Baby Now We Got Bad Blood: Breakup Results in 1099-MISC & A Lawsuit

Your Guide to State, Local, Federal, Estate + International Taxation

From November 2009 until March of 2011, Lewis Burns (72) and Diane Blagaich (54) were romantically involved. During early 2010, Burns wired $200,000 to Blagaich’s bank account, gave her a $70,000 Corvette and wrote her various checks totalling $73,819 (in all, $343,819).

Burns had no desire to marry, but wanted to confirm his commitment to Blagaich and provide for her financially, so in November of 2010, the couple signed a written agreement promising to respect each other, spend time together, and be faithful to one another. The agreement also required Burns to make an immediate payment of $400,000 to Blagaich, which he did.

Alas, true love was not to be and the relationship deteriorated over the course of the next few months. In March of 2011, Blagaich moved out of Burns’ residence and Burns sent her a notice of termination of their agreement. Burns also claimed he suspected Blagaich had been unfaithful, despite her assurances to the contrary.

In late March 2011, Burns initiated a civil suit in the state court against Blagaich, seeking nullification of the agreement and return of the Corvette, diamond ring, and all cash that Burns had provided to her. He also filed a Form 1099-MISC with the Internal Revenue Service, reporting $743,819 in miscellaneous income payments to Blagaich for 2010.

Believing the money and car were gifts, Blagaich did not report the income on her 2010 return. Gifts are non-taxable under IRC Sec. 102(a). The IRS acted on the 1099-MISC and added the $743,819 to her taxable income for the year, assessing additional tax, penalties and interest. When Blagaich protested the assessment, the IRS asked the Tax Court to delay action on the case until the conclusion of the state court case.

In November 2013, the state court found that Blagaich had fraudulently induced Burns to enter into the agreement and ordered her to repay the $400,000 to Burns’ estate (Burns had passed away shortly after the trial). The Corvette, $200,000 wire transfer and various checks were found to be “clearly gifts” and she was entitled to keep them. Subsequently, one of the executors of Burns’ estate issued an amended 1099-MISC reducing the income reported to Blagaich in 2010 to $400,000.

Following the state court decision, the IRS concluded that Blagaich should be taxed on the entire $743,819. Blagaich disagreed, arguing that the IRS was bound by the state court ruling that $343,819 was a non-taxable gift. Also, since she’d repaid the $400,000 per court order, under the doctrine of rescission she should not be required to include that amount in income.

The Tax Court disagreed with Blagaich on both points. They pointed out that the IRS was not a party to the litigation over the nature of the $343,819 so were not required to adhere to the state court’s findings. They also found that the doctrine of rescission didn’t apply, thus, the full $743,819 was considered taxable income for federal purposes, even though a state court had found otherwise. I think it’s safe to say Burns and Blagaich are never ever ever getting back together.

By Janet Berry-Johnson, CPA