In a split decision, the Ninth Circuit Court of Appeals reversed the Tax Court to hold that a taxpayer could not deduct as alimony the half-interest in his vested pension benefits he paid his ex-wife under a California divorce decree. The decision may carry implications for how divorcing couples divide pension benefits in California and other community property states and when the employee-spouse elects to retire.
John Dunkin, a Los Angeles Police Department officer, and his wife, Julie, divorced in 1997. The divorce court awarded Julie half of John’s pension, based on California’s community property laws. Although he was eligible to retire and receive benefits, John decided to continue working. Consequently, the court ordered John to pay Julie the present value of her share of the pension, which the court determined to be $25,511 a year. He paid her the sum in 2000 from his wages and deducted it from his federal taxable income as alimony. The Service argued that he was subject to income taxes on that amount. The Tax Court ruled for Dunkin, and the government appealed.
The Ninth Circuit noted that under IRC § 71, for a payment to qualify as alimony, it must cease at the recipient’s death. In this case, the payments were to continue to Julie’s estate if she died while John remained employed by the Police Department. Therefore, it could not be alimony.
One member of the three-judge panel, in a dissenting opinion, noted that if Dunkin had retired, the portion of the pension paid to his wife would have been taxable to her. The majority’s holding “defies reason, not to mention fairness,” wrote the dissenting judge, Stephen Reinhardt, who proposed the question be addressed by the California Supreme Court.
In the meantime, in negotiating divorce settlements, it is important to consider state property rights, pension vesting and expected retirement dates to avoid unexpected tax outcomes.
Commissioner v. John Michael Dunkin , 100 AFTR2d 2007-5870
Prepared by Edward J. Schnee , CPA, Ph.D., Hugh Culverhouse Professor of Accounting and director, MTA Program, Culverhouse School of Accountancy, University of Alabama, Tuscaloosa.