Schatten v. U.S.

• Decision Date: 05 September 1984
• Docket Number: No. 83-5503,83-5503
• Parties: -1417, 84-2 USTC P 9965 Joan S. SCHATTEN, Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee.
• Court: U.S. Court of Appeals — Sixth Circuit

Page 319

746 F.2d 319

55 A.F.T.R.2d 85-1417, 84-2 USTC P 9965

Joan S. SCHATTEN, Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee.

No. 83-5503.

United States Court of Appeals, Sixth Circuit.

Sept. 5, 1984.

Joseph Gibbs (argued), Boult, Cummings, Conners & Berry, Nashville, Tenn., for plaintiff-appellant.

Robert E. Rice, Trial Atty., Bruce Ellisen (argued), Tax Div., Civil Section, U.S. Dept. of Justice, Washington, D.C., Joe B. Brown, U.S. Atty., Nashville, Tenn., Glenn L. Archer, Jr. (LEAD), Asst. Atty. Gen., Michael L. Paup, Michael J. Roach, Chief, Appellate Section Tax Div., Dept. of Justice, Washington, D.C., for defendant-appellee.

Before EDWARDS and CONTIE, Circuit Judges, and BALLANTINE, District Judge. ^*

PER CURIAM.

Joan Schatten appeals from a district court decision, 563 F.Supp. 294, holding that certain payments being received by Schatten from her ex-husband pursuant to a divorce settlement agreement are taxable as ordinary income. We affirm.

Emanuel and Joan Schatten were married in 1954. Although the couple had virtually no assets at the time of the marriage, Mr. Schatten's real estate business subsequently became successful. The marital estate was worth between three and five million dollars at the time of the divorce. Mrs. Schatten's primary contribution to the marital estate was that of wife, mother of three children and homemaker.

The parties cross-filed for divorce. The state court made no findings on the grounds for divorce asserted by the parties because they settled the matter on April 2, 1973. Both parties were represented by counsel during the settlement negotiations. The settlement agreement approved by the state court provided that Mr. Schatten would pay his ex-wife $470,000.00 in "support and maintenance in recognition of her need for support" over a fifteen year period. The monthly payment was set at $2,610.00. Although Mr. Schatten's duty to pay would survive his death or his ex-wife's remarriage, the obligation would cease if Mrs. Schatten died. The settlement agreement expressly provided that the payments would be ordinary income to Mrs. Schatten and deductible by Mr. Schatten.

The settlement agreement further provided that Mr. Schatten would pay his ex- wife's Blue Cross and major medical insurance premiums as part of his alimony obligations. This obligation would terminate upon Mrs. Schatten's remarriage or death. The agreement stated that the premiums paid would be ordinary income to Mrs. Schatten and deductible by Mr. Schatten. ¹

A separate portion of the settlement agreement sought "to make a just and equitable distribution of jointly held property." The couple was to hold their home as tenants in common, with Mrs. Schatten holding a three-fourths share. In addition, Mr. Schatten agreed to convey ten percent of the common stock of King's Lodge, Inc., a Tennessee corporation having a leasehold interest in King's Lodge in Chattanooga.

On her 1974, 1975 and 1976 federal income tax returns, Mrs. Schatten claimed the monthly payment and insurance premium payments as ordinary income. Mrs. Schatten did not claim the payments on her 1977 and 1978 returns, however, on the ground that the payments were part of the couple's property settlement rather than part of the agreement concerning alimony. The Commissioner ruled that the payments constituted alimony taxable as ordinary income and assessed a deficiency. Mrs. Schatten then paid the tax and sued for a refund in the district court.

The district court agreed with the Commissioner and articulated alternative reasons for its holding. Following the Third Circuit's decision in Commissioner of Internal Revenue v. Danielson, 378 F.2d 771 (3d Cir.1967), the district court held that Mrs. Schatten could challenge the tax consequences of the language of the settlement agreement only by proving that the agreement was voidable because of mistake, undue influence, fraud or duress. The court declined to find the settlement agreement void on any of those grounds. In the alternative, the court held that if Mrs. Schatten could go beyond the terms of the settlement agreement in order to show that the payments in question were intended as a part of the property settlement rather than as alimony, then the government would still prevail under the seven factor test enunciated by the Tax Court in Beard v. Commissioner of Internal Revenue, 77 T.C. 1275, 1284-85 (1981). It is from this judgment that Mrs. Schatten appeals.

Although alimony received by a wife is taxable as ordinary income, money received pursuant to a divorce property settlement is non-taxable. See 26 U.S.C. Sec. 71(a); 26 C.F.R. Sec. 1.71-1(b)(1) and (4). Conversely, periodic alimony payments by a husband are deductible whereas property settlement payments are non-deductible. See 26 U.S.C. Secs. 71(c) and 215. In the present case, it is to Mrs. Schatten's advantage to have the money she is receiving characterized as being part of the property settlement rather than as alimony.

This court repeatedly has held that whether a payment is made to satisfy property rights of the wife or support duties of the husband is primarily a question of intent that will not be disturbed unless clearly erroneous. See Crouser v. Commissioner of Internal Revenue, 668 F.2d 239, 242 (6th Cir.1981); Lambros v. Commissioner of Internal Revenue, 459 F.2d 69, 72 (6th Cir.1972); Porter v. Commissioner of Internal Revenue, 388 F.2d 670, 671 (6th Cir.1968). What is less clear is whether a party to a divorce settlement agreement may go beyond the terms of that agreement in order to show that the intent of the parties was different than the plain language of the agreement suggests.

The settlement agreement at issue here plainly and unambiguously provides that both the monthly payments and the insurance premium payments are alimony taxable as ordinary income to Mrs. Schatten and are deductible by Mr. Schatten. For three reasons, we agree with the Third and Fifth Circuits that a party may not challenge the tax consequences of a settlement agreement absent "proof which in an action between the parties to the agreement would be admissible to alter the construction or to show its unenforceability because of mistake, undue influence, fraud or duress." Danielson, 378 F.2d at 775. See also Spector v. Commissioner of Internal Revenue, 641 F.2d 376, 385-86 (5th Cir.), cert. denied, 454 U.S. 868, 102 S.Ct. 334, 70 L.Ed.2d 171 (1981) (adopting the Danielson test).

First, allowing a party collaterally to attack a divorce settlement agreement years after it has been entered into would nullify the predictability of tax consequences that parties in divorce situations are seeking to achieve. Id. A successful collateral attack upon the settlement agreement might, for instance, spur the Commissioner to initiate proceedings against Mr. Schatten in an attempt to invalidate the Sec. 215 deductions that the letter has been taking since 1974. If parties in Mr. Schatten's position cannot depend upon settlement agreements but instead learn that they face potentially dramatic increases in their federal income tax liabilities depending upon whether ex-spouses are successful in collaterally attacking these agreements, then such agreements will not be entered into.

Second, the tax consequences of structuring a divorce settlement agreement in a particular way obviously affect the terms of the agreement. If Mrs. Schatten is in effect permitted to alter the tax consequences that she bargained for, then she will have succeeded in...