Unpaid child support and alimony payments - bad debt deduction?

• Author: Price, Charles E.

Since 1965 there have been only two regular and four memo Tax Court decisions on bad debt deductions for unpaid child support and alimony payments. But the IRS apparently feels the issue is alive enough to issue Rev. Rul. 93-27. The Service seems to want to make it clear that arrearages in alimony or child support have no possibility of being deducted as a nonbusiness bad debt. The IRS should have little to fear since the decision has gone beyond the Tax Court only once (Imeson, 9th Cir., 1973, aff'g TC Memo 1969-180). And, in all cases the Service's position has been upheld.

One may ask why, 24 years after Swenson, 43 TC 897 (1965), the Tax Court decided to issue another regular opinion and even further why the IRS decided to issue a revenue ruling on the subject at all.

The Tax Court and the Service's position generally involves two points: the taxpayer never established a basis in the alleged debt or the worthlessness of the debt.

Taxpayer positions

Taxpayers have generally argued that a worthless debt is created by the unpaid court-ordered payments. As a result of the alleged unpaid debt, taxpayers seek a deduction under Sec. 166(a)(1). Sec. 166(b) provides that the amount of the deduction will be the adjusted basis provided in Sec. 1011 for computing gain or loss. This basis is provided for in Sec. 1012 as cost. Sec. 166(d) allows short-term capital loss treatment for the nonbusiness bad debts of noncorporate taxpayers.

The courts' analyses

The taxpayers generally argue that they have developed a creditor relationship with the former spouse for out-of-pocket payments they have had to make to support either their children (child support) or themselves (alimony). As long as these payments were more than the amount received from the former spouse, but not more than the amount originally ordered by the court, taxpayers allege that they should have a bad debt deduction.

The Tax Court has repeatedly stated that there is no creditor relationship. All the out-of-pocket payments made by the taxpayers are made at their own discretion and have no relationship to the court-ordered payments of former spouses. In Swenson, the Tax Court stated that it is a well-known principle that "bad debts" must be "debts created by advances out of capital or out of income previously taxed or exempted or, in other words, debts with a regard to which the taxpayer has a basis. The court continued:

Waldram's obligation to make the payments here involved was imposed...