If payments qualify as alimony pursuant to federal tax law, the payments may be tax deductible by the payor spouse and included in gross income to the payee spouse. The opposite is true if the amounts are not alimony for federal tax law. Whether an expense counts as alimony is frequently the subject of disputes between taxpayers and the IRS.
The Common Alimony Tax Disputes
It is very common for the IRS, on audit, to recharacterize alimony payments. For payee spouses, this often results in the IRS finding that the spouse failed to report their alimony income. For the payor spouses, this often results in the IRS disallowing tax deductions for the alimony payments. The IRS and the courts often reach conflicting conclusions given which taxpayer is being examined, be it the payee or payor.
For example, in Przwoznik v. Commissioner, T.C. Summary Opinion 2008-50, the U.S. Tax Court found that “unallocated family support” was child support and not tax deductibe alimony. The U.S. Tax Court reached the opposite conclusion in Raga v. Commissioner, T.C. Summary Opinion 2008-46, finding that “unallocated maintenance and child support” was alimony and therefore it had to be included in the payee spouse’s gross income.
Other Alimony Tax Disputes
The alimony tax rules also result in several other types of tax disputes for unwary taxpayers.
For example, in Melvin v. Commissioner, T.C. Memo. 2008-115, the U.S. Tax Court concluded that transfers of property made several years in advance of the divorce that were accepted by the payee spouse in satisfaction of later alimony payments were not paid in cash and therefore did not entitle the payor spouse to a tax deduction.
In Morris v. Commissioner, T.C. Memo. 2008-65, the U.S. Tax Court concluded that the payor spouse was not entitled to deduct alimony payments because he failed to substantiate that the payments were alimony and not child support.
Alimony Tax Planning Can Help
With advance tax planning, these problems may have been avoided. This type of tax planning may allow the separating and divorcing spouses to recognize significant federal income tax savings.
Separating and divorcing spouses should be aware of what payments do not qualify as alimony for purposes of federal tax law. Generally, payments do not qualify as alimony for purposes of federal tax law if:
- the payments are not made pursuant to a divorce decree or separation agreement,
- the spouses are married and file a joint tax return (married couples who file a joint tax return may qualify for innocent spouse relief),
- the spouses are members of the same household at the time the payments are made,
- the divorce decree or separation agreement designates the payments as non-alimony,
- there is an obligation to continue the payments after the death of the payee spouse (either in the decree or agreement or in state law),
- the payments consist of property rather than money,
- the payments call for significantly larger payments in the first three years following separation or divorce,
- the payments are for the payee spouse’s bills (such as mortgage payments and real estate taxes), and
- the payments are child support.
Ideally, one or both of the separating or divorcing spouses will consider these rules. This may even be raised as part of an innocent spouse claim filed during marriage or after divorce.
Also, spouses should ensure that their divorce decrees or separation agreements are written in a way that addresses these rules. As with other major financial transactions, taxpayers should consult with their tax counsel if they have any doubt about the taxation of their alimony or other payments.
In 40 minutes, we'll teach you how to survive an IRS audit.
We'll explain how the IRS conducts audits and how to manage and close the audit.