After a married couple has filed a divorce petition, the higher-earning spouse often must make various types of support payments to the lower-earning spouse. Some of these payments represent alimony and separate maintenance payments (referred to simply as alimony in this column), which are deductible by the payer and are taxable income to the payee. Other payments represent nondeductible child support and/or property distribution payments.
Taxpayers are free to choose the tax effect of alimony. It can either be deductible to the payer and taxable to the payee or receive the same tax treatment as child support if an “election out” is made. With child support payments or property settlements (i.e., payments that do not qualify as alimony), however, there is no option. Such payments are always nondeductible to the payer and nontaxable to the payee.
The IRS governs tax treatment of alimony, not divorce agreements or court orders. There are several definitions of alimony and/or spousal support. Since each of these definitions is different, you must take care not to assume that an item called “alimony” or “spousal support” qualifies as such under the tax code. It is entirely possible for a divorce instrument to call a given payment “alimony” even though it does not qualify as alimony for income tax. Likewise, it is possible a payment can be treated as alimony for income tax purposes even though it does not qualify as alimony under state law.
For a divorce after 1984, a payment is treated as alimony for federal tax purposes if all the following requirements are met:
- The payment must be made under a divorce decree (or a written instrument incident to such a decree) or a written separation agreement.
- Spouses cannot live together after legal separation or divorce.
- The payment must be in cash or cash equivalents.
- The payment must be paid to (or on behalf of) a spouse or former spouse.
- The divorce or separation instrument cannot specifically state that payments are not alimony.
- The spouses must file separate tax returns.
- The payment cannot be called child support or deemed to be child support.
- There must be no obligation to pay if the receiving spouse has died (unless it is a delinquent amount that was owed prior to the spouse’s death).
Divorce decrees and related agreements frequently contain multiple provisions requiring one spouse to make payments to or on behalf of the other spouse. Each payment or stream of payments is tested separately for all alimony criteria. If a payment or stream of payments fails one of the tests, that payment cannot be treated as alimony for tax purposes. Other payments or streams of payments that meet all the tests qualify as alimony even though one or more of the payments do not.
Spouses should consult with their CPA during the negotiation and drafting of the separation agreement or divorce settlement.
The requirement that a payment must be to or on behalf of a spouse or former spouse means that payments made to a live-in companion, commonly called palimony, do not qualify as alimony. Palimony may be subject to gift tax or other provisions.
This is an excerpt from a publication on November 1 2011 by Albert B. Ellentuck Esq., which was adapted from a case study from PPC’s Guide to Tax Planning for High Income Individuals, 12th Edition, by Anthony J. DeChellis, Patrick L. Young, James D. Van Grevenhof, and Delia D. Groat, published by Thomson Tax & Accounting, Ft. Worth, TX, 2011 ((800) 323-8724; ppc.thomson.com).