Tax Court Double Feature; Two Taxpayers Get in Trouble Over Treatment of Alimony Payments

Two recent Tax Court opinions highlight the danger of ignoring the Internal Revenue Code 71 when handling spousal support issues.

Christina Mehriary v. Commissioner, T.C. Memo 2015-126, issued July 9, 2015

Taxpayer tried to deduct the transfer of the home she was given in the divorce as an investment loss. In the divorce she owed a substantial amount of alimony to her ex-spouse and he agreed to accept the home in lieu of cash payments of alimony. Ultimately the Tax Court found that the transfer was a transfer incident to divorce and thus no loss can be recognized; additionally, the court found that the transfer was not considered alimony because it was not cash payments as required under IRC 71. This was in spite of the ex-spouse’s agreement to accept it as alimony. “[T]he intent of the parties does not determine the deductibility of a payment as alimony under section 71.”

Michael Muniz v. Commissioner, T.C. Memo 2015-125, issued July 9, 2015.

Taxpayer tried to deduct a lump-sum alimony payment on his tax return. Under Florida law, lump sum alimony payments are payable to the ex-spouse’s estate if the ex-spouse dies before receipt. This fact alone converted the alimony payment into a transfer incident to divorce and therefore not deductible. IRC 71 is very clear that a payment obligation to the recipient’s estate is not alimony.

Both opinions make clear that intent of the parties and labeling of the payments do not override the Code. I am not sure if either taxpayer spoke about the tax consequences with either their divorce attorney, accountant, or tax attorney (though Muniz was formerly an attorney and CPA), though they should have.

IRS Fumbles the Ball in Tax Court Case Involving Former NFL Star

George Lawrence Starke v. Commissioner T.C. Summary Opinion 2015-40, Filed July 7, 2015

George Starke had an illustrious career in the NFL. During his time with the Redskins, he went to three Superbowls, including the Redskins 27-17 win over the Dolphins in 1983. Nicknamed the “Head Hog”, he was part of the Redskins famous “Hogs” offensive line. In 1984, Starke finished his career in the NFL and became a businessman. In his post-NFL career he: started a car dealership; co-founded a non-profit to provide vocational training for at-risk individuals; and opened a restaurant, appropriately, called “Head Hog BBQ”.

It is Starke’s involvement in the non-profit that is the cause of his IRS troubles. In 1997, he founded the “Excel Institute” (the “Institute”) to train at-risk individuals to be automotive service technicians. When his co-founder died, Starke started handling fundraising for the Institute and he stayed in this capacity until 2010, when he resigned; the opinion suggests that this was due to conflicts with a board member and allegations of financial improprieties within the Institute.

In his capacity as a fundraiser for the charity, Starke was paid a base salary along with a company credit card, which he used to pay personal and business expenses. Important for this discussion, from 2003 to 2006 Starke made personal charges that were treated as advances for future wages or business expenses. In 2005, the Institute began to withhold money from Starke’s paycheck to pay back these advances. In 2010, however, when he resigned there was still a balance due of $83,000. As a result, the Institute issued Starke a 1099-MISC form in 2010, treating the whole amount as miscellaneous income. It was not explained why, but Starke did not include the $83,000 as income on his return. Subsequently the IRS audited in 2012 and assessed additional taxes and penalties for the 2010 tax year.

What makes this opinion interesting, besides Starke’s nickname, is that the court’s opinion is short on details about what arguments the parties made. Starke handled this case pro se and his position on the $83,000 of income is not clear, except to say that he told the court that he did not know he owed the money to the Institute. The IRS, on the other hand, argued that the $83,000 was an advance, and not a loan, and thus taxable. That’s it. After the court recited the basic law on this issue, the court then agrees with the IRS that the money taxable to Starke…but not in 2010. Advances, the court said, are taxable in the year received which in this case is between 2003 to 2006. The court then states that those years are not at issue in this case and finds in Starke’s favor. Case closed.

Ouch! The IRS won on the issue that the $83,000 in advances was taxable but loses because it made the assessment for the wrong year! Generally, the IRS has three years from the due date of the tax return (April 15th), unless extended (then on October 15th), to assess additional taxes. If the assessment date passes then the IRS is barred from assessing any additional tax (and hence collecting that tax), unless the assessment period is extended through such things as fraud (forever) or a substantial understatement of tax (up to six years after the due date). Tough break.

Likely, the IRS tried to make a Hail Mary pass to keep this case alive; it probably knew that 2003 to 2006 tax years were closed to assessment and so it had to go forward with the case. Honestly, I am not sure how the IRS could have been clued in sooner about these advance but them’s the breaks. Unless the IRS can show that fraud was involved then even if there was a substantial understatement those tax years are closed.

Postscript: here is the gorgeous George “the Head Hog” Starke now, making a pitch for Bubbles Haircutters. Not often you see Bubbles and Hog together, probably a good thing.