In a bench opinion issued in the case of Ragan v. Commissioner, Case No. 16251-17S[1] the Tax Court looked at an issue still relevant for pre-2019 divorces—whether amounts paid to Leah Ragan had to be included in her income as alimony.

The divorce in this case was finalized long before the Tax Cuts and Jobs Act (TCJA) eliminated both the deduction for alimony paid and taxation of alimony received. The divorce took place in 2003. The dispute arises over payments that Ms. Ragan is receiving from her former spouse. As the Court summarized the issue:

Ms. Ragan was divorced in 2003 and has been receiving payments from her ex-husband since then. Through a series of documents including a decision, two amended judgments, and a letter explaining the last amended judgment, the judge presiding over the divorce ordered that the payments made to Ms. Ragan be net of taxes until such time as the divorcing parties resolved how much the payments should be increased to take into account the tax liability that would be imposed on those payments. They never reached agreement. Ms. Ragan did not include the payments in her 2014 income. The Commissioner determined that the payments Ms. Ragan received were taxable. She disagrees.[2]

For divorce agreements governed by pre-TCJA provisions, the federal definition of alimony controls the tax treatment. Note that this definition does not depend on what label the state might apply to the payments in question[3]. The opinion summarizes the rule as follows:

There are four elements that must be met for payments to fit the definition of alimony or separate maintenance payments as defined in section 71(b)(1). 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.[4]

In this case, the question was whether Ms. Ragan had a divorce instrument that designates the payment as not includable in her gross income. The IRS and the taxpayer agreed that the other tests would have the payments treated as taxable alimony to Ms. Ragan.

The payments in question proved to be more of a problem to finally resolve between the former spouses than had been expected. The opinion describes the payments as follows:

On May 22, 2003, Judge Herr finalized the Ragans’ divorce. In her decision, Judge Herr awarded Ms. Ragan monthly alimony of $6,279. That decision was rendered orally and appears in a transcript that was served on the previously married parties. Before embarking on a discussion of how much the alimony should be, Judge Herr noted, in the future tense, that alimony “would, of course, be taxable” to Ms. Ragan. However, after discussing the factors leading to her determination of the amount of alimony, Judge Herr ordered that Mr. Ragan pay alimony “net of any taxes.” She then left it to the parties to “provide the Court with the tax reserve needed . . . so that [Ms. Ragan’s] gross alimony can be calculated accordingly.” Judge Herr required the parties to agree on the deductions that each party would take, determine the gross payments needed to reach the net alimony amount she had awarded, and report the tax reserve needed to calculate the gross alimony. But the parties could not reach an agreement, which led Judge Herr to issue several orders amending her original judgment.[5]

The parties clearly intended for the final payments to be treated as taxable alimony by Ms. Ragan, but until a final number was resolved the payments were “net of tax.” But that agreement upon a final number proved elusive, resulting in the Judge amending the agreement first in June, then made the final adjustment in September. This last set of documents is what the Court is scrutinizing to see if they designate the payments as not taxable to Ms. Ragan:

On September 26, 2003, Judge Herr further amended her judgment through an order issued to enforce Ms. Ragan’s rights under the previous decision as amended. In that order, Judge Herr ordered Mr. Ragan to pay the delinquent amount of unallocated alimony, split the total monthly amount of $6,279 into two installments, and changed the enforcement procedures such that two missed payments would result in the issuance of a bench warrant for Mr. Ragan. Notably, Judge Herr, in her own handwritten alteration to the order, referred to the payment to be made to Ms. Ragan as “monthly unallocated support” as distinguished from her prior references to alimony.

Judge Herr further clarified her intent with respect to her September 26, 2003 order by transmitting it with a cover letter that explicitly reference “the enclosed order.” 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 non-taxable support for [Ms. Ragan] of $6,279.”[6]

While Ms. Ragan continued to try and get her ex-spouse to agree to an amount for the gross alimony, the parties never agreed to that amount.

The IRS argued that this situation was similar to the one found in the 1999 case of Jaffe v. Commissioner, TC Memo 1999-196:

The mere obligation of the payor to bear the ultimate tax cost is not sufficient to classify a payment as being other than alimony or separate maintenance. In Jaffe v. Commissioner, T.C. Memo., 1999-196, 77 T.C.M. 2167 (1999), the divorce instrument stated that the payor “shall be responsible for income taxes due.” We held that this language was not sufficient to constitute a designation as nontaxable to the payee under section 71(b)(1)(B). That language merely required the payor be responsible for the taxes (which could, for example, be accomplished through a gross-up) and did not address the payee’s excluding the payment from income.[7]

But the Court found that Ms. Ragan’s case was different enough from that in Jaffe to change the result:

Here, 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 September 26, 2003, 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 September 26, 2003 order and the transmittal letter.

The language in Ms. Ragan’s divorce instrument substantively differs from the contested instrument at issue in Jaffe. The language in the Jaffe instrument delegated the ultimate burden of paying the taxes, using language similar to that found in an indemnification clause. In contrast, Judge Herr designated the tax treatment of the support payments, explicitly referring to them as nontaxable.[8]

The IRS argued that only the Judge’s September 23, 2003 order should be consulted to determine the tax status, ignoring the cover letter. But the Tax Court didn’t accept that view:

The Commissioner posits that we should look no further than the judgement of divorce and the amended judgments of divorce. 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.[9]

Thus, the bench order concludes:

The payments received by Ms. Ragan were classified by the judge in the written instruments incident to the divorce decree as nontaxable. Thus, the payments fall outside of the section 71(b)(1) definition of alimony and are not subject to inclusion in Ms. Ragan's gross income.[10]

[1] Ragan v. Commissioner, Case No. No. 16251-17S, March 11, 2021, https://www.taxnotes.com/research/federal/court-documents/court-opinions-and-orders/payments-from-ex-husband-not-includable-in-income-as-alimony/4v97y?h=Ragan (retrieved April 15, 2021)

[2] Ragan v. Commissioner, Case No. No. 16251-17S, March 11, 2021

[3] Ragan v. Commissioner, Case No. No. 16251-17S, March 11, 2021

[4] Ragan v. Commissioner, Case No. No. 16251-17S, March 11, 2021

[5] Ragan v. Commissioner, Case No. No. 16251-17S, March 11, 2021

[6] Ragan v. Commissioner, Case No. No. 16251-17S, March 11, 2021

[7] Ragan v. Commissioner, Case No. No. 16251-17S, March 11, 2021

[8] Ragan v. Commissioner, Case No. No. 16251-17S, March 11, 2021

[9] Ragan v. Commissioner, Case No. No. 16251-17S, March 11, 2021

[10] Ragan v. Commissioner, Case No. No. 16251-17S, March 11, 2021