Diez-Arguelles v. Commissioner
48 T.C.M. 496, 1984 T.C. Memo. 356, 1984 Tax Ct. Memo LEXIS 316 (1984)
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Rule of Law:
Uncollectible court-ordered child support payments are not deductible as a nonbusiness bad debt under I.R.C. § 166 because the recipient taxpayer has no tax basis in the obligation.
Facts:
- In 1972, Christina Diez-Arguelles divorced Kevin Baxter and was granted custody of their two children.
- A divorce decree incorporated a property settlement agreement requiring Baxter to pay Christina $300 per month for child support.
- From 1972 through 1978, Baxter failed to make the full required payments, accumulating an arrearage of $4,325.
- During 1979, Baxter paid only $600, resulting in an additional arrearage of $3,000 for that year.
- Due to Baxter's failure to pay, Christina and her new husband, Ernesto Diez-Arguelles, had to bear the entire cost of the children's support with their own funds.
- Christina diligently attempted to collect the past-due support payments through the divorce court but was unsuccessful.
- The Diez-Arguelleses deducted the unpaid amounts on their 1978 and 1979 joint income tax returns as nonbusiness bad debts.
Procedural Posture:
- The Commissioner of Internal Revenue issued notices of deficiency to Ernesto and Christina Diez-Arguelles for the 1978 and 1979 tax years, disallowing their claimed bad debt deductions for unpaid child support.
- The Commissioner later filed an amended answer increasing the deficiency determined for 1978.
- The Diez-Arguelleses, as petitioners, challenged the deficiencies by filing separate petitions for each year with the United States Tax Court.
- The Tax Court consolidated the two cases for trial, briefing, and opinion.
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Issue:
Does a taxpayer have a sufficient tax basis in uncollectible court-ordered child support payments to allow for a nonbusiness bad debt deduction under I.R.C. § 166?
Opinions:
Majority - Shields
No. A taxpayer does not have a sufficient tax basis in uncollectible child support payments to qualify for a bad debt deduction. A bad debt deduction under I.R.C. § 166(b) is limited to the taxpayer's basis in the debt. A taxpayer has no basis in unpaid child support because they have not made an outlay of capital that created the debt, nor have they previously recognized the unpaid amounts as taxable income. The court rejected the argument that spending one's own funds to support the children creates a basis in the debt, reaffirming its holdings in Swenson v. Commissioner and Long v. Commissioner. The court reasoned the taxpayer is not 'out of pocket' in a tax-recognizable sense, as they are merely spending their own funds on a pre-existing parental obligation, not making a loan or losing a previously taxed asset.
Analysis:
This decision reinforces the established tax principle that an economic loss does not automatically equate to a deductible tax loss. It solidifies the Tax Court's position that a 'basis' for a bad debt deduction requires either a cash outlay creating the debt (like a loan) or prior inclusion of the amount in income, neither of which applies to unpaid child support. The ruling prevents taxpayers from converting a personal financial hardship into a capital loss deduction, maintaining a clear line between nondeductible personal expenses and deductible investment or business losses.
