Mitchell v. Comm'r

OPINION

Respondent determined a deficiency of $1,471 in petitioners’ Federal tax for 2001. The issue for decision is whether $5,126 received by petitioner Maria A. Walton Mitchell (petitioner) for her interest in her former husband’s military retired pay is includable in her gross income. For the reasons stated herein, we hold that it is.

Background

The following facts are stipulated or are not disputed by the parties. The parties’ stipulation of facts and the accompanying exhibits are incorporated herein by this reference.

Petitioners resided in California at the time that the petition was filed.

Before her marriage to Larry G. Mitchell, petitioner was married to Bobbie Leon Walton. At the time of their marriage, Mr. Walton was on active duty in the U.S. Air Force (USAF). Mr. Walton and petitioner separated in 1985. Pursuant to a final judgment entered by the Superior Court of the State of California (superior court) their divorce became final on August 29, 1986. On August 1, 1990, Mr. Walton retired from the USAF after 26 years on active duty and began receiving military retired pay. Petitioner subsequently petitioned the superior court with respect to her interest in Mr. Walton’s military retired pay. On January 2, 1991, the superior court entered an order (order) which stated in pertinent part:

2. Servicemember [Mr. Walton] retired from the United States Air Force on August 1, 1990, with fully vested retirement rights and benefits, a portion of which are community property of Servicemember and of Servicemember’s former spouse,

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4. * * * [Petitioner] is now entitled to an order dividing the military retirement to the extent same was earned by Servicemember during the marriage to * * * [her].

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8. * * * [Petitioner] shall be awarded as her sole and separate property, one-half (Vz) of the community property interest in Servicemember’s net disposable military retirement pay as set forth in the California case of Mansell v. Mansell decided by the U.S. Supreme Court on May 30, 1989, wherein the net disposable military retirement pay is defined as the net after deducting (a) amounts owned [sic] by the military member to the United States; (b) required by law to be deducted from total pay, including employment taxes, and fines and forfeitures ordered by courts-martial; (c) properly deducted from Federal, State and [sic] income taxes; (d) withheld pursuant to other provisions under the Internal Revenue Code; (e) deducted to pay government life insurance premiums; and (f) deducted to create an annuity for the former spouse (10 U.S.C. #1408 (a)-(4)-(A)-(F)).

9. The community property interest in the Servicemember’s net disposable retirement pay is determined to be 48.7%.

10. * * * [Petitioner’s] interest in Servicemember’s net disposable retirement pay is determined to be 24.35%.

Attached to the order was a factsheet titled “DIRECT PAYMENTS FROM U.S. AIR FORCE RETIRED PAY PURSUANT TO THE UNIFORMED SERVICES FORMER SPOUSES’ PROTECTION ACT” (factsheet). The factsheet stated in pertinent part:

j. Taxes may be held only from the Air Force retiree’s pay. Funds may not be held for taxes from the ex-spouses portion. For further information, we refer you to the nearest Internal Revenue Service office.

Sometime in 1991 petitioner began receiving monthly payments from the Defense Finance and Accounting Service (DFAS) for her interest in Mr. Walton’s military retired pay pursuant to the order. For the taxable year 2001 she received payments from DFAS in the aggregate amount of $5,126. DFAS issued to petitioner a Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., for the taxable year 2001 which reported both the gross distribution and the taxable amount as $5,126 and the amount of Federal income tax withheld as zero.

Petitioners timely filed a joint Form 1040, U.S. Individual Income Tax Return, for 2001 but did not report the $5,126 distribution that petitioner received from DFAS. On November 10, 2003, respondent issued to petitioners a notice of deficiency for the taxable year 2001. In the notice respondent determined that petitioners failed to report the $5,126 in their gross income.

On February 9, 2004, petitioners filed an imperfect petition. On March 26, 2004, petitioners filed an amended petition alleging that taxes were to be taken into account before petitioner was issued her share of Mr. Walton’s retirement benefits and that if petitioner’s share were taxed, it would be subject to double taxation.

A trial was held on June 24, 2005, in Los Angeles, California.

Discussion

Petitioners argue that taxes should have been withheld on the entire amount of the pension payments disbursed to Mr. Walton before petitioner was paid her share. Petitioners maintain that if petitioner is required to pay Federal income tax on her share, then Mr. Walton’s pension is being subject to double taxation, both on disbursement to Mr. Walton and again when petitioner receives her share. Respondent argues that tax was withheld only on Mr. Walton’s share of the military pay, not on petitioner’s share.2

Petitioner’s interest in the military retired pay was determined according to the laws of the State of California. In the State of California, community property principles apply in divorce proceedings. Consistent with these principles, each spouse is considered to have a one-half ownership interest in all property earned by either spouse during the marriage. See Cal. Fam. Code sec. 2550 (West 2004). In McCarty v. McCarty, 453 U.S. 210 (1981), the Supreme Court held that the Federal statutes then governing military retirement pay prevented State courts from treating military retirement pay as community property. In response to McCarty, Congress enacted in 1982 the Department of Defense Authorization Act, 1983, Pub. L. 97-252, sec. 1002, 96 Stat. 730 (1982), which added section 1408 to title 10 of the United States Code. Under 10 U.S.C. sec. 1408(c)(1) (2006), a State court may treat disposable military retired pay in a divorce proceeding either as property solely of the servicemember or as property of the military retiree and his or her spouse in accordance with the law of the jurisdiction of the court. If a divorce was effective before February 3, 1991, only the disposable retired pay, which is the total monthly retired pay to which a member is entitled less, inter alia, amounts properly withheld for Federal, State, or local income taxes, may be treated as the property of the member and his spouse. 10 U.S.C. sec. 1408(a)(4) (1988); National Defense Authorization Act for Fiscal Year 1991 (NDAA), Pub. L. 101-510, sec. 555(b)(3), (e)(2), 104 Stat. 1569, 1570 (1990).

Under California law post -McCarty, military retirement benefits earned during marriage are community property. Casas v. Thompson, 720 P.2d 921, 925 (Cal. 1986); see Gillmore v. Gillmore, 629 P.2d 1, 3 (Cal. 1981).

While State law determines the nature of a property interest, Federal law determines the Federal taxation of that property interest. United States v. Mitchell, 403 U.S. 190 (1971). Furthermore, the tax liability for income from property attaches to the owner of the property. Eatinger v. Commissioner, T.C. Memo. 1990-310 (citing Helvering v. Clifford, 309 U.S. 331, 334 (1940), Blair v. Commissioner, 300 U.S. 5, 12 (1937), Poe v. Seaborn, 282 U.S. 101 (1930), and Lucas v. Earl, 281 U.S. 111 (1930)).

As a general rule, the Internal Revenue Code imposes a tax on the taxable income of every individual. See sec. 1. For purposes of calculating taxable income, section 61(a) defines gross income as “all income from whatever source derived” unless otherwise specifically excluded. Gross income specifically includes amounts derived from pensions. Sec. 61(a)(ll). Military retired pay constitutes a pension within the meaning of that section. See Eatinger v. Commissioner, supra (“A military retirement pension, like other pensions, is simply a right to receive a future income stream from the retiree’s employer.”); sec. 1.61-2(a)(l), Income Tax Regs.; sec. 1.61-11(a), Income Tax Regs. (“Pensions and retirement allowances paid either by the Government or by private persons constitute gross income unless excluded by law.”); see also 10 U.S.C. 1461(a) (2006) (defining the Department of Defense Military Retirement Fund).

Under section 402(a) a pension distribution is normally taxed to the distributee. Pursuant to section 402(e)(1)(A), the spouse or former spouse is treated as the distributee with respect to distributions allocated to that spouse pursuant to a qualified domestic relations order (qdro), and such distributions therefore become taxable income to that spouse. The spouse receiving the distribution pursuant to the QDRO is also known as an “alternate payee”. Secs. 402(e)(1)(A), 414(p)(8).

A domestic relations order (dro) qualifies as a QDRO only if it: (1) Creates or recognizes the existence of an alternate payee’s right to, or assigns to an alternate payee the right to, receive all or a portion of the benefits payable with respect to a participant under a plan; (2) clearly specifies facts required by section 414(p)(2); and (3) does not alter the amount or form of the plan benefits. Sec. 414(p)(l)-(3). In addition, the DRO must be presented to the plan administrator, who must determine whether it is a QDRO. Sec. 414(p)(6). Finally, under section 402(e)(1)(A) an alternate payee is treated as the distributee of a distribution from a qualifying plan only if the distribution is made to the alternate payee under a QDRO. The parties do not dispute that the order constitutes a QDRO, and we agree that the order satisfies the requirements of section 414(p).

Nonetheless, even if the superior court order had not constituted a QDRO under section 414(p), petitioner’s interest in the military retired pay would be taxable income to her on the basis of community property law. See Powell v. Commissioner, 101 T.C. 489, 498 (1993); Eatinger v. Commissioner, supra.

Petitioners do not dispute that the superior court awarded petitioner a community property interest in Mr. Walton’s military retired pay and that she received $5,126 pursuant to the QDRO. Instead, petitioners argue that the payments petitioner received for her interest in Mr. Walton’s military retired pay are not subject to income tax because the QDRO specified that all taxes should have been withheld from the military retirement pay before it was divided and distributed. Petitioner draws support for this argument from a paragraph in the factsheet attached to the QDRO which stated in pertinent part:

i. The amount payable to a spouse or former spouse under this law is limited to 50 percent of the disposable retired pay. Please see 10 U.S.C. sec. 1408(a)(2)(C) and (e)(1). [Emphasis added.]

The QDRO defined “net disposable military retirement pay” as “the net after deducting * * * properly deducted Federal, State and [sic] income taxes”. This definition is consistent with the plain language of 10 U.S.C. sec. 1408(a)(4)(C) (1988), as it was in effect when the superior court entered both the final judgment and the QDRO.

Congress recognized that subtracting tax withholdings from the computation of disposable retired pay created unfairness to the service member’s spouse. H. Rept. 101-665, at 279-280 (1990). Accordingly, Congress amended the definition of “disposable retired pay” such that the disposable retired pay is not reduced by income taxes withheld. 10 U.S.C. sec. 1408(a)(4) (Supp. ill 1991); NDAA sec. 555(b)(3), (e)(2). This amendment, however, is effective only for divorces entered into on or after February 3, 1991, which is after both petitioner’s final judgment and the QDRO and is therefore not applicable in the instant case. See 10 U.S.C. sec. 1408(a)(4) (Supp. ill 1991); NDAA sec. 555(b)(3), (e)(2).

The calculation of disposable retired pay, however, does not mean that petitioner’s allotment is not taxable, nor does it mean that petitioner’s allotment is exempt from tax because tax was already withheld on Mr. Walton’s allotment. Title 10 U.S.C. sec. 1408(a)(4) (2006) merely defines petitioner’s property rights in the military retired pay, not the tax consequences of her receipt of the benefit. Because the State of California is a community property State, petitioner is treated as having earned the distributions she is currently receiving. Accordingly, petitioner is liable for tax on those distributions, regardless of the terms of the QDRO.

Petitioner essentially argues that her disbursement is being subjected to double taxation. Petitioner, however, did not produce any evidence, and the record is void of any evidence, that double taxation occurred. Petitioner did not provide any evidence about the amount of the pension which was included in Mr. Walton’s taxable income. Moreover, there is nothing in the QDRO stating that petitioner’s interest in Mr. Walton’s military retired pay is not taxable or has already been subject to tax. As indicated above, the factsheet provides in pertinent part that “Taxes may be held only from the Air Force retiree’s pay. Funds may not be held for taxes from the ex-spouses [sic] portion.” This supports respondent’s argument that taxes were not withheld on petitioner’s portion of the military retired pay.

On the basis of the law as it was in effect on the date of petitioner’s final judgment and the date of the QDRO, petitioner’s interest is calculated on Mr. Walton’s military retired pay less income tax withheld. Petitioner provided no evidence that income taxes were withheld from her portion of the military retired pay. As explained earlier, petitioner’s interest is taxable. Accordingly, we conclude that the $5,126 petitioner received in 2001 for her interest in Mr. Walton’s military retired pay is includable in petitioners’ gross income.

To reflect the foregoing,

Decision will be entered for respondent.

Reviewed by the Court.