Originally published on Forbes.com Aug 12th, 2013
The way tax rules interact with divorces rules is complicated enough. Throw in military retirement rules and it can get very confusing. In the case of Elmer Nuss, it looks like the Administrative Division of the Alabama DOR came up with a reasonable response, but it also seems like it shouldn’t be this hard.
Mr. Nuss was divorced in 1998. The Court ordered that one half of his military retirement pay go to his ex. The case does not state this explicitly, but my inference is that the federal government was paying her directly. According to this, a state court can order any split it wants of military retirement pay, consistent with state law. There are limits, though, on what portion the federal government will pay directly to an ex-spouse. Apparently, that is what created the problem.
Disability pay is not subject to division as property. It is subject to garnishment for alimony or child support, however.
Mr. Nuss began receiving VA benefits, which reduced his retirement pay.
The ex-wife subsequently garnished the Taxpayer’s bank account to receive the difference between what she had received in military retirement pay before the Taxpayer began receiving the VA benefits, and the reduced amount she had received after he began receiving the VA benefits.
The Taxpayer filed a motion in Madison County Circuit Court to quash the garnishment. The Court ruled that the ex-wife had a vested interest in one-half of the Taxpayer’s military retirement pay, and that as a property settlement it could not be reduced. The Court accordingly ordered the Taxpayer to pay his ex-wife the difference between the reduced military retirement she received after the Taxpayer began receiving VA benefits and the amount she would have received but for the VA benefits. The Taxpayer paid those amounts to the ex-wife during the years in issue. He also deducted the amounts as alimony on his Alabama returns in those years.
Alabama Department of Revenue came after him about the alimony deduction. I always find reading cases more interesting if I root for one side or the other. I usually root for the taxpayer, unless they are being ridiculous (which is not all that uncommon). I have to tell you though, I am absolutely always going to root for a disabled veteran. So I am really pleased that Mr. Nuss won, even though I am not sure the decision is correct.
The problem that DOR had with the alimony deduction was that the assignment of retirement pay to the ex-spouse had been considered a “property settlement”. Alabama follows federal principles in this regard and most of the point of the rules about alimony seems to be to prevent property settlements being considered alimony. The ruling saw it differently:
….. the divorce decree specifies that the payment of one-half of the Taxpayer’s military retirement to his ex-wife constituted a property settlement. The Alabama Court of Civil Appeals has held on several occasions, however, that the substantive nature of an award given in a divorce decree takes precedence over the label applied in the decree.
There was no explicit provision in the agreement indicated that it was not to be included in gross income of the recipient and that was good enough. They cited Proctor, a 2007 United States Tax Court decision.
At the end of the day, this case is about how the benefit of converting from military retirement pay to veterans benefits should be divided. If the case had gone the other way, half the benefit would have gone to the ex-spouse. The simple guiding principles should be that when in doubt you go with the disabled veteran, but, of course, those judges can’t just come out and say that. As a practical matter, divorce agreements allocating military retirement payment should probably explicitly address what happens if the pay is reduced due to veterans benefits.
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