On October 4, 2021, the Tax Court issued its opinion in Leyh v. Commissioner (157 T.C. No. 7). The primary issue presented in Leyh v. Commissioner was whether the petitioner was entitled to deduct, as alimony, an amount equal to the premiums paid to provide health insurance coverage for his then spouse
Held: Yes, sir.
Background to Leyh v. Commissioner
In 2012, the petitioner in Leyh v. Commissioner, Mr. Leyh, filed for divorce from his then wife, Ms. Leyh. The petitioner and Ms. Leyh filed and signed an agreement in 2014 incident to their divorce proceeding, in which agreement the petitioner agreed to pay Ms. Leyh alimony pendente lite until the final divorce decree was granted.[1] As part of the agreement, the petitioner further agreed to pay for Ms. Leyh’s health and vision insurance.
In 2015, the petitioner paid (as alimony) $10,683 for Ms. Leyh’s health insurance premiums as pretax payroll reductions from his wages through his employer’s “cafeteria plan.” On his 2015 Form 1040, the petitioner excluded from his gross income the total amount of health care coverage premiums he and Ms. Leyh received through his employer’s “cafeteria plan.” He also claimed an alimony deduction for the premiums-qua-alimony payments.
The IRS cried foul and disallowed the petitioner’s deduction for alimony payments, and it further determined that the petitioner was liable for an accuracy-related penalty under IRC § 6662(a).
Exclusion From Gross Income
As Briefly Taxing has noted in a number of previous posts, gross income includes all income “from whatever source derived,” unless otherwise specifically excluded. IRC § 61. Thus, when an employee receives health insurance coverage for himself or his spouse and dependents as a benefit through an employer-sponsored health care plan, the premiums paid for such coverage may generally be excluded from that employee’s gross income. IRC § 106(a); IRC § 125(a); Treas. Reg. § 1.125-1(h)(2).
The petitioner received health insurance compensation while Ms. Leyh was still considered his spouse under Pennsylvania law. Consequently, the Tax Court found that there was no dispute that he was entitled under IRC § 106 and IRC § 125 to exclude the health insurance compensation from his gross income (including the portion covering Ms. Leyh’s health insurance coverage). The IRS did not challenge this; however, it did balk at the petitioner’s attempt to also deduct the alimony payments. Amongst the things the IRS loathes, highest on the list (in this order) stapler changes and double deductions.[2]
The Code’s “Alimony Regime”
If a taxpayer pays alimony as defined in IRC § 71(b), then he may deduct such payments from gross income, but only if the amounts are includible in the gross income of the recipient under IRC § 71. IRC § 62(a)(10); IRC § 215(a), (b). The Tax Court was satisfied, and even the IRS did not dispute, that (a) the alimony payments statutorily qualify as alimony, and (b) that Ms. Leyh was required to include these amounts in her gross income in accordance with IRC § 71.
In most cases there is little question as to whether the taxpayer may deduct a payment if it qualifies as alimony under the Code and is included in the recipient’s income. However, the facts here required the Tax Court to consider another matter outside the statute:
Did the petitioner claim an impermissible “double deduction” when deducting the alimony payments and excluding the health insurance compensation from his gross income?
Stay tuned, dear readers, it’s about to get interesting…
Deductions, a Primer
As we know, deductions are a “matter of legislative grace,” and the taxpayer bears the burden of clearly showing the right to a claimed deduction. Interstate Transit Lines v. Commissioner, 319 U.S. 590, 593 (1943). Moreover, “double deductions (or their practical equivalent) for the same economic loss are impermissible absent a clear declaration of congressional intent.” Thrifty Oil Co. & Subs. v. Commissioner, 139 T.C. 198, 205 (2012); accord United States v. Skelly Oil Co., 394 U.S. 678, 684 (1969); Charles Ilfeld Co. v. Hernandez, 292 U.S. 62, 68 (1934).
By way of example, a taxpayer may not claim a deduction for a loss or expense where the taxpayer recognized a deduction for that same event or item for a prior tax year. See Ilfeld Co., 292 U.S. at 68; Thrifty Oil Co., 139 T.C. at 218.
Notwithstanding the general prohibition, the Tax Court had have not previously considered whether claiming an alimony deduction based on the payment of a spouse’s tax-exempt health insurance premiums pending a final decree of divorce gives rise to an impermissible multiple deduction scenario. An examination of the practical operation and effect of the general alimony regime, together with the prior caselaw on this matter, reveals that such a deduction is appropriate.
The Alimony Deduction, Specifically
The alimony deduction differs from most other personal deductions in that it is “a method of designating the proper taxpayer for a given amount of income, rather than a tax allowance for a particular expenditure.” See Bittker & Lokken, et al., Federal Income Taxation of Individuals, ¶ 36.08 (3d ed. 2002); see IRC § 162(a); IRC § 212; IRC § 213(a); IRC § 163(a). To that end, the alimony deduction requires consideration of persons other than the taxpayer claiming the deduction.
More specifically, IRC § 215 requires that an alimony recipient’s tax consequences under IRC § 71 be taken into account when determining the payor’s eligibility for the alimony deduction. This distinction is crucial as it signifies that the payee should not be entirely ignored when evaluating the effect of the totality of these provisions on the payor. See Fox v. Commissioner, 14 T.C. 1131, 1135 (1950). Only by considering the recipient, which the IRS “apparently chose not to do,” and comparing the overall net tax effect on all parties both before and pending divorce is was “revealed” to the Tax Court “that a double deduction scenario is illusory.”
Examining Alimony through the Leyh Case
As a married couple awaiting a final decree of divorce, that is, whilst pendente lite, the petitioner and Ms. Leyh could have chosen to file a joint return for 2015 and avoid the alimony regime altogether. If they had, they would have had an exclusion from gross income equal to the amount of the health insurance compensation, no alimony deduction for that amount, and no alimony income inclusion for that amount.
Instead, the petitioner and Ms. Leyh chose to file separately and treat the alimony payments, well…as alimony. But for the alimony regime, Ms. Leyh would not have been required to include any portion of the alimony payments in her gross income. It follows that, per the general matching design of the alimony regime, if Ms. Leyh is required to include the alimony payments in her income, then the petitioner should be permitted a corresponding deduction to preserve this equilibrium.
In other words, the petitioner’s alimony deduction should be properly viewed as being matched against Ms. Leyh’s alimony income, not against his excluded wage income.
In seeking to uphold the disallowance of the petitioner’s alimony deduction, the IRS argued that permitting the alimony deduction in this instance creates a “windfall” to the petitioner by granting him the practical equivalent of multiple deductions for the same economic outlay. The Tax Court found, however, that there is no such risk of a “windfall” to the petitioner in allowing him an alimony deduction. Doing so simply maintains the Government’s parity and, as provided by the Code, continues to shift the ultimate tax burden of the income item to the recipient.
Indeed, disallowing the alimony deduction in this circumstance would instead leave the petitioner with a greater tax burden (relative to his position if he received the benefit of the deduction or had elected the married filing jointly filing status pending his divorce) that runs counter to the intended purpose and operation of the general alimony regime as previously interpreted by the Tax Court. See, e.g., Emmons v. Commissioner, 36 T.C. 728, 735 (1961) (finding that the purpose behind the alimony provisions is to shift the income tax burden to the recipient), aff’d without published opinion, 311 F.2d 223 (6th Cir. 1962).
The Tax Court observed that, if the IRS is concerned that the petitioner’s situation might create an unanticipated statutory “loophole”—which the Tax Court did not believe was the case here—then it would be up to Congress, not the IRS or the Tax Court, to retroactively address this ignominious result.
No Support in Prior Case Law
The alimony deduction is not a spring chicken when it comes to the Code. Indeed, the creation of the alimony deduction, which was an attempt by Congress to relieve a payor-spouse from the tax burden of whatever part of an alimony payment was “includible in the payor’s gross income,” traces its roots to World War II. See S. Rept. No. 77-1631, at 83S, 83 (1942).
Thus, it struck the Tax Court as odd that it was wholly unaware of (and the IRS failed to direct the Tax Court to) any case in which an alimony deduction has been disallowed on the basis of the double deduction principle. The common law “double deduction” doctrine (alliteration always allowed and appreciated) has been limited to instances in which a taxpayer has attempted to claim the practical equivalent of multiple deductions for the same expense, where Congress did not specifically intend such a result. See, e.g., Skelly Oil Co., 394 U.S. at 684; Ilfeld Co., 292 U.S. at 68; Thrifty Oil Co., 139 T.C. at 205.
The Third Circuit also recently observed that the proper scope and application of the “double deduction” doctrine may be limited to that of the consolidated return context. See Duquesne Light Holdings, Inc. & Subs. v. Commissioner, 861 F.3d 396, 407 (3d Cir. 2017), aff’g T.C. Memo. 2013-216. Thus, the Tax Court found that the petitioner indisputably qualified for both the exclusion and the alimony deduction, and no double tax benefit outcome can arise when considering the alimony regime as a whole, i.e., by factoring in Ms. Leyh’s matching requirement to include the alimony payments in her gross income under IRC § 71.
By asking the Tax Court to disallow the alimony deduction where the Code plainly permits petitioner this right, the IRS attempts to disrupt the uniformity of the general alimony regime to its own net advantage under the guise of the double deduction rules when no such threat is present.
But…But, What about IRC § 265?
In a last-ditch effort, the IRS argued that IRC § 265(a) provides a backstop to disallow petitioner’s alimony deduction, insofar as IRC § 265(a)(1) generally provides that an amount may not be deducted if it is allocable to wholly tax-exempt income (other than interest). Tax-exempt income includes any class of income wholly excluded from gross income under subtitle A of the Code or under any other provision of law. Treas. Reg. § 1.265-1(b)(1).
The Tax Court has previously noted that a principal purpose of IRC § 265 is to restrict deductions of expenses incurred in connection with an ongoing trade or business or investment activity, the conduct of which generates exempt income. See Manocchio v. Commissioner, 78 T.C. 989, 994 (1982) (describing the legislative history and purpose of section 265), aff’d, 710 F.2d 1400 (9th Cir. 1983). The Tax Court has also applied this rule more broadly to embrace situations where, but for a given expense, the receipt of tax-free income “fundamentally” connected to the expense item would not have been possible. Id. at 994-95.
The Tax Court, however, has never, not once, applied IRC § 265(a)(1) to disallow an alimony deduction, or, to its collective and most learned knowledge, in any instance where the supposed “exempt” item of income at issue was actually included in gross income by a different taxpayer.
Never. Not Once. Not even a little.
Indeed, the Tax Court’s decisions broadly interpreting IRC § 265(a)(1) have, instead, generally shared the same basic concern—but for the application of IRC § 265, a taxpayer would have recognized a double tax benefit where one was not otherwise available to him. See, e.g., Induni v. Commissioner, 98 T.C. 618, 623 (1992), aff’d, 990 F.2d 53 (2d Cir. 1993); Rickard v. Commissioner, 88 T.C. 188, 193 (1987); Manocchio, 78 T.C. at 994-95, 997.
Such application is consistent with the text of the statute. As the Tax Court has explained, this threat does not exist in the present case given the special nature of the alimony regime. Furthermore, the alimony payments are not considered allocable to wholly tax-exempt income for IRC § 265 purposes, because Ms. Leyh actually was required to include it in her income. For these reasons, the Tax Court declined to extend the reach of IRC § 265 to the petitioner’s alimony deduction.
Holding in Leyh v. Commissioner
Neither the double deduction doctrine arising under common law, nor IRC § 265 apply to prevent the deduction of alimony where a separated couple pending a final decree of divorce create an alimony pendente lite agreement that includes continued health care coverage as provided by the payor spouse’s employer, premiums for which are properly excluded from the payor’s gross income and included in the recipient spouse’s gross income.
Accordingly, the petitioner was entitled to deduct an amount equal to the alimony payments from his gross income, and the IRS was entitled to go pound sand. Which they did, at a typical Federal pace.
(157 T.C. No. 7) Leyh v. Commissioner
Footnotes
[1] For your Latin lesson today, the phrase “pendente lite” means “whilst the suit is pending.” “While the suit is pending” is fine, but it’s Latin, and how many times can you use “whilst” whilst not seeming like an intellectual douche? If you are ever in need of a good online Latin dictionary, my go-to is Whitaker’s Words, produced by the Notre Dame Classic’s Department. As an interesting side note, Tax Court Judge Patrick J. Urda is a proud alumnus of the Notre Dame Classics Department, having graduated Summa Cum Laude with a B.A. in Classics in 1998. As a classics major myself, I find it necessary to remind our dear readers of the esteemed Judge Urda’s classical provenance whenever possible.
[2] Oh, the infamous 1985 Swingline-to-Bostich schism. As I explained the history of the schism in this post, the effects thereof still reverberate in the halls of the Service to this day.
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