Where The Magic Paper Saves the Day

While infrequent, Tax Court cases, even small claimers, involving New Jersey divorces furnish good blogfodder. Remember Tim Micek? No? I know, it’s been ten years, so see my blogpost “The Magic Paper Saves the Deduction,” 4/7/11.

Today, we have the magic paper again, but it saves the exclusion for Leah J. Regan, Docket No. 16251-17S, filed 4/13/21, an off-the-bencher from Judge Buch.

Leah and her ex Mike divorced in 2003, and Judge Herr in NJ Chancery awarded Leah $6K per month net of tax. Leah and Mike were supposed to agree upon the amount of a tax reserve to be set up so Leah paid no tax on the $6K.

Except of course they didn’t. So Judge Herr twice amended her order, always referring to the monthly payment to Leah as “net of taxes.” Judge Herr sent the parties the last revised order with a transmittal letter.

“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 nontaxable support for [Ms. Ragan] of $6,279.'” Transcript, at pp. 6-7.

IRS hits Leah for year at issue, apparently because Mike took the Section 215 alimony deduction, and claiming Judge Herr’s allocation of tax doesn’t make Leah’s monthly payments nontaxable. Back to the Section 71(b) foursome that TCJA put on hold through 2026.

“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.” Transcript, at pp. 8-9.

IRS wants to forget about Judge Herr’s letter. Judge Buch won’t let them.

While there’s no magic language to effectuate the not-includible-not-deductible piece of the equation, here the transmittal letter shows “… 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 … 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…order and the transmittal letter.” Transcript, at p. 10.

IRS claims the letter isn’t part of the divorce instrument.

Judge Buch does a quick dictionary chaw. After all, even a small claimer off-the-bencher needs a dictionary chaw.

“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.” Transcript, at p. 12.

Once again, in NJ, when people divorce, the magic paper saves the day.