In the recent case of Leslie v. Commissioner (T.C. Memo, 2016-171), the Tax Court had an opportunity to review the different tax treatments that apply to payments for spousal support compared with a property settlement. In connection with their pending divorce, Maria Leslie and her husband, Byron Georgiou, entered into a marital separation agreement. Under the agreement, Ms. Leslie received a number of different payments. Her husband, an attorney, became involved in the Enron class action litigation and intheir separation agreement agreed to pay Ms. Leslie an amount equal to 10 percent of whatever fee he might receive as a result. The agreement did not specifically stipulate that this contingent payment would terminate upon the death of Ms. Leslie; however, it did state that it was to be considered spousal support and intended to be deductible by Mr. Georgiou and includible in income by Ms. Leslie. He ultimately received $55 million in fees from the Enron litigation, to be paid during the period 2008 through 2010.

Payments of spousal support are typically deductible by the spouse making the payment and taxable to the spouse receiving the payment. Transfers pursuant to a settlement of the parties’ property rights are generally not subject to tax. For payments to be considered spousal support: (i) the payments must be received by the payee spouse under a divorce or separation instrument; (ii) the payments must not be designated by the instrument as payments that are not includible in the recipient’s income and not deductible by the payer; (iii) if the payee and payer are legally separated rather than divorced, they cannot be members of the same household at the time the payments are made; and (iv) the payments must terminate on the death of the payee spouse.

Ms. Leslie received approximately $5 million out of the Enron fee and took the position that it was part of a nontaxable property settlement, rather than taxable spousal support as provided in the separation agreement. Her position was based on the fact that even though the separation agreement designated the Enron payment as spousal support, it failed to specify that the payment was terminable upon her death.

The Tax Court determined that even though the separation agreement did not specifically state the payment would terminate upon the death of Leslie, it was nevertheless properly treated as taxable spousal support because a provision of California law provided that the payment would terminate upon the death of Ms. Leslie. Section 4337 of the California Family Code provides “except as otherwise agreed by the parties in writing, the obligation of a party under an order for the support of the other party terminates upon the death of either party or the remarriage of the other party.”

Fortunately for Mr. Georgiou (and unfortunately for Ms. Leslie), his tax deduction was salvaged by the California statute. The better practice for payments that the parties intend to be treated as spousal support is to provide in the agreement or court order that the payments will terminate upon the death of the recipient spouse.