Kean v. Commissioner IRS

Opinions of the United
2005 Decisions States Court of Appeals
for the Third Circuit
5-10-2005
Kean v. Commissioner IRS
Precedential or Non-Precedential: Precedential
Docket No. 04-2931
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PRECEDENTIAL
UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
___________
NOS. 04-2931 & 04-3018
___________
PATRICIA P. KEAN
Appellant
v.
COMMISSIONER OF INTERNAL REVENUE
Appellee
___________
ROBERT W. KEAN, III
Appellee
v.
COMMISSIONER OF INTERNAL REVENUE
Appellant
___________
Consolidated Appeals from Decisions of the United States
Tax Court
(Docket Nos. 8966-00 & 9144-00)
Tax Court Judge: Honorable Arthur L. Nims, III
___________
Argued March 8, 2005
BEFORE: SCIRICA, Chief Judge, and ROTH and VAN
ANTWERPEN, Circuit Judges
(Filed May 10, 2005)
___________
OPINION
___________
Alan R. Adler (Argued)
10 North Park Place
Suite 320
Morristown, NJ 07960
Counsel for Appellant Patricia P. Kean
Bethany B. Hauser (Argued)
David I. Pincus
Teresa E. McLaughlin
United States Department of Justice
Tax Division
P.O. Box 502
Washington, DC 20044
Counsel for Appellee/Appellant
Commissioner of Internal Revenue
2
Jeffrey M. Garrod (Argued)
Orloff, Lowenbach, Stifelman & Siegel
101 Eisenhower Parkway
Roseland, NJ 07068-1082
Counsel for Appellee Robert W. Kean, III
VAN ANTWERPEN, Circuit Judge
These consolidated tax appeals arise from the
Commissioner of Internal Revenue’s tax treatment of
payments made by Robert Kean, pursuant to a series of
support orders issued pendente lite during a divorce
proceeding. The recipient of those payments, Patricia Kean,
argues that the Commissioner and Tax Court erred in
concluding that those payments were “alimony or separate
maintenance payments” (hereinafter “alimony”) as defined by
I.R.C. § 71(b).
I. FACTUAL AND PROCEDURAL HISTORY
Patricia P. Kean (Ms. Kean) and Robert W. Kean, III
(Mr. Kean) were married on September 12, 1970 and have
three children. In October 1991, Ms. Kean brought an action
for divorce from Mr. Kean in the Superior Court of New
Jersey, Chancery Division-Family Part, Somerset County. On
April 7, 1992, while the action was pending, Judge Graham T.
Ross, J.S.C., P.J.F.P., issued an order (the “April 7, 1992
Order”) which required Mr. Kean to deposit $6,000 each
month into a joint checking account maintained by Mr. and
Ms. Kean. Ms. Kean was instructed to use the funds from the
3
joint checking account to maintain herself, the children and
the household. The court also required Mr. Kean to pay all
household expenses, including the mortgage, taxes and
utilities; pay all expenses for the children, including private
school tuition; and maintain health insurance coverage and
pay all unreimbursed medical expenses for Ms. Kean and the
children.
On November 25, 1992, the court issued an order
denying the parties’ separate applications for physical custody
of the children and required them to continue with the existing
custodial arrangement. The order also instructed the parties to
share equally in the legal authority and responsibility for
major decisions concerning the children.
On March 5, 1993, the court stated that Ms. Kean had
exclusive use of the $6,000 deposited in the joint checking
account for the support of herself, the children, and the
household (the “March 5, 1993 Order”). On April 23, 1993,
the court further explained that the monthly $6,000 was to be
used to pay for all shelter, transportation, and personal
expenses of Ms. Kean and the children. On January 30, 1995,
the court ordered Mr. Kean to make all future payments to
Ms. Kean through the applicable probation department (the
“January 30, 1995 Order”).
On January 9, 1996, the court issued an order which
continued the Kean’s joint legal custody of the children and
specified how physical custody of the children should be
shared. On April 11, 1996, the court reduced Mr. Kean’s
pendente lite support obligation from $6,000 to $1,600 and
4
required him to pay all of the household bills and expenses of
the children. The court issued a Final Judgment of Divorce
on February 19, 1997.
Pursuant to the applicable court orders, Mr. Kean paid
Ms. Kean $54,000 for the taxable year 1992, $57,388 for the
taxable year 1993, and $71,500 for the taxable year 1994.
From January 1 through February 10, 1995, Mr. Kean
paid Ms. Kean $9,000 pursuant to the applicable court orders.
From March 6 through December 7, 1995, Mr. Kean
continued his obligation by paying Ms. Kean $61,200 through
the Somerset County Probation Department as required by the
January 30, 1995 Order. Ms. Kean reported no alimony
income on her 1995 U.S. Individual Income Tax Return. Mr.
Kean claimed a $72,000 deduction for alimony paid on his
1995 U.S. Individual Income Tax Return.
For the taxable year 1996, Mr. Kean paid Ms. Kean
$32,400 pursuant to the applicable court orders, through the
Somerset County Probation Department. Ms. Kean reported
$14,400 in alimony income on her 1996 U.S. Individual
Income Tax Return. Mr. Kean claimed a $37,715 deduction
for alimony paid on his 1996 U.S. Individual Income Tax
Return.
On May 26, 2000, the Commissioner of Internal
Revenue (the “Commissioner”) issued a notice of deficiency
to Ms. Kean asserting deficiencies in federal income tax of
$14,229 for 1992, $17,419 for 1993, $20,116 for 1994,
$18,390 for 1995, and $4,393 for 1996. The Commissioner
5
also assessed additions to tax under I.R.C. § 6651(a)(1) for
failure to timely file returns for 1992 and 1994. Id. On
August 22, 2000, Ms. Kean timely petitioned the Tax Court
for a redetermination of the deficiencies and additions to tax.
On May 26, 2000, the Commissioner also sent a notice
of deficiency to Mr. Kean, asserting deficiencies in federal
income tax of $27,584 for 1995 and $16,781 for 1996. Mr.
Kean also petitioned the Tax Court for a redetermination of
the deficiencies.
On June 4, 2003, the Tax Court issued an opinion
addressing both of the Keans’ cases in which it concluded that
the payments made by Mr. Kean to Ms. Kean met the
definition of “alimony” as detailed in I.R.C. § 71(b). On
April 16, 2004, the Tax Court declared Ms. Kean deficient in
income tax due for the taxable years 1992, 1993, 1994, 1995,
and 1996 in the amounts of $14,229, $16,490, $19,936,
$17,821 and $4,393, respectively. The Tax Court also found
additions to tax due for the taxable years 1992 and 1994 in the
amount of $3,557 and $4,984, respectively. On the same day,
the tax court issued a decision declaring Mr. Kean deficient in
income tax due for the taxable years 1995 and 1996 in the
amounts of $585 and $1,382, respectively.
Ms. Kean timely appealed the decision in her case to
this Court on July 6, 2004 and the Commissioner timely
appealed the decision in Mr. Kean’s case to this Court on July
14, 2004. The sole issue for us to decide is whether the
pendente lite support payments should be considered
“alimony or separate maintenance payments” for federal
6
taxation purposes.
II. JURISDICTION AND STANDARD OF REVIEW
The Tax Court had jurisdiction over the petitions of
Mr. Kean and Ms. Kean pursuant to I.R.C. §§ 6213(a), 6214
and 7442. This Court has jurisdiction over appeals from
decisions of the Tax Court pursuant to 26 U.S.C. §
7482(a)(1), and we exercise plenary review over the legal
conclusion of the Tax Court, Lazore v. Commissioner, 11
F.3d 1180, 1182 (3d Cir. 1993).
We note at the outset that although the Commissioner
argues strenuously against Ms. Kean’s position, he took an
inconsistent stance with respect to Mr. Kean’s case. This is a
permissible practice to protect the public fisc and prevent the
“whipsaw” effect of a decision in Ms. Kean’s favor. Gerardo
v. Commissioner, 552 F.2d 549, 555 (3d Cir. 1977). Mr.
Kean does not dispute the relatively minimal deficiencies
assessed to him by the Tax Court.
III. ANALYSIS
An individual may deduct from his or her taxable
income the payments he or she made during a taxable year if
those payments are for alimony or separate maintenance.
I.R.C. § 215(a). Consequently, the recipient of alimony
payments must include those payments when calculating his
or her gross income. I.R.C. 61(a)(8). Therefore, a
determination that a payment is or is not “alimony,” is also a
determination of who must shoulder the tax burden of that
7
payment.
Alimony is defined in section 71(b) of the Internal
Revenue Code.1 This section was originally enacted to
provide a uniform definition of alimony so that alimony
payments could be distinguished from property settlements
1
I.R.C. § 71(b)(1) states:
(b) Alimony or separate maintenance payments defined. For
purposes of this section--
(1) In general. The term “alimony or separate
maintenance payment” means any payment in cash if--
(A) such payment is received by (or on behalf of)
a spouse under a divorce or separation instrument,
(B) the divorce or separation instrument does not
designate such payment as a payment which is not
includible in gross income under this section and
not allowable as a deduction under section 215,
(C) in the case of an individual legally separated
from his spouse under a decree of divorce or of
separate maintenance, the payee spouse and the
payor spouse are not members of the same
household at the time such payment is made, and
(D) there is no liability to make any such payment
for any period after the death of the payee spouse
and there is no liability to make any payment (in
cash or property) as a substitute for such
payments after the death of the payee spouse.
8
which receive different tax treatment. H.R. Rep. No.
98-432(II), at 1495 (1984), reprinted in 1984 U.S.C.C.A.N.
697, 1137. As the Sixth Circuit explained in Hoover v.
Commissioner, 102 F.3d 842, 845 (6th Cir. 1996), “Congress
specifically intended to eliminate the subjective inquiries into
intent and the nature of payments that had plagued the courts
in favor of a simpler, more objective test.”
This objective test was necessary because state courts
sometimes used the term “alimony” indiscriminately. For
instance, in Hoover, an Ohio court awarded Mrs. Hoover
“alimony as division of equity in the amount of $410,000,”
(which was later increased to $521,640). Id. at 844. The state
court ordered Mr. Hoover to pay Mrs. Hoover $3,000 per
month until the amount was paid in full, and granted Mrs.
Hoover a lien on some of Mr. Hoover’s shares as security for
the alimony. Id. Even though the state court used the term
“alimony,” the Sixth Circuit found that the payments were
actually part of a property settlement and therefore Mr.
Hoover was not permitted to claim a deduction for alimony
payments under I.R.C. § 215. Id. at 847-48.
Under section 71(b)(1), a payment or payments can
only be considered “alimony” when: (A) the payment is
received by (or on behalf of) a spouse under a divorce or
separation instrument; (B) the instrument does not designate
the tax treatment of the payments; (C) the parties are not
members of the same household if legally separated by a
divorce or separate maintenance decree; and (D) the payor
spouse is not liable to continue making the payments after the
death of the payee spouse, nor must the payor spouse make a
9
substitute payment. I.R.C. § 71(b)(1)(A)-(D).
The parties in this case agree that the payments in
question meet the requirements of section 71(b)(1)(B), and
that section 71(b)(1)(C) is not applicable because Mr. and Ms.
Kean were not legally separated under a decree of divorce or
separate maintenance. The dispute is whether the payments
meet the requirements of sections 71(b)(1)(A) and (D).
A. The Payments Were Received by Ms. Kean
Under section 71(b)(1)(A), a payment will only be
considered alimony when “such payment is received by (or on
behalf of) a spouse under a divorce or separation agreement.”
I.R.C. § 71(b)(1)(A). According to Ms. Keen, the payments
in question were not “received” because, (1) the payments
were deposited into a joint checking account (shared by Mr.
Kean), and (2) the court placed certain conditions on the use
of the funds in the account. We find these arguments
unpersuasive.
First, Ms. Kean had unfettered access to the funds.
The divorce court required Mr. Kean to deposit $6,000 each
month into the account and allowed Ms. Kean “unlimited
access to the parties’ joint checking account and checkbook to
maintain herself, the children and the household.” (Appellant
App. at A-57). If there was any doubt as to who controlled
the money, the divorce court settled that matter in the March
5, 1993 Order which stated that Ms. Kean was to have
10
exclusive use of the payments..2
Ms. Kean’s alternate argument is without merit in light
of the Supreme Court’s opinion in Commissioner v. Lester,
366 U.S. 299, 303-04 (1961)(overruled by I.R.C. § 71(c)(2))
which remains persuasive even though the ultimate holding
was overruled by statute, Preston v. Commissioner, 209 F.3d
1281, 1284 (11th Cir. 2000). In Lester, the Court examined a
statute that preceded section 71 and explained that slight
restrictions on the use of payments should not color a court’s
overall analysis of the nature of the payments. Lester, 366
U.S. at 304. “Under the type of agreement here, the wife is
free to spend the monies paid under the agreement as she sees
fit. ‘The power to dispose of income is the equivalent of
ownership of it.’” Id. (quoting Helvering v. Horst, 311 U.S.
112, 118 (1940)). Although the divorce court offered broad
guidance as to how the money was to be spent, Ms. Kean’s
use of the money was sufficiently unrestricted. Because Ms.
Kean’s access and control of the money was unfettered, we
have no trouble concluding that she “received” the funds as
required by section 71(b)(1)(A).
B. Mr. Kean had No Liability to Make Payments Upon the
Death of Ms. Kean
2
If Mr. Kean had interfered with some of the money prior to
the March 5, 1993 Order, we might conclude that Ms. Kean did
not receive those funds. However, Ms. Kean made no such
argument, but instead stipulated that Mr. Kean made payments
to her in the amount of $54,000 in 1992 and $57,388 in 1993.
11
Ms. Kean also claims that Mr. Kean’s payments cannot
be considered alimony because they do not meet the
requirements of section 71(b)(1)(D), which states that a
payment can only be considered alimony when “there is no
liability to make any such payment for any period after the
death of the payee spouse and there is no liability to make any
payment (in cash or property) as a substitute for such
payments after the death of the payee spouse.” I.R.C. §
71(b)(1)(D). According to Ms. Kean, Mr. Kean would have
been required to continue making the pendente lite payments
even if she had died, and therefore section 71(b)(1)(D) is not
satisfied.
The pendente lite orders directing Mr. Kean to make
payments to Ms. Kean did not specify whether Mr. Kean’s
responsibility to make payments would terminate upon Ms.
Kean’s death. When the order does not expressly state that
the payments cease upon the death of the payee, we must
examine the state law to determine whether the death of the
recipient terminates the payment order. I.R.S. Notice 87-9,
1987-1 C.B. 421 (“The termination of liability need not . . . be
expressly stated in the instrument [if], for example, the
termination would occur by operation of State law.”).
A support order issued pendente lite in a New Jersey
divorce proceeding does not survive the death of the payee.
Wilson v. Wilson, 181 A. 257, 260 (N.J. Ch. 1935) (“The
termination of the suit rendered the order for maintenance
therein prospectively inoperative, so that no installments
accrued thereon after such termination.”). See also Sutphen v.
Sutphen, 142 A. 817, 817 (N.J. Ch. 1928) (“The right to
12
alimony, if it exists, is a purely personal right, at least prior to
decree or determination. . . . It follows that by her death
pending suit the cause of action abates and (in the absence of
statutory provision -- and none such exists), cannot be revived
by or in favor of her personal representative or legatee.”)
overruled in part by Williams v. Williams, 281 A.2d 273, 275
(N.J. 1971). However, Ms. Kean argues that because the
payments were unallocated support payments for both herself
and her children, Mr. Kean would have been obliged to
continue making the payments after her death.
To support her position, Ms. Kean suggests that we
should follow the Tenth Circuit’s opinion in Lovejoy v.
Commissioner, 293 F.3d 1208, 1211-12 (10th Cir. 2002),
which held that, under Colorado law, support payments made
during divorce proceedings do not fit the definition of
“alimony” as set out in I.R.C. § 71(b). Ms. Kean also directs
our attention to the Tax Court’s holding in Gonzales v.
Commissioner, 78 T.C.M. (CCH) 527 (1999) which held, in a
case similar to the one before us, that New Jersey law would
not have relieved the payor spouse of an obligation to pay
family support if the payee spouse died before the entry of
judgment. Having considered both cases, we believe that the
decisions rely too heavily on the intricacies of family law and
fail to take into account the overall purpose of section 71.
Furthermore, these cases ignore the interplay between section
71(b) and section 71(c) and their importance in distinguishing
between alimony, child support and property settlement
payments for the purpose of tax treatment.
Section 71(b)(1)(D) must be examined in the context
13
of the rest of the section 71(b) requirements. Accordingly, the
question presented is whether the payor must continue to
make payments to or on behalf of the spouse, as outlined in
71(b)(1)(A). Although it may be true that Mr. Kean would
still have had responsibilities to his children had Ms. Kean
died, he would not have been required to make any payments
to Ms. Kean or her estate, nor would he have made any
payments on her behalf. “Divorce proceedings abate with the
death of one of the parties.” Carr v. Carr, 576 A.2d 872, 875
(N.J. 1990). Consequently, Mr. Kean’s responsibilities to his
children, both financial and custodial, properly would have
been determined by New Jersey family law (most likely in
separate proceedings) and would not have arisen from the
pendente lite order issued in the divorce proceedings.
A contrary decision would violate the intent of I.R.C. §
71(c). Under section 71(c), child support payments may be
separated out of alimony payments for tax purposes, but only
if the amount intended for child support is sufficiently
identifiable. Under I.R.C. § 71(c)(1)-(2), payments are not
considered alimony to the extent that the divorce or separation
instrument fixes a sum of money as child support, or provides
that the payments are reduced on the happening of an event
related to the child, or at a time associated with such an
event.3 Where support payments are unallocated, as in this
3
I.R.C. § 71(c) states:
(c) Payments to support children.
(1) In general. Subsection (a) shall not apply to
14
case, the entire amount is attributable to the payee spouse’s
income. Otherwise, we would be left with a situation in
which the portion of the unallocated payment intended for the
that part of any payment which the terms of the divorce
or separation instrument fix (in terms of an amount of
money or a part of the payment) as a sum which is
payable for the support of children of the payor spouse.
(2) Treatment of certain reductions related to
contingencies involving child. For purposes of
paragraph (1), if any amount specified in the instrument
will be reduced--
(A) on the happening of a contingency
specified in the instrument relating to a child
(such as attaining a specified age, marrying,
dying, leaving school, or a similar contingency),
or
(B) at a time which can clearly be
associated with a contingency of a kind specified
in subparagraph (A),
an amount equal to the amount of such reduction will be
treated as an amount fixed as payable for the support of
children of the payor spouse.
(3) Special rule where payment is less than
amount specified in instrument. For purposes of
this subsection, if any payment is less than the
amount specified in the instrument, then so much
of such payment as does not exceed the sum
payable for support shall be considered a payment
for such support.
15
support of the payee spouse would be taxable to the payor
spouse.
This treatment of support payments is not accidental,
and can benefit families going through a divorce. See N.J.
Court Rules, 1969 R. 5:7-4(a) (“In awarding alimony,
maintenance or child support, the court shall separate the
amounts awarded for alimony or maintenance and the
amounts awarded for child support, unless for good cause
shown the court determines that the amounts should be
unallocated.”) By ordering the payor spouse to make an
unallocated support payment taxable in full to the payee
spouse, the couple may be able to shift a greater portion of
their collective income into a lower tax bracket.
Consequently, an unallocated payment order not only frees the
parents from restrictive court instructions that dictate who
pays for what, but may allow the parties to enjoy a tax benefit
at a time when they face increased expenses as they establish
independent homes. This advantage would be lost by taxing
all unallocated payments to the payor spouse.
For the reasons set forth above, we affirm the decisions
of the Tax Court in both cases.
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