"Pension" Payments Made by Dissolved Corporation in Satisfaction of Shareholder's Alimony Obligations Were Not Deductible

In 1967, W and B founded the WSB Corporation; both W and B worked for WSB. From 1967 until 1983 or 1984, B was WSB's office manager and corporate secretary.

W and B were divorced in 1984. B began working less than full-time and ultimately an unrelated employee took over all her duties. B continued to receive a weekly paycheck from WSB; however, B's presence caused some disruption in WSB's office.

In 1989, B agreed to retire from WSB. She executed two agreements; one was a property settlement agreement between B and W, which specifically referred to a pension agreement that provided that WSB would pay B a weekly amount for life. The settlement agreement provided that the payments were in lieu of alimony.

WSB issued W-2s to B, reporting the pension payments as employee compensation and claiming a deduction for the payments. B reported no alimony income and W claimed no alimony deductions.

In 1997, WSB sold substantially all its assets to an unrelated third party. In connection with this sale, W and B released WSB from its obligations under the pension agreement.

The IRS issued a deficiency notice to WSB, disallowing any deduction for the pension payments to B. WSB argued that the amounts were deductible as business expenses, because they were part of a severance package to B and were made to induce B's retirement.

In a memorandum decision, the Tax Court holds for the Service; the payments were disguised alimony and not deductible as compensation.

Deductibility of Payments

This case raises the question of whether WSB is entitled to deduct payments it made to B after she ceased providing services to WSB. WSB argued that the payments were deductible for two reasons: (1) they were severance payments made in consideration for past services for which B had been undercompensated and (2) they served a business purpose by inducing B's retirement because her presence in the workplace disrupted WSB's operations. The IRS argued that the payments in actuality satisfied a shareholder's personal obligation—W's alimony obligations to B.

WSB relied heavily on the pension agreement to support its position that the payments to B were in the nature of severance or retirement benefits to compensate her for past services for which she was undercompensated. For a payment to be deductible as compensation, it must have been made with the intent to compensate. This is a question of fact decided on the basis of all the facts and circumstances of a given case. Further, transactions involving closely held corporations and their controlling shareholders demand close scrutiny. While the pension agreement did recite that B "during many years accepted compensation at a rate substantially less than her services would have commanded on the open market" and that WSB intended to "appropriately compensate" B's past service with a retirement pension, there is no evidence that B's compensation for past services was less than market rate or that the value of the payments provided in the pension agreement approximated the past undercompensation. Indeed, the available evidence points to a contrary conclusion that B was overcompensated for her services, at least during the period her weekly salary increased significantly notwithstanding the substantial curtailment of her responsibilities and time spent at the office. In the absence of corroborating evidence, we accord little weight to the self-serving recitals in the pension agreement.

We are similarly unimpressed with WSB's argument that its business interests were served by providing a monetary inducement for B to retire because her office presence had become disruptive. If an employee interferes with the efficient operation of an employer's business, we do not find it plausible that the employer would "induce" the employee to retire with an offer of full salary for life, adjusted for inflation. The provisions connected with the termination of B's services for WSB make considerably more sense when placed in the context of B's status as (1) the estranged former spouse of WSB's controlling shareholder and (2) the probable holder of a significant equitable interest in WSB, by virtue of her property rights arising from the marital relationship and/or her contributions as a cofounder to WSB's success.

The settlement agreement, which is clearly interdependent with the pension agreement, made the character of the payments clear and fully supports the Service's contention that the payments functioned as alimony or as a constructive dividend to B. Although WSB argued that the pension agreement and the settlement agreement are independent and separate, both agreements were executed on the same day and the settlement agreement made specific reference to the pension agreement. More significantly, the settlement agreement modified and supplemented the terms of the pension agreement, in one instance providing for a modification of the amount of the payments and in another supplementing the pension agreement's terms.

In addition, the settlement agreement effectively imposed obligations on WSB, despite the fact that it was not a party to the agreement. The settlement agreement did so by having WSB's controlling shareholders "agree" that the payments under the pension agreement would be increased in certain circumstances. Obviously, the settlement agreement contemplated that WSB's shareholders would use their controlling positions to implement any modifications in the payments mandated outside of the pension agreement's terms. In light of their contemporaneous execution and interrelated terms, the pension agreement and the settlement agreement governed the payments at issue in this case and both are therefore relevant in ascertaining the nature of the payments.

The settlement agreement by its terms constituted a settlement of B's and W's "respective rights and obligations against and to one another" in connection with their marriage and "a partition of all marital property." The settlement agreement acknowledged that both B and W have an interest in WSB and contains a detailed disposition thereof. The transfer to B of half of W's 80% stock interest is required. The settlement agreement then acknowledged WSB's obligation to make payments to B under the pension agreement and in the same section obligated W to cause WSB to provide B certain additional "benefits," including the use of two automobiles of her choosing, together with fuel and maintenance and payment of B's income tax liability arising from receipt of the foregoing, as well as health insurance comparable to that provided to W.

On the basis of these provisions, and the fact that the settlement agreement by its terms was intended to settle W's and B's "respective rights and obligations against and to one another," the payments satisfied B's rights to alimony and relieved W of an obligation to make alimony payments.

To the extent the payments relieved W of his obligation to pay alimony, they are nondeductible by WSB. A corporation's payment of its shareholder's personal expense or obligation is not deductible by the corporation.

WSB Liquidating Corp., TC Memo 2001-9