The IRS argued that Charles Leyh should not be allowed a deduction for alimony for amounts he paid for health insurance for his soon to be ex-wife via his employer’s cafeteria plan pursuant to a separation agreement, arguing Charles got an impermissible double benefit since the amount paid for her insurance was not included in his income.[1]  But in a published opinion, the Tax Court disagreed, finding that no impermissible double benefit existed, as his spouse reported that amount as income on her separate return for the year.

The facts of the case are summarized as follows:

In 2012 petitioner filed for divorce from his then wife, Cynthia Leyh (Ms. Leyh), in the Pennsylvania Court of Common Pleas of Westmoreland County. Petitioner and Ms. Leyh filed and signed an agreement in 2014 (2014 agreement) incident to their divorce proceeding in which petitioner agreed to pay Ms. Leyh alimony pendente lite until the final divorce decree was granted. As part of the 2014 agreement, petitioner agreed to pay for Ms. Leyh’s health and vision insurance. In 2015 petitioner paid $10,683 for Ms. Leyh’s health insurance premiums as pretax payroll reductions from his wages through his employer’s “cafeteria plan” (alimony payments). On his 2015 Form 1040, U.S. Individual Income Tax Return, petitioner excluded from his gross income the total amount of health care coverage premiums he and Ms. Leyh received through his employer’s “cafeteria plan” (health insurance compensation) and also claimed an alimony deduction for the alimony payments.[2]

The opinion notes that for the years in question, the couple were still considered married and the amounts were properly excluded from Charles’ income for tax purposes:

Petitioner received the health insurance compensation while Ms. Leyh was still considered his spouse as Pennsylvania law recognizes only divorce, not legal separation, and a final decree of divorce was not granted until 2016. See Argyle v. Commissioner, T.C. Memo. 2009-218, 2009 WL 2972888, at *3, aff’d, 397 F. App’x 823 (3d Cir. 2010). Consequently, there is no dispute that petitioner was entitled under sections 106 and 125 and the regulations thereunder to exclude from his gross income the health insurance compensation, including the portion covering Ms. Leyh’s health insurance coverage.[3]

The IRS also agreed that, aside from the fact he obtained the insurance as a tax free employee benefit, that the payment of insurance qualified as alimony under the agreement.  The IRS argued, though, that allowing Charles to deduct the premium as alimony means he obtains a double deduction for the same payment:

In seeking to uphold the disallowance of petitioner’s alimony deduction, respondent argues that permitting the alimony deduction in this instance creates a “windfall” to petitioner by granting him the practical equivalent of multiple deductions for the same economic outlay.[4]

The Tax Court did not agree with this view, pointing out that his spouse was reporting an identical amount as income:

There is, however, no such risk of a “windfall” to petitioner in allowing him an alimony deduction; doing so simply maintains the Government’s parity and, as provided by the Code, continues to shift the ultimate tax burden of the income item to the recipient. Disallowing the alimony deduction in this circumstance would instead leave petitioner with a greater tax burden (relative to his position if he received the benefit of the deduction or had elected the married filing jointly filing status pending his divorce) that runs counter to the intended purpose and operation of the general alimony regime as previously interpreted by this Court. See, e.g., Emmons v. Commissioner, 36 T.C. 728, 735 (1961) (finding that the purpose behind the alimony provisions is to shift the income tax burden to the recipient), aff’d without published opinion, 311 F.2d 223 (6th Cir. 1962).[5]

The IRS points to a statement by the Senate Finance Committee from 1942 that stated the alimony deduction was created by Congress “to relieve a payor-spouse from the tax burden of whatever part of an alimony payment was “includible in * * * [the payor’s] gross income.” S. Rept. No. 77-1631, at 83 (1942), 1942-2 C.B. 504, 568.”[6]  But the Tax Court found that the plain text of the statute did not provide such a rule, and that the Committee Report could not create such a requirement that was not in the law:

We believe, however, that this legislative history cannot be read to override the plain text of sections 62, 215, and 71 by interpreting these comments as imposing a precondition not present in the statutes themselves. These sections are clear that a payor of alimony may deduct such expenses to the extent they constitute alimony and are includible in the recipient’s gross income. Respondent recognizes that these elements are present in petitioner’s case by conceding that the alimony payments meet the section 71(b) definition of alimony and would otherwise be deductible under sections 62 and 215 but for petitioner’s exclusion of the health insurance compensation from his gross income. If respondent is concerned that petitioner’s situation might create an unanticipated statutory “loophole” (which we do not believe is the case here), it would be up to Congress, not the Commissioner or this Court, to retroactively address. See Alcoma Ass’n, Inc. v. United States, 239 F.2d 365, 367 (5th Cir.  1956) (stating that where the Code explicitly provides for a deduction “the Commissioner cannot cut it down without specific statutory authority”); Hunter v. Commissioner, 46 T.C. 477, 491 (1966) (stating the Tax Court cannot legislate for Congress); Evans v. Dudley, 188 F. Supp. 9, 12 (W.D. Pa. 1960) (noting that courts are not empowered to impose restrictive conditions which are not in the statute), aff’d, 295 F.2d 713 (3d Cir. 1961).[7]

The IRS did have a second argument.  The IRS argued that the deduction was barred under IRC §265(a) as a deduction allocable to tax-exempt income.  The Tax Court agrees that they have applied this rule before in business or investment situations:

We have previously noted that a principal purpose of section 265 is to restrict deductions of expenses incurred in connection with an ongoing trade or business or investment activity, the conduct of which generates exempt income. See Manocchio v. Commissioner, 78 T.C. 989, 994 (1982) (describing the legislative history and purpose of section 265), aff'd, 710 F.2d 1400 (9th Cir. 1983). We have also applied this rule more broadly to embrace situations where, but for a given expense, the receipt of tax-free income “fundamental[ly]” connected to the expense item would not have been possible. Id. at 994-995.[8]

But the Tax Court did not find the provision applicable in this case:

The Court, however, has never applied section 265(a)(1) to disallow an alimony deduction, or, to our knowledge, in any instance where the supposed “exempt” item of income at issue was actually included in gross income by a different taxpayer. Our decisions broadly interpreting section 265(a)(1) have instead generally shared the same basic concern: But for the application of section 265, a taxpayer would have recognized a double tax benefit where one was not otherwise available to him. See, e.g., Induni v. Commissioner, 98 T.C. 618, 623 (1992), aff’d, 990 F.2d 53 (2d Cir. 1993); Rickard v. Commissioner, 88 T.C. 188, 193 (1987); Manocchio v. Commissioner, 78 T.C. at 994-995, 997. Such application is consistent with the text of the statute. As we have explained supra, this threat does not exist here given the special nature of the alimony regime. Furthermore, the alimony payments are not considered allocable to wholly tax-exempt income for section 265 purposes as Ms. Leyh was required to include it in her income. For these reasons, we decline to extend the reach of section 265 to petitioner’s alimony deduction.[9]

[1] Leyh v. Commissioner, 157 TC No. 7, October 4, 2021, https://www.taxnotes.com/research/federal/court-documents/court-opinions-and-orders/alimony-deduction-allowed-for-health-insurance-premium-payments/79hcn (retrieved October 5, 2021)

[2] Leyh v. Commissioner, 157 TC No. 7, October 4, 2021

[3] Leyh v. Commissioner, 157 TC No. 7, October 4, 2021

[4] Leyh v. Commissioner, 157 TC No. 7, October 4, 2021

[5] Leyh v. Commissioner, 157 TC No. 7, October 4, 2021

[6] Leyh v. Commissioner, 157 TC No. 7, October 4, 2021

[7] Leyh v. Commissioner, 157 TC No. 7, October 4, 2021

[8] Leyh v. Commissioner, 157 TC No. 7, October 4, 2021

[9] Leyh v. Commissioner, 157 TC No. 7, October 4, 2021