Although the tax implications of alimony payments are relatively well-settled among the tax community, some divorce attorneys and CPA’s are unaware of the intricacies surrounding the deductibility of alimony payments. In certain situations, the misinterpretation of case law on the subject can lead to disastrous tax consequences, potentially giving rise to a malpractice suit. Because of this reality, competent tax counsel should always be consulted prior to giving advice on the legal consequences of an alimony obligation.
Section 71 of the Internal Revenue Code (IRC) provides that alimony payments are includable in the gross income of the spouse who receives them. Furthermore, IRC Section 215 provides for a deduction for the amount of alimony paid by the payor spouse. Those rules are relatively simple, but in practice, payment obligations that are called “alimony” or “spousal support” for family law purposes may not be respected as such for income tax purposes.
In order for a payment to be considered alimony or a “separate maintenance payment’ for federal income tax purposes, the payment obligation must, among other requirements, terminate upon the death of the payee spouse.[1] Payments that are made to a spouse that do not fall within the requirements of being alimony or a separate maintenance payment are generally considered to be nontaxable to either spouse.[2] Thus, payments made pursuant to an “alimony agreement” or any other memorialization that establishes spousal support payments that do not terminate at the death of the payee spouse may be nontaxable for income tax purposes. It should be noted that under the law of some states, the right to receive spousal support terminates at the death of either party unless there is an agreement to the contrary.[3]
It is easy to see that the payor spouse would prefer, for income tax purposes, to have payments made to their former spouse considered alimony because of their deductibility to the payor spouse. Conversely, the spouse receiving such payments would likely prefer that they not be characterized as alimony payments to avoid the income inclusion.
Often times, situations arise where spouses seek a lump-sum alimony payment. These situations can arise for many reasons, including when spouses agree to settle future alimony payment obligations with a current lump-sum payment or where an increase in alimony is sought. Some practitioners have been tempted to rely on Nye v. Commissioner for the principal that lump-sum payments under a court order are nontaxable if they lack a provision terminating the obligation upon the death of the payee spouse.[4]
In Nye, the payor spouse was ordered to pay the payee spouse $1,400 per month in alimony. The original divorce decree contained a clause that terminated the obligation upon the death of the payee spouse. Later, the parties returned to court where the recipient spouse was attempting to secure and increase in the alimony under the original divorce decree. They agreed to a consent judgement that discontinued the monthly alimony obligation and replaced it with the payor spouse paying the payee spouse two lump-sum payments of $50,000. The payor spouse took the position that the lump-sum payments were alimony for federal income tax purposes, because the lump-sum payments were a negotiated settlement based on the alimony under the original divorce decree. In disagreeing with the payor spouses position, the Tax Court stated that because the subsequent consent decree did not contain a terminate-at-death clause, the lump-sum payments did not qualify as alimony.
Notwithstanding the above, it is common for payee spouses to seek a writ of execution from a court in an attempt to recover back-alimony payments that have gone unpaid. Some divorce attorneys and CPAs may view this situation similarly to that of the situation in Nye. That is simply not the case. A taxpayer receiving a writ of execution from a court is not receiving a new judgement (like the consent judgement in Nye), but is instead receiving an order allowing them to collect on a prior obligation. If the prior alimony agreement/decree that the writ is based on met all of the qualifications of being characterized as alimony, monies recovered through a writ of execution should be afforded the same treatment as the payments would have been given if received according to the original instrument’s terms.
If a payee spouse receives a writ of execution allowing them to recover an arrearage of alimony and is successful in their efforts in recovering the back-alimony payments, such amounts recovered should be included in the recipient spouse’s gross income if the payments would have been considered taxable alimony when originally due. Failing to include alimony in the gross income of the payee spouse will result in the understatement of income and the underpayment of tax owed.
This nuance of tax law relating to alimony payments evidences the need for divorce and family attorneys to consult with competent tax counsel before advising clients on the taxability of alimony/spousal support payments and to deal with a myriad of tax related issues surrounding a divorce. Non-tax attorneys and most accountants are simply not as equipped to determine the tax consequences of payments made pursuant to a divorce or separation and other divorce related tax issues. Although not common, a practitioner who is aware of these rules but knowingly gives a taxpayer contrary advice could be found guilty of tax fraud and aiding and abetting tax evasion. Thus, extremely special care should be taken when dealing with payment taxability and other divorce related tax issues.
The tax and accounting professionals at the Tax Law Offices of David W. Klasing have experience in assisting divorce and family counsel in the determination of the taxability of payments made incident to a divorce or separation and other divorce related tax issues. Including an experienced tax attorney on a divorce team could save the parties involved a lot of money and many headaches. Don’t attempt to determine the tax consequences of complicated divorce matters alone. Contact the Tax Law Offices of David W. Klasing today.
[1] IRC Section 71(b)(1)(D).
[2] IRC Section 1014(a).
[3] California Family Code Section 4337 provides that “Except as otherwise agreed by the parties in writing, the obligation of a party under an order for the support of the other party terminates upon the death of either party of the remarriage of the other party.”
[4] Nye v. Commissioner, T.C. Memo. 2013-166, (2013).
