A taxpayer, who was required under a 2014 settlement agreement incident to divorce proceedings to pay health insurance premiums for his wife during the period before their divorce was final, was allowed to exclude the premiums (which were paid by his employer through a cafeteria plan) from gross income and also take an alimony deduction for the amount of the premiums paid.
Background
In 2012, Charles Leyh, filed for divorce from his then wife, Cynthia. The couple filed and signed an agreement in 2014 incident to their divorce proceeding in which Charles agreed to pay Cynthia alimony pendente lite until the final divorce decree was granted. As part of the 2014 agreement, Charles agreed to pay for Cynthia's health and vision insurance in 2015, and during 2015 he paid $10,683 for Cynthia's health insurance premiums pretax through his employer's "cafeteria plan."
On his 2015 Form 1040, U.S. Individual Income Tax Return, he excluded from his gross income the total amount of health insurance premiums paid through his employer's cafeteria plan. Because he was required under the 2014 agreement to provide health insurance to Cynthia prior to a final divorce decree being granted, he also claimed an alimony deduction for the amount of the premiums his employer paid for Cynthia's health insurance.
On examining Charles's return, the IRS took exception to the alimony deduction for the health insurance premiums paid, finding that it constituted an impermissible double deduction because Charles also excluded the health care premiums from gross income. The IRS therefore issued a notice of deficiency disallowing Charles's deduction for the alimony payments and imposed an accuracy-related penalty. Charles filed a petition in Tax Court challenging the IRS's determination.
The Tax Court's decision
The Tax Court held that Charles could take an alimony deduction for the amount of the health insurance premiums paid for Cynthia through his employer's cafeteria plan before he and she were granted a final divorce decree. Due to nature of the alimony deduction under Sec. 215, the court concluded that taking the deduction did not give rise to an impermissible multiple-deduction scenario.
If a taxpayer pays alimony under Sec. 71(b) pursuant to a divorce or separation agreement executed or modified before 2019, under Sec. 215 the taxpayer may take a deduction for the alimony paid if it is includible in gross income of the alimony recipient under Sec. 71. However, as the Tax Court noted, the Sec. 215 alimony deduction differs from most other personal deductions in that it is a method of designating which taxpayer must include an amount in income, instead of being a tax allowance for an expenditure. In the case of an alimony deduction, the tax consequences of the payer and the alimony recipient are taken into account in determining whether the payer is eligible for the deduction. The Tax Court stated that this point was crucial because, under the facts in Charles's case, only by comparing the overall net tax effect on both the alimony payer and the recipient before a pending divorce could it be shown that the double-deduction scenario claimed by the IRS did not exist.
As a married couple with a final divorce decree pending under state law, the Tax Court explained, Charles and Cynthia could have file married filing jointly for 2015 and avoided the alimony regime. If they had, the couple would have excluded health insurance coverage premiums from gross income, taken no alimony deduction for the premiums paid, and had no alimony income inclusion for them. However, they instead filed married filing separately and treated the health insurance coverage premiums as alimony. But for the alimony regime, Cynthia would not have been required to include any portion of the alimony payments in her gross income, so the Tax Court reasoned that, per the general matching design of the alimony regime, if Cynthia was required to include the alimony payments in her income, then Charles "should be permitted a corresponding deduction for those payments to preserve this equilibrium. In other words, [Charles's] alimony deduction should be properly viewed as being matched against [Cynthia's] alimony income, not against his excluded wage income."
The IRS also argued that if Charles were allowed to take an alimony deduction, he would receive a windfall in the form of multiple deductions for the same economic outlay. The court, however, stated that it had previously determined that the intended purpose of the general alimony regime was to shift the income tax burden of alimony to the recipient, and disallowing Charles's alimony deduction in this circumstance would instead leave him with a greater tax burden, which would be counter to this purpose.
The IRS further maintained that a statement from the Senate Finance Committee regarding the alimony deduction supported its position. In that statement, the committee described the creation of the alimony deduction as an attempt by Congress to relieve a payer-spouse from the tax burden of whatever part of an alimony payment was "includible in . . . [the payer's] gross income" (S. Rep't No. 77-1631 at 83 (1942), 1942-2 C.B. 504, 568). The Tax Court did not agree, finding it could not read this statement from the legislative history as overriding the plain text of Secs. 62, 215, and 71 by interpreting it to impose a precondition not present in those statutes.
The Tax Court, in addition, pointed out that the IRS had failed to cite any case in which an alimony deduction had been disallowed on the basis of the common law double-deduction principle. The court stated that the application of this doctrine has been limited to instances in which a taxpayer has attempted to claim the practical equivalent of multiple deductions for the same expense but where Congress did not specifically intend such a result. However, under Charles's circumstances, the court found that he undisputedly was entitled to both the exclusion from income for the health insurance premiums paid by his employer and the alimony deduction. Thus, the court concluded that "[b]y asking us to disallow the alimony deduction where the Code plainly permits petitioner this right, [the IRS] attempts to disrupt the uniformity of the general alimony regime to the net advantage of the [IRS] under the guise of the double deduction rules when no such threat is present."
Finally, the IRS argued that Sec. 265(a) generally provides that an amount may not be deducted if it is allocable to wholly tax-exempt income (other than interest). The regulations define tax-exempt income for this purpose as any class of income wholly excluded from gross income under Subtitle A of the Code or under any other provision of law.
The Tax Court, citing Manocchio, 78 T.C. 989 (1982), explained that the cases where it had held that Sec. 265(a)(1) applied generally shared the same basic concern: But for the application of Sec. 265, a taxpayer would have recognized a double tax benefit where one was not otherwise available to him. Because the chance for a double deduction did not exist for Charles given the special nature of the alimony regime, and the alimony payments were not allocable to tax-exempt income since Cynthia was required to include them in her income, the court declined to apply Sec. 265 to disallow Charles's alimony deduction for the health insurance premiums he paid on her behalf.
Reflections
The law known as the Tax Cuts and Jobs Act, P.L. 115-97, changed the alimony regime, effective for alimony agreements executed after Dec. 1, 2018, so that now the payer-spouse does not receive a deduction and the recipient-spouse does not include the alimony in income. Presumably, under the new regime and the Tax Court's reasoning, Cynthia would not be required to include in her gross income as alimony the health insurance premiums paid on her behalf and Charles would be allowed to exclude those premium payments from income but would not be able to take an alimony deduction for them.
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