Andrew J. Redleaf and Elizabeth G. Redleaf contested the tax treatment of deferred cash payments made by Andrew to Elizabeth following their divorce, with the United States Court of Appeals for the Eighth Circuit reviewing decisions from the United States Tax Court. The key issue was whether these payments qualified as "spousal maintenance" under Minnesota law, specifically Minn. Stat. 518.552. The court affirmed the Tax Court's ruling that the payments were not deductible as alimony by Andrew, nor taxable as alimony income for Elizabeth.
The couple, married in 1984, divorced in 2008, agreeing to a Marital Termination Agreement (MTA) that stipulated Elizabeth waived her right to permanent spousal maintenance. Andrew claimed deductions for $51 million in payments made during 2012 and 2013, asserting they were deductible alimony. Conversely, Elizabeth argued the payments were nontaxable property transfers under 26 U.S.C. 1041.
The Commissioner of Internal Revenue issued deficiency notices to both parties, leading to their petitions before the Tax Court. The Tax Court sided with the Commissioner, determining that Andrew's payment obligations would persist despite Elizabeth's potential death and that the MTA explicitly excluded the payments from being included in Elizabeth's gross income. The appellate court reviewed the Tax Court's interpretation de novo and upheld both the disallowance of Andrew's deductions and the summary judgment favoring Elizabeth.
Former Section 215 of the Internal Revenue Code allowed deductions for alimony or separate maintenance payments under 26 U.S.C. 71. The Deficit Reduction Act of 1984 revised Section 71 to simplify the criteria for deductibility, removing subjective inquiries into the intent behind payments. Under the new 26 U.S.C. 71(b)(1), deductible payments must meet specific requirements: they must be received by a spouse under a divorce or separation instrument, not designated as non-deductible, made when the spouses are not living together, and not extend beyond the payee spouse's death. This revision aimed to clearly differentiate alimony from property settlements, preventing deductions for payments that effectively transfer property unrelated to the recipient's support needs.
The survival criterion in 26 U.S.C. 71(b)(1)(D) is critical for distinguishing between support and property settlements. Federal law governs the taxation of property interests determined by state law. The Tax Court, as noted in Hoover v. Comm’r, follows a sequential approach to assess whether a payor has ongoing payment obligations after the payee's death. This involves first checking for a clear termination provision in the divorce instrument, then assessing state law implications, and finally referring back to the divorce instrument if state law is ambiguous.
In the case of Andrew and Elizabeth, they stipulated in their marital settlement agreement (MTA) that Elizabeth would receive both family homes, most furnishings, valuable artwork, and four vehicles, while Andrew retained a piano, select artwork, one vehicle, and his 84.5% ownership interest in Whitebox Advisors, LLC, a hedge fund he founded in 1999. Andrew proposed this settlement just before business valuation appraisers were set to meet regarding the valuation of Whitebox, a key marital asset.
Elizabeth is to receive a total of approximately $140 million from Andrew as part of their marital asset settlement under Part VI, Paragraph 23 of the MTA. The payment schedule includes: $750,000 and $20 million due by February 15, 2008; $1.5 million monthly for 60 months starting March 15, 2008; and a final payment of $30 million due on March 15, 2013. Andrew has secured this settlement and will accelerate payments if there is a “Change of Control of Whitebox” before February 2, 2013.
Additional provisions in the MTA state that Elizabeth is not employed outside the home and has sufficient financial resources from the settlement to support herself and their minor child. Both parties have waived any rights to temporary or permanent spousal maintenance, divesting the court of jurisdiction to modify these terms, in accordance with relevant Minnesota statutes and case law.
The parties claim their property division is equitable, based on their contributions during the marriage, and agree not to contradict this division in any tax filings. The MTA clarifies that Andrew retains all rights to Whitebox, with Elizabeth waiving any claims to his business interests. Notably, the MTA lacks provisions regarding the tax treatment of payments as income or deductions and does not specify Andrew's obligations concerning payments after Elizabeth’s death.
Approximately eight months post-divorce decree approval, Andrew informed Elizabeth that the 2008 financial crisis affected his ability to make $1.5 million monthly payments related to Whitebox. Elizabeth refused to revisit the Marital Termination Agreement (MTA). Andrew ceased payments in January 2009 and sought to reopen the property division on the basis that equity had changed. The District Court denied his motion, stating he failed to demonstrate an unforeseen circumstance, as his market predictions were inaccurate. A year later, his renewed request to amend the decree was also denied. The court highlighted that the property settlement could not be reinterpreted as spousal maintenance, referencing specific paragraphs in the MTA and decree. The Minnesota Court of Appeals upheld this decision, confirming Elizabeth’s entitlement to half the value of Whitebox, which she opted to settle for cash without an appraisal.
The Tax Court noted ambiguity in the MTA regarding the survivability of payments upon Elizabeth's death. Under Minnesota law, maintenance is defined as payments from one spouse’s future income to support the other, terminating upon either party's death unless otherwise specified. Andrew contended that the payments would cease upon Elizabeth's death, aligning with the criteria for deductible alimony under federal law. However, this assumption incorrectly categorized the MTA as a maintenance order. Minnesota law requires evidence of need for maintenance, which Andrew argued was met due to Elizabeth's purported extravagant lifestyle. This argument contradicts established Minnesota case law, which emphasizes that maintenance must be based on demonstrated need.
The statute requires consideration of the financial resources of the party seeking maintenance, including marital property and independent financial capabilities (Minn. Stat. 518.552, Subd. 2(a)). In this case, there was an equal division of a significant marital estate over 32 years, allowing the wife to maintain her high standard of living, leading to the conclusion that the spousal maintenance award must be reversed. The Court has reiterated that only after establishing a spouse's need will the amount and duration of maintenance be evaluated (Curtis v. Curtis, 887 N.W.2d 249, 252 (Minn. 2016)). Minnesota law clarifies that the MTA was a contractual division of marital property, not a spousal maintenance agreement. Consequently, under Minn. Stat. 573.01, obligations from divorce agreements persist beyond the death of a party, indicating that payments are not deductible since they survive Elizabeth’s death. This aligns with 26 U.S.C. 71(b)(1)(D), which aims to prevent deductions for property transfers unrelated to support needs. Unlike Ohio law, Minnesota has removed prior references to “alimony,” establishing that only a maintenance order under Chapter 518 satisfies the applicable federal requirements. Additionally, the MTA explicitly states it was a property settlement, reinforced by Elizabeth's waiver of future spousal maintenance rights, leading the Hennepin County District Court to question the classification of the MTA as spousal maintenance. Ultimately, the Tax Court's Orders in Docket Nos. 10526-16 and 13901-17 are affirmed.
