Opinion ID: 746472
Heading Depth: 2
Heading Rank: 1

Heading: The 1988 Payments

Text: 8 The relevant portion of § 71 effective in 1983 when the Richardsons entered into their separation agreement provides: 9 If a wife is separated from her husband and there is a written separation agreement ..., the wife's gross income includes periodic payments ... received after such agreement is executed which are made under such agreement and because of the marital or family relationship.... This paragraph shall not apply if the husband and wife make a single return jointly. 10 I.R.C. § 71(a)(2) (1982). Irene insists that the payments made to her by Edward in 1988 were not made under a written separation agreement. She bases this contention on the fact that the Appellate Court of Illinois held in In re Marriage of Richardson, 237 Ill.App.3d 1067, 179 Ill.Dec. 224, 606 N.E.2d 56 (1992), that her 1983 separation agreement with Edward was unconscionable. 11 The relevant treasury regulation provides that payments made pursuant to a written separation agreement are includible in the wife's gross income whether or not the agreement is a legally enforceable instrument. Treas. Reg. § 1.711(b)(2)(i). Irene submits, without support, that the regulation does not apply to fraudulent agreements. We believe, however, that the better reading of the regulation is that Irene must pay tax on the money she received under the 1983 agreement, notwithstanding that the agreement was later declared unconscionable. The general rule is that a contract unenforceable under state law can still be a valid written separation agreement for purposes of the Tax Code. Taylor v. Campbell, 335 F.2d 841, 845-46 (5th Cir.1964). On its face, the regulation applies regardless of the reason that a particular agreement may be deemed unenforceable. State laws governing fraud, unconscionability and duress are simply different ways to prove that an agreement is legally unenforceable. The purpose of the statute and the regulation is uniformity of tax consequences notwithstanding variations in state law. Id. The regulation and the statute it interprets are aimed at uniform results, a goal that would be thwarted by making tax consequences under § 71 turn on the states' various laws governing contract enforceability. We suspect that the states' laws with respect to fraud, duress and unconscionability are as varied as their laws are with respect to other contractual defenses. There is no basis for creating an exception to the general rule for cases in which the separation agreement is found to be unenforceable because of unconscionability, duress or fraud. 12 Irene notes that the cases cited by the Commissioner and the Tax Court do not involve fraudulent agreements. She notes further that the Sixth Circuit stated in Schatten v. United States, 746 F.2d 319 (6th Cir.1984), that, [w]here parties to a divorce settlement agreement are represented by counsel, a party may collaterally attack the plain language of the agreement in order to obtain a tax advantage only by showing mistake, undue influence, fraud or duress. Id. at 322. Schatten, however, involved a different issue; the former wife there wanted the payments she received by her husband to be classified as property settlement payments, despite the fact that the settlement agreement expressly provided that the payments would be treated as ordinary income to her. Unlike Irene, Joan Schatten was trying to alter the construction of her otherwise valid agreement. The court in Schatten held that she could not attack the plain language of the agreement absent fraud or the like. The court, citing cases dealing with covenants not to compete, did not mention the effect of the treasury regulation; and the issue with which we are confronted was not before it. 2 13 The logic of Irene's argument would write Treasury Regulation § 1.71-1 out of the books. She says that a fraudulent agreement is no agreement at all and that, as a result, payments under such an agreement cannot be taxed. Yet the same could be said for all unenforceable agreements, and the regulation states clearly that payments made under separation agreements shall be included in gross income even if the agreement is legally unenforceable. Irene wants us to hold that somehow fraud, duress and unconscionability are different; however, courts then would have the problem of deciding which state contract defenses are not covered by the regulation and why. The regulation makes no such distinctions, and we generally defer to treasury regulations if they are reasonable, Goulding v. United States, 957 F.2d 1420, 1423 (7th Cir.1992). Given the regulation here, we see no justification for distinguishing the basis upon which Irene's agreement was declared unenforceable from the other contract defenses which are clearly covered by the regulation. 14 We hasten to add, as a member of this panel noted at oral argument, that Irene is not claiming fraud in the factum. (Nor is she claiming that Edward secretly gave her money without her knowledge or forced her to take it.) The Illinois appellate court did not find, for example, that Edward had obtained her signature on the settlement agreement by tricking her into thinking that she was actually signing another document. See generally 1 E. Allan Farnsworth, Farnsworth on Contracts § 4.10, at 402-04 (1990) (discussing differences between fraud in the factum and fraud in the inducement). Such a case, as counsel for the Commissioner conceded at oral argument, may present a more difficult problem. Here, of course, the basic problem with the settlement agreement was not that there was fraud in the execution; rather, the agreement did not award Irene enough money, see In re Marriage of Richardson, 237 Ill.App.3d 1067, 179 Ill.Dec. 224, 233-37, 606 N.E.2d 56, 65-69 (1992). Yet Irene knowingly received the money, and she knew the reason Edward was paying was because he was contractually committed to do so. True, the Illinois court eventually ruled that Irene should have been given more; but it makes no sense to hold, on the basis of that ruling, that she does not have to pay federal income tax on the money she knowingly received under the 1983 agreement. Given that the regulation requires tax to be paid on payments received under separation agreements, even if unenforceable, Irene's payments fall within the general tax principle that people have to pay tax on all income received, including alimony payments. Conversely, under I.R.C. § 215, the 1988 payments were deductible by Edward; therefore, he is not liable for any additional tax or penalties.