 the payments involved amount to $5,568,200.
These payments represented 10% of the fee the taxpayer’s former spouse received for his work as an attorney in litigation related to the failure of Enron. There were three payments made, one for $4,000,000 in November of 2008, one for $1,560,000 in December of 2009 and a final payment of $8,200 made in June of 2010.
The Enron litigation was in process as Ms. Leslie was going through her divorce, and the marital separation agreement had a special provision regarding the fee, the amount of which was not knowable at that time. The provision was contained in the portion of the agreement related to the division of property, but was worded as follows:
With respect to any and all fees distributed to Mr. Georgiou as a result of his involvement in the Enron securities litigation through the firms, Mr. Georgiou shall receive ninety percent (90%) as his sole and separate property and Ms. Leslie shall receive ten percent (10%) of all net fees distributed to Mr. Georgiou by the Lerach Coughlin firm or Milberg Weiss firm "the firms". [ sic ] Ms. Leslie's ten percent (10%) interest in the Enron fee is a spousal support award from a contingent liability, the amount of which could not be definitely set at the time of this agreement, since Mr. Georgiou cannot be certain of the amount of fees that he will receive from the Enron litigation. This ten percent (10%) distribution to Ms. Leslie is taxable to Ms. Leslie and deductible to Mr. Georgiou as spousal support.
As well, the 2009 payment did not go directly to Ms. Leslie. Rather, as the Court notes:
The 2009 payment had some twists. Georgiou definitely segregated this money from his distribution, and directly deposited it into an account at California Bank & Trust. That account had both his name and Leslie's on it, but she credibly testified that she had no control over it. She was not given any checks to sign from the account, and her impression of the payment was that it wasn't yet legally hers. In January 2010 she tried to gain control by filing a declaration in support of the "Release of Enron Payments from Trust Account" with the San Diego Superior Court. Georgiou opposed her petition, and the state court at first refused to grant it. It's not clear from the record when or if Leslie ever gained control over the account containing the 2009 payment.
Maria did not treat the payment as alimony, but rather argued that the payment represented a property settlement—after all, it was in the part of the agreement labeled as property settlement.
As the Court summarized her position:
Leslie argues that we should turn to a set of factors under Beard v. Commissioner, 77 T.C. 1275 (1981). Beard requires the Court to examine the facts of these cases under a set of seven subjective factors -- largely the intent of the parties -- to determine if a payment is more in the nature of alimony or in the nature of a property settlement. Id.
The problem, as the Court notes, is that in 1984 Congress changed the law specifically to eliminate this sort of inquiry into the intent of the parties, replacing it with a subjective test. As the Court notes that takes Beard out of consideration, holding “will analyze the treatment of the Enron payments under section 71(b).”
IRC §71(b) imposes a four-part test to determine if a payment is alimony. If all four tests are passed the payment is treated as alimony, while even if one is not satisfied the payment will not treated as alimony.
The four tests are:
- The payment is received by (or on behalf of) a spouse under a divorce or separation instrument,
- The divorce or separation instrument does not designate such payment as a payment which is not includible in gross income under this section and not allowable as a deduction under section 215,
- In the case of an individual legally separated from his spouse under a decree of divorce or of separate maintenance, the payee spouse and the payor spouse are not members of the same household at the time such payment is made, and
- There is no liability to make any such payment for any period after the death of the payee spouse and there is no liability to make any payment (in cash or property) as a substitute for such payments after the death of the payee spouse.
Ms. Leslie’s payments clearly meet the first three tests—it came per the separation agreement, the agreement did not specific it would not be treated as alimony, and they were not members of the same household. Note that the fact the agreement says it shall be taxable to Ms. Leslie is relevant only to the extent it shows the parties did not agree it would not be so treated—but it does not mean it will be alimony.
Rather the last test is the key—would these payments still be required to be paid if Ms. Leslie had died in the interim? The agreement did not provide one way or the other with regard to this issue, so the Court had to look to the application of state laws (in this case California), with the question being whether the payment would still have been required had Ms. Leslie died.
The Court concluded the following in its analysis of the application of California law to this matter:
Under California law, "[e]xcept as otherwise agreed by the parties in writing, the obligation of a party under an order for the support of the other party terminates upon the death of either party or the remarriage of the other party." Cal. Fam. Code sec. 4337 (West 2013). "A written agreement to waive section 4337 'must be specific and express.'" Johanson v. Commissioner, 541 F.3d 973, 977 (9th Cir. 2008) (quoting In re Marriage of Thornton, 115 Cal. Rptr. 2d 380, 383 (Ct. App. 2002)), aff'g T.C. Memo. 2006-105. The parties here have not produced any such agreement. The mere failure to include language terminating support upon death is not enough to constitute a waiver. Id. By operation of California law, then, payments from the Enron settlement would have terminated upon Leslie's death.
The requirement that any liability to make payments terminates upon the death of the payee spouse is central in distinguishing between alimony and [*17] property settlements. See H.R. Rept. No. 98-432 (Part 2), at 1496 (1984), 1984 U.S.C.C.A.N. 697, 1138; Hoover, 102 F.3d at 845-46. Its presence here by operation of state law means the contingent Enron payments were alimony taxable to Leslie.
However, the Court found that Ms. Leslie did not have constructive receipt of the 2009 payment based on the facts in this case. Ms. Leslie testified that she was not even aware of the funds until after the end of 2009, thus they could not be taxable in that year.
The Court notes that it is generally required that a taxpayer have knowledge of the funds in order to have constructive receipt. And even after she finally had that knowledge, she still was denied access to the funds when she tried to have the funds released, something the California court refused to do when she petitioned that court in 2010.
The IRS argued that her ex-spouse was acting as her agent, but the Tax Court did not accept this view:
The Commissioner’s argument that Georgiou acted as Leslie's agent is also faulty. Receipt by an agent is receipt by the principal, Gale v. Commissioner, T.C. Memo. 2002-54, but the Commissioner has provided no evidence, nor does there exist on the record any evidence suggesting that Georgiou had any authority to act as Leslie’s agent. Georgiou’s interest was adverse to Leslie’s: When Leslie tried to get the court to release the 2009 payment to her, he opposed it.