124 T.C. No. 10
UNITED STATES TAX COURT
JOHN MICHAEL DUNKIN, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 4448-03. Filed March 31, 2005.
Petitioner (P), who was divorced, was entitled to retire and receive pension payments. If P had retired, his former spouse would have been entitled under California community property law to receive an amount from P equal to one-half of his pension. However, P continued working, delaying his receipt of pension benefits. During the years P continued working, P’s former spouse was entitled under California community property law to receive a monthly payment from P equal to one-half of the pension benefit which P had earned during their marriage and which P would have received if he had retired on the date of their divorce.
Held, P’s gross income from his continued employment, which he received in lieu of retirement benefits, does not include the amount of payments to which his former spouse was entitled under California community property law on the basis of the pension earned by P. - 2 -
John Michael Dunkin, pro se.
Vicken Abajian, for respondent.
COLVIN, Judge: Respondent determined a deficiency of $8,222
in petitioner’s Federal income tax for 2000. The sole issue for
decision is whether petitioner may reduce his gross income by the
$25,511 that he was required by California community property law
to pay to his former spouse in 2000. We hold that he may.
Unless otherwise stated, section references are to the
Internal Revenue Code as amended and in effect for 2000.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
Petitioner
Petitioner resided in Long Beach, California, when the
petition was filed.
The Superior Court for the County of Los Angeles,
California, entered a judgment of divorce for petitioner and his
former spouse on August 19, 1997. As of 1997, petitioner had
been employed by the City of Los Angeles for 27 years.
Petitioner participated in a defined benefit pension plan
(the pension plan) administered by the Board of Pension
Commissioners (the pension board). He became eligible to receive
benefits under the pension plan on May 19, 1989. The divorce
judgment provided in pertinent part as follows: - 3 -
2. IDENTIFICATION, VALUATION AND DIVISION OF COMMUNITY PROPERTY
(a) * * * [Petitioner’s former spouse] is awarded the following as her sole and separate property and shall assume and pay any encumbrances thereon and hold * * * [petitioner] indemnified therefrom:
* * * * * * *
(8) THE DEFINED BENEFIT PLAN:
(a) One Half of the community interest in all benefits (including but not limited to service or disability pension, conditional survivorship rights, refundable contributions, cost-of-living adjustments) of * * * [petitioner’s] L.A. City Article XVIII/LAPD Defined Benefit Pension Plan * * *
(b) The community interest shall be calculated per Brown Formula (marital period divided by employment period multiplied by * * * [petitioner’s] service entitlement).
If petitioner had retired on August 19, 1997, his former
spouse would have been entitled to receive, and the pension board
would have paid to her as her community property interest in the
pension plan, $2,072 per month, representing one-half of his
monthly benefit. Petitioner had not retired as of that date. - 4 -
Citing In re Marriage of Gillmore, 629 P.2d 1 (Cal. 1981),1
the superior court ordered petitioner to pay his former spouse
$2,072 per month until he retired. The Court ordered as follows:
(9) * * * [PETITIONER’S FORMER SPOUSE’S] EXERCISE OF “GILLMORE PENSION RIGHTS”:
(a) The court finds, upon the stipulation of the parties, that the * * * [petitioner] has been eligible to retire and collect the pension under the DEFINED BENEFIT PLAN described herein above since May 19, 1989 but he has not retired to date; and
(b) That were he to retire as of date of trial, he would have accrued 27.7899 service years and would receive a starting pension benefit of $4,311.30 monthly * * * and * * * [petitioner’s former spouse] would be entitled to one half or $2,072 monthly; and
(c) That * * * [petitioner’s former spouse] has exercised her “Gillmore Rights” to be paid her said monthly pension interest and therefore is awarded the same and * * * [petitioner] is ordered to pay directly to her $2,072 monthly * * * beginning as of April 1, 1997 and continuing until he retires and the Plan begins direct payment to her pursuant to the award and order made in Par. 2(A)(8) herein. * * * .
1 A nonemployee spouse has the right to be paid the amount to which that spouse would have been entitled if the employee spouse had retired and begun drawing benefits in a pension plan that, on the date of divorce, was fully vested, matured, and drawable but was not paid because the employee spouse continued to work. In re Marriage of Gillmore, 629 P.2d 1 (Cal. 1981). As used in this Opinion, the term “nonemployee spouse” is the spouse with a community property interest in the retirement benefits of the other spouse (the employee spouse). If both spouses have earned rights in retirement plans, each spouse is the “nonemployee spouse” in relation to the retirement rights of the other spouse. - 5 -
The superior court also ordered that, if petitioner’s former
spouse dies before petitioner, her benefit will be payable to her
beneficiaries.
The superior court ordered petitioner and his former spouse
to prepare a California qualified domestic relations order (QDRO)
to be signed by the judge and entered in the court’s record
providing that the pension plan would pay petitioner’s former
spouse $2,072 per month when petitioner retired.
Petitioner paid his former spouse $25,511 in 2000 as ordered
in the divorce judgment.2 Petitioner deducted $26,604 as alimony
on his 2000 Federal income tax return.3
Petitioner retired on September 22, 2002. After petitioner
retired, the pension board separately paid petitioner and his
former spouse.4
2 The parties agree that petitioner paid his former spouse $25,511 in 2000. They do not explain why that amount is more than $2,072 x 12. 3 Petitioner concedes that $1,124 that he paid to his former spouse on January 1, 2001, and that he included in the $26,604, is not deductible for 2000. 4 Because he worked for 5 years after his divorce, petitioner received a larger benefit than he would have received if he had retired on the date of his divorce. However, petitioner’s former spouse was entitled under California law, and the pension board paid to her, an amount equal to one-half of the benefit petitioner would have received if he had retired on the date of the divorce. See In re Marriage of Gillmore, supra at 7 n.9. - 6 -
OPINION
A. Background and Contentions of the Parties
The parties dispute whether petitioner is taxable on the
amount he paid to his former spouse because of her community
property rights in his pension.
1. Principles of California Community Property Law Relevant to This Case
Under California community property law, each spouse has a
one-half ownership interest in the community estate, including
income earned by both spouses during their marriage. Cal. Fam.
Code sec. 2550 (West 2004).
A pension is deferred compensation for past employment. In
re Marriage of Brown, 544 P.2d 561, 565 (Cal. 1976). Pension
rights are community property, and, as part of a divorce
settlement or order, those rights can be distributed either
through periodic (e.g., monthly) retirement payments or by lump
sum based on the present value of the future benefit.5 In re
5 Under California law, parties to a divorce may divide community property rights to pension plan benefits in different ways. First, all pension rights may be awarded to the employee spouse if the nonemployee spouse is compensated with other community property equal in value to the present value of the nonemployee’s share. In re Marriage of Gillmore, supra at 6-7; In re Marriage of Skaden, 566 P.2d 249, 253 (Cal. 1977); In re Marriage of Brown, 544 P.2d 561, 566 (Cal. 1976); Phillipson v. Bd. of Admin., 473 P.2d 765, 774-775 (Cal. 1970). Second, the employee spouse can pay the other spouse the present value of the nonemployee spouse’s share of the pension plan. In re Marriage of Gillmore, supra. Third, the employee spouse can pay the other spouse a share of the retirement payments monthly. Id. (continued...) - 7 -
Marriage of Gillmore, supra at 8; In re Marriage of Brown, supra
at 567. If pension benefits are distributed through periodic
payments, the nonemployee spouse may be entitled to up to one-
half of each payment; the allocation depends on the percentage of
the employee spouse’s working years that the parties were
married. In re Marriage of Gillmore, supra at 6; In re Marriage
of Brown, supra at 562-563.
In some situations, people may choose not to begin receiving
retirement benefits when they are first eligible to do so.
Postdivorce earnings are separate property, not community
property. Cal. Fam. Code sec. 771 (West 2004) (earnings and
accumulations of each spouse following date of separation are
that spouse’s separate property). Nonetheless, in these
situations under California law, a formerly married person is
entitled to payments based on the amount of pension benefits to
which the employee spouse would have been entitled if the
employee spouse had retired when first eligible. In re Marriage
5 (...continued) Petitioner’s retirement plan at issue in this case is a defined benefit plan. The record contains no evidence that petitioner, his former spouse, or the superior court sought to determine the present value of the former spouse’s interest in petitioner’s retirement plan. See Projector, “Valuation of Retirement Benefits in Marriage Dissolutions”, 50 L.A. Bar Bull. No. 6, at 229 (1975) (valuation of a defined benefit plan includes an estimate of the value of the pension measured at the future retirement date, discounting for the time value of money, mortality, and vesting) (cited in In re Marriage of Gillmore, supra at 4 n.4). - 8 -
of Gillmore, supra at 6. This rule is intended to prevent the
employee spouse from unilaterally depriving the nonemployee
spouse of his or her interest in the retirement benefits by
transmuting community property into separate property. In re
Marriage of Gillmore, 629 P.2d at 4; In re Marriage of Stenquist,
582 P.2d 96, 98 (Cal. 1978); In re Marriage of Fithian, 517 P.2d
449, 455 (Cal. 1974).6 Thus, California law protects the
substance of the former spouse’s community property rights even
though the employee spouse chooses to receive payments which are
not community property, such as income earned after the divorce,
instead of retirement benefits. See In re Marriage of Gillmore,
supra at 6.7
6 Similarly, employee spouses who are eligible to receive either retirement or disability payments may elect to receive disability payments. Disability payments are not community property under California law. In re Marriage of Jones, 531 P.2d 420, 425 (1975). However, in these situations, under California law a formerly married person is entitled to payments based on the amount of pension benefits to which the employee spouse would have been entitled if the employee spouse had not elected to receive disability payments. In re Marriage of Stenquist, 582 P.2d 96, 100-102 (Cal. 1978). 7 In In re Marriage of Gillmore, 629 P.2d at 6 n.7 (quoting Note, “In re Marriage of Stenquist: Tracing the Community Interest in Pension Rights Altered by Spousal Election”, 67 Cal. L. Rev. 856, 879 (1979)), the California Supreme Court included the following analysis:
“[F]rom an economist’s perspective, the employee spouse’s compensation for continued employment is not the full amount of his paycheck. Rather, his compensation is only that amount above the pension benefits that he will not receive while he continues (continued...) - 9 -
2. Federal Taxation of Income Paid Pursuant to Rights in Community Property
State law determines the rights of persons to income and
property, and Federal law governs the Federal taxation of those
rights. United States v. Natl. Bank of Commerce, 472 U.S. 713,
722 (1985); United States v. Rodgers, 461 U.S. 677, 683 (1983);
Aquilino v. United States, 363 U.S. 509, 513 (1960). Income is
taxed to the person who has the right to receive it. Poe v.
Seaborn, 282 U.S. 101, 111-112 (1930); Lucas v. Earl, 281 U.S.
111, 114 (1930). In Poe v. Seaborn, the U.S. Supreme Court held
that, under community property law in the State of Washington,
each taxpayer spouse owned an undivided one-half interest in the
income earned by each spouse during the marriage and was liable
for income tax on that one-half.8
7 (...continued) working. For example, in the matured pension situation, if the employee can receive retirement pay in the amount of X dollars without working, then his actual compensation for services rendered is not the amount of his paycheck, Y dollars, but Y minus X dollars. This is nothing more than a reapplication of the ‘benefits foregone’ formula of Stenquist (21 Cal.3d. 779, 148 Cal.Rptr. 9, 582 P.2d 96). [Fn. omitted.] Therefore, rather than penalizing the spouse for not retiring, the contrary is true--the community is being penalized because it is forced to subsidize the employee spouse’s salary, which becomes his separate property.” * * * 8 Poe v. Seaborn, 282 U.S. 101 (1930), gave married taxpayers in community property States the tax advantage of income splitting. In 1948, to reduce the disparity between community property and noncommunity property States, Congress (continued...) - 10 -
We followed Poe v. Seaborn in Eatinger v. Commissioner, T.C.
Memo. 1990-310. The taxpayer in Eatinger was the nonemployee
former spouse. The employee spouse retired in 1972 and was
receiving monthly pension payments which were community property.
The Eatingers divorced in 1977. The divorce court ordered the
employee spouse to pay his former spouse an amount equal to her
community property share of his monthly pension benefits. We
held that the payments that a former spouse was entitled to
receive because of her rights under community property law were
taxable to the former spouse. Similarly, the nonemployee former
spouse is liable for tax on his or her community property share
of a lump-sum distribution from a qualified pension plan. Powell
v. Commissioner, 101 T.C. 489, 498 (1993).
3. Respondent’s Contentions
Respondent contends: (a) Petitioner is taxable on the
payments he made to his former spouse on account of her community
property rights in his pension because, unlike the spouse in
Eatinger, petitioner was not yet receiving pension benefits; (b)
not taxing petitioner on payments he was required by California
community property law to make to his former spouse would be
8 (...continued) authorized married taxpayers to file joint Federal income tax returns. Revenue Act of 1948, ch. 168, 62 Stat. 110, 115. However, Poe v. Seaborn has not been overturned by Congress or overruled by the U.S. Supreme Court. - 11 -
contrary to the assignment of income doctrine; and (c) the result
in this case is determined by section 402 and the QDRO rules.
B. Whether the Fact That Petitioner Was Not Yet Receiving Pension Benefits Means He Is Taxable on Payments He Made to His Former Spouse on Account of Her Community Property Rights in His Pension
Respondent contends that the fact that petitioner was not
yet receiving pension benefits means he is taxable on payments he
made to his former spouse on account of her community property
rights in his pension.
The employee spouse in Eatinger v. Commissioner, supra, was
ordered to pay to his former spouse an amount equal to one-half
of his pension payments because his pension was community
property. See In re Marriage of Brown, 544 P.2d 561 (Cal. 1976).
That was also why petitioner was ordered to pay an amount equal
to one-half of the pension he would have received if he had not
elected to continue working past the date of his divorce. See In
re Marriage of Gillmore, supra at 6.
Respondent contends that cases relating to the taxation of
community property, such as Poe v. Seaborn and Eatinger, do not
apply here because petitioner’s postdivorce wages are not
community property. We disagree. Respondent’s argument
overlooks the fact that California community property rights do
not depend on the form of the payments received by the employee
spouse or the source of the payments to the former, nonemployee
spouse. In re Marriage of Gillmore, supra; In re Marriage of - 12 -
Stenquist, supra. Just as the rights of divorced spouses under
California law do not depend on the form of the payments to the
employee spouse, neither should the Federal taxation of those
rights. Generally speaking, money is fungible. See United
States v. Sperry Corp., 493 U.S. 52, 62 n.9 (1989); Berry
Petroleum Co. v. Commissioner, 104 T.C. 584, 643 n.37 (1995),
affd. without published opinion 142 F.3d 442 (9th Cir. 1998).
Because of the fungibility of money, we did not know whether the
employee spouse in Eatinger paid the nonemployee spouse from his
retirement benefits or from other funds. Similarly, whether
petitioner paid his former spouse from current wages or
retirement benefits is not determinative here. See Taylor v.
Campbell, 335 F.2d 841, 844-845 (5th Cir. 1964) (the source of an
otherwise deductible payment will not affect its deductibility
when proceeds from a property division in a divorce are used to
pay alimony); Benedict v. Commissioner, 82 T.C. 573, 579 (1984)
(quoting and applying Taylor v. Campbell, supra).
C. Whether Petitioner’s Position Violates Assignment of Income Principles
Respondent contends that the $25,511 petitioner paid to his
former spouse was an assignment of income that was taxable to
petitioner under Lucas v. Earl, supra. In Lucas v. Earl, supra
at 114-115, the U.S. Supreme Court disregarded for Federal income
tax purposes an agreement between a husband and wife to share
equally in the income each received. A holding for the taxpayers - 13 -
would have meant that they, by contract, would have had the
benefits of joint filing and income splitting, features not added
to the Federal income tax until 1948. See Revenue Act of 1948,
ch. 168, 62 Stat. 115.
Respondent’s reliance on Lucas v. Earl, 281 U.S. 111 (1930),
is misplaced. In that case, the Supreme Court decided how the
assignment of income doctrine applies to a contract between
husband and wife but did not discuss how the assignment of income
doctrine applies to community property.9 That issue was decided
in Poe v. Seaborn, 282 U.S. 101 (1930), in which, as stated
above, under community property law in the State of Washington,
each spouse was taxed on one-half of his or her own income and
one-half of the income of the other spouse. In Poe v. Seaborn,
the U.S. Supreme Court distinguished Lucas v. Earl on grounds
that the earnings of a taxpayer in a community property State
were the property of the community and not of the taxpayer
providing services to earn income. Because the nonemployee
spouse was entitled to the payments at issue here under community
9 The taxpayers in Lucas v. Earl, 281 U.S. 111 (1930), lived in California. In 1920-21, spouses in California did not have a vested present interest in all property of the community. Community Property--Income and Estate Taxes, 32 Op. Att’y Gen. 435, 456 (1921); Donworth, “Federal Taxation of Community Incomes–-The Recent History of Pending Questions”, 4 Wash. L. Rev. 145, 148 n.40 (1929). In Lucas v. Earl, the Supreme Court analyzed the issue based on contract law, not community property law. - 14 -
property law, Poe v. Seaborn, supra, applies, not Lucas v. Earl,
supra.
D. Whether Section 402 or QDRO Rules Govern This Case
Respondent argues that the payments are tax free to
petitioner’s former spouse under section 402(a)10 (and, we
assume, contends inferentially that they are taxable to
petitioner) because the payments were not distributions from her
former husband’s pension plan.11 Section 402(a) provides how
distributions made from a qualified trust under a qualified
pension plan are taxed. No distributions from a qualified trust
were made in this case. Thus, contrary to respondent’s argument,
by its terms section 402 does not apply to this case.12
We did not discuss section 402 in Eatinger v. Commissioner,
T.C. Memo. 1990-310, when we held that the nonemployee spouse was
10 Sec. 402(a) provides:
SEC. 402(a). Taxability of Beneficiary of Exempt Trust.--
Except as otherwise provided in this section, any amount actually distributed to any distributee by any employees’ trust described in section 401(a) which is exempt from tax under section 501(a) shall be taxable to the distributee, in the taxable year of the distributee in which distributed, under section 72 (relating to annuities). 11 Because petitioner’s former spouse is not a party in this case, we do not consider here how she might be taxed on the payments at issue. 12 Respondent does not cite or rely on Karem v. Commissioner, 100 T.C. 521 (1993). Unlike the instant case, Karem involved taxation of a distribution from a pension plan. - 15 -
taxable on her share of retirement benefits.13 Instead, we based
our decision on the former spouse’s ownership of retirement
rights under California community property law and the principle
that property is taxed to its owner. See Poe v. Seaborn, supra.
We believe the same approach is appropriate here.
An order to a retirement plan to pay an early retirement
benefit (i.e., a retirement benefit payable to the nonemployee
spouse before the employee spouse retires) can be a QDRO. Sec.
414(p)(4). Respondent contends that petitioner could have
obtained a QDRO providing an early retirement benefit to his
former spouse under which she would have been taxable on the
payments at issue.
Because domestic relations are preeminently matters of State
law, Congress rarely intends to displace State authority in this
area. Mansell v. Mansell, 490 U.S. 581, 587 (1989). Even if
petitioner could have obtained an early retirement QDRO,
respondent does not contend that Federal law prohibits the
arrangement under California community property law that was made
in this case; i.e., petitioner paid his former spouse the benefit
13 The pension plan in Eatinger v. Commissioner, T.C. Memo. 1990-310, was not a qualified trust because it was a Government plan, and, at that time, Government retirement plans were not qualified plans. Karem v. Commissioner, supra at 526 n.4; see H. Rept. 101-247, 1443 (1989). - 16 -
to which she would have been entitled if he had retired.14 Since
use of an early retirement QDRO was not required here, we see no
“clear and unequivocal” congressional intent for Federal law to
supplant State law, see Mansell v. Mansell, supra, and no reason
to avoid taxation of petitioner according to his rights and
obligations under California community property law.
E. Conclusion
We conclude that petitioner may reduce his gross income by
$25,511 for 2000.
Decision will be
entered for petitioner.
14 Cf. Ablamis v. Roper, 937 F.2d 1450, 1459-1460 (9th Cir. 1991) (Employee Retirement Income Security Act of 1974, Pub. L. 93-406, sec. 1056(d), 88 Stat. 829, preempted a predeceasing nonemployee spouse’s right under California community property law to leave her interest in her former husband’s pension to a third person in her will). The U.S. Court of Appeals in Ablamis did not consider the Federal tax consequences of application of community property law or hold that community property rights should be disregarded in applying Federal tax law.