The Tax Court held that a taxpayer’s share of her ex-husband’s military retirement payments was subject to tax despite the fact that a domestic relations order specified that taxes were to be withheld from the payments before the taxpayer’s share of the payments was determined.
Maria Mitchell was formerly married to Bobbie Walton, a member of the U.S. Air Force (USAF). Walton and Mitchell divorced in California, a community property state. Under a qualified domestic relations order (QDRO) issued after Walton’s retirement from the USAF, Mitchell was awarded one-half of the community property interest in Walton’s net disposable military retirement pay. The QDRO defined net disposable military retirement pay as gross retirement pay less a variety of deductions, including withholding for income taxes.
After Walton’s retirement in 1991, Mitchell began receiving payments from the Defense Finance and Accounting Service (DFAS) for her share of Walton’s retirement pay. Mitchell did not include the payments that she received in income in any year. In 2003, the IRS sent Mitchell a notice of deficiency for tax on the payments she received in 2001. Mitchell filed a petition with the Tax Court challenging the notice of deficiency.
Mitchell argued that the payments she received for her interest in Walton’s military retirement pay were not subject to income tax because the QDRO specified that the DFAS should have withheld all taxes from Walton’s military retirement pay before it divided and distributed the pay. Therefore, according to Mitchell, the DFAS should have withheld taxes on the full amount of Walton’s retirement pay before it paid Mitchell her share. Because the DFAS did not do this, Mitchell contended that if she were required to pay tax on her share, then Walton’s retirement pay would be subject to double taxation, having been taxed once when distributed to Walton and again when Mitchell received her share. The IRS countered that although the DFAS withheld tax on Walton’s retirement pay, it only withheld tax on his share of it.
Tax Court’s Decision
In a decision reviewed by the full court, the Tax Court held that Mitchell’s arguments were without merit and that the retirement pay she received was taxable. The Tax Court found that the method of calculating the portion of Walton’s retirement pay to which Mitchell was entitled had no bearing on whether the payments she received were taxable, nor did it mean the payments were exempt from tax because tax had already been withheld from them.
According to the Tax Court, the method of calculation specified in the QDRO merely defined Mitchell’s property rights in Walton’s military retirement pay, not the tax consequences of her receipt of the benefit. Under California community property law, Mitchell was liable for tax on those distributions, regardless of how their amount was calculated under the QDRO. Finding that Mitchell had provided no other evidence that the payments had been subject to double taxation, the Tax Court held that Mitchell was subject to tax on the payments she received.
Mitchell had previously litigated the same issue with respect to the retirement payments she received in 2000 in a Tax Court small case proceeding (Mitchell, T.C. Summ. 2004-160). Although the Tax Court did not address the argument, the IRS contended that because she had already litigated the issue, Mitchell’s case should have been dismissed under the doctrine of collateral estoppel, which bars relitigation by the same parties of an issue that has already been decided in a previous case.
In a concurring opinion, Tax Court Judge Holmes argued that the Tax Court should have availed itself of this opportunity to rule on whether a decision in a small tax case estops a party from litigating the same issue in a regular tax case. While on previous occasions the Tax Court has said that it would apply collateral estoppel to small tax case decisions, the fact that it heard and decided the second Mitchell case seems to contradict that stance. While the small case decisions are without precedential effect, Judge Holmes argued that the Tax Court’s decision means “that they are without effect on future litigation at all.”
Mitchell, 131 T.C. No. 15 (2008)
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