Means the start of the tax

Sharon F. Schilling finds herself without the help and support of three of her five children to avoid taxation on her alimony in T. C. Memo. 2012-256, filed 9/5/12, Judge Swift delivering the bad news.

This is yet another in a series I’ve posted on taxable alimony, but the first as to the recipient’s tax liability.

For the payor’s tax posture, see my blogposts: “Oh Death, Where Is Thy Sting?”, 7/2/12; “Same Again?”, 8/11/11; “Essmiss Essmoore, Esmiss Essmore”, 8/16/11; and “The Magic Paper Saves the Deduction”, 4/7/11.

Sharon split with husband (unnamed), 24 years and five children after they promised to love, honor, cherish and all that jazz. Their separation agreement carefully crafted reductions in alimony as each of the five offspring reached the age of 18 years. But the alimony entirely terminates on a date certain six years after it commenced.

Three of the five had so aged out as the year at issue (three years before the automatic termination) progressed.

The general rule, of course, is that alimony is taxable to the recipient unless it is either expressly designated as child support, or doesn’t terminate with recipient’s death (either explicitly or by operation of State law). While the agreement didn’t speak of termination at death, a critical feature in deductible alimony, relevant State law (Ohio) so provided.

Since no child aged out during the year at issue, IRS credited Sharon with whatever per-child amount was left for the remaining two kids who had not aged out, and declared the rest to be taxable.

Sharon first claimed the pre-1986 law controlled, relying on the lack of an express statement in the agreement (the divorce decree incorporated the agreement) that payment terminated at death, but the 1986 amendment to Section 71, putting State law into play, rendered that a non-starter.

Then she claimed that the automatic six-year termination was a reduction in alimony related to a child or a contingency referable to a child (see Section 71(c)(2)), thereby rendering the entire payment non-taxable to Sharon for the remaining years, including, but without in any way limiting the generality thereof (as the high-priced lawyers say), the year at issue.

Nope, says Judge Swift.

While Reg. 1.71-1T Q&A 18 seems to give Sharon some comfort, the favorable presumptions raised therein are conclusively rebutted by an automatic termination after six-years provision. The termination does not relate to a child, even though child C does turn 21 within 6 months of the termination date, because the termination is automatic. And child C aged out already, so there would need to be a child D to help out.

But there is no child D whose 18th birthday is within 6 months of the automatic termination date (poor timing, Sharon; but you can blame that on your ex). So termination is not clearly connected to a child or a contingency related to a child. Once all the child-related reductions are off the table, whatever’s left is taxable.

Of course, as the remaining two children age out (if they age out before the six-year cutoff), that’s another story, but those years aren’t in issue.

Moreover, “(B)ecause neither the separation agreement, the divorce decree, nor the shared parenting plan specifically designated any portion of the spousal support payments for the support of the children, the entire amount of such payments is includible in petitioner’s income as alimony….” T. C. Memo. 2012-256, at p. 12.

Apparently IRS didn’t seek penalties, because none are discussed in Judge Swift’s decision.