Opinion ID: 746472
Heading Depth: 2
Heading Rank: 2

Heading: The 1989 and 1990 Payments

Text: 15 Section 71, as amended, governs the payments made to Irene in 1989 and 1990 pursuant to the 1989 Illinois circuit court's opinion and order. See I.R.C. § 71(b). Under that version of § 71, the payments made pursuant to a divorce or separation instrument qualify as alimony or separate maintenance payments if, inter alia, 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. I.R.C. § 71(b)(1)(B). 16 The dispositive question in this case is whether the Illinois decree designates Irene's payments as not includible in her gross income. 3 Irene insists that the state court's opinion can be read as implicitly designating her payments as nontaxable. First, she notes, the state court determined Irene's monthly payments by analyzing an affidavit she had submitted that estimated her monthly expenses. Her affidavit did not list federal taxes as an expense, so when the court awarded her a monthly amount to cover her expenses, it did not include an amount to cover federal tax liability on her payments. Also, Irene contends, the state court opinion analyzes Edward's net (after-tax) income to determine whether $29,000 per month would be a reasonable amount to require Edward to pay. The state court estimated that the ordered payments would constitute roughly 40% of Edward's after-tax income. From these portions of the state court opinion Irene infers that the opinion contemplates that Edward will have already paid tax on the money to be paid to Irene. As a result, in Irene's view, the state court opinion effectively designates that her payments shall not be includible in her gross income and shall not be deductible by Edward. 17 The Commissioner rejoins that, although the state court made a rough calculation of Edward's aftertax income, it did so only after arriving at a monthly amount for Irene and only for the purpose of showing that the payments were reasonable relative to Edward's income. The Commissioner also urges that it is irrelevant that Irene did not ask the state court for an amount to cover her federal tax liability. Indeed, the Commissioner asserts, the only reason the court did not order an amount to pay federal taxes is that Irene did not ask for such an amount in her affidavit. At any rate, submits the Commissioner, § 71 applies unless the court decree designates that the payments are not includible in gross income; the state court opinion here does not so designate. 18 We agree with the Commissioner. In common usage, the term designate means to make known directly. Webster's Third New International Dictionary Unabridged 612 (1981); see also Black's Law Dictionary 447 (6th ed. 1990) (To mark out and make known; to point out; to name; indicate.). For a legal instrument to make known directly that a spouse's payments are not to be treated as income, we believe that the instrument must contain a clear, explicit and express direction to that effect. The legal instrument in this case does not expressly state one way or the other what the tax treatment of Irene's payments will be. Irene may be correct that the state court was under the misimpression that Irene was not going to have to pay tax on the payments it ordered Edward to make. As she notes, the state court determined Irene's expenses by reference to Irene's affidavit, which did not list federal income taxes as an expense. Also, the court did discuss Edward's after-tax income in such a way that one could argue that the court assumed Irene's payments were coming out of Edward's after-tax income. However, state court assumptions aside, the statute says that the payments are to be included in Irene's income if the state court order does not designate otherwise. Even if the state court made some (mistaken) assumptions, it is clear to us that the court did not designate in any way that the payments were not deductible by Edward and not includible by Irene. 4 Although we can imagine cases in which the question whether an instrument's designation of tax treatment is explicit enough for the purposes of the Tax Code, we have no difficulty holding that the instrument here does not designate anything with respect to whether the payments were to be included in Irene's income. Stated simply, a designation requires more than we have in this case. To set the bar as low as Irene proposes would create the unnecessary difficulty of courts having to pick apart a state court order to determine (or make inferences about) what assumptions the state court was laboring under. The relative ease of administration in requiring explicit direction confirms our belief that the word designate in § 71(b)(1)(B) must be given its plain commonsense meaning. Because the order in this case does not designate that the payments to Irene be tax-free, they are included in her gross income as alimony or separate maintenance payments under I.R.C. § 71. Conversely, the Tax Court was correct to decide that Edward could deduct the 1989 and 1990 payments under I.R.C. § 215 and that he is not liable for any understatement penalty for those years.