As we all know, some marriages disintegrate and payments may have to be made to the ex-spouse. It can be a big help if the spouse making the payments can treat some or all of them as tax-deductible alimony.
On the other side of the coin, amounts that can be deducted as alimony must be reported as taxable income on the ex’s tax return.
The hard part can be meeting the tax law requirements for deductible alimony. If you fail to set things up properly before you sign off on your divorce papers, it may be too late to salvage deductions — as one Tax Court decision illustrated. We will provide details of the case but first, here are the rules and how to get the best tax results for payments to an ex-spouse.
For a payment to your ex to qualify as deductible alimony for federal income tax purposes, seven requirements must be met.
1. The payment must be made under a written divorce or separation agreement.2. Your obligation to make payment (other than a payment of delinquent amounts) must cease if your ex-spouse dies.
3. The payment must be in cash or cash equivalent.
4. The payment must be made to or on behalf of your ex. Payments to third parties, such as attorneys and mortgage lenders, are okay if they are made on behalf of your ex pursuant to the divorce or separation agreement or at the written request of your ex.
5. The payment cannot be considered fixed or deemed child support (see right-hand box).
6. The divorce or separation agreement cannot say the payment is not alimony.
7. After you are divorced or legally separated (meaning after you are considered divorced for federal income tax purposes), you and your ex cannot live in the same household or file a joint Form 1040.
Only payments that meet all of these requirementscount as deductible alimony — regardless of what the divorce decree might say about the payments and regardless of what you and your ex might intend.
More specifically, payments that fail to meet all of these requirements will be treated as either part of the divorce property settlement or as child support — both of which are non-deductible for you and tax-free for your ex-spouse.
Avoiding Alimony Recapture
Let’s assume you’ve successfully cleared all the hurdles explained so far. There’s still one more requirement to go. It’s the so-called alimony recapture rule. Under this rule, you must make a calculation to figure whether your deductible alimony payments are excessively “front-loaded” during the first two calendar years. If they are, you must recapture in the third year some of the deductions you claimed in the first two years.
In other words, you must report the recaptured amount as taxable income on your Form 1040 for the third year. Correspondingly, your ex-spouse gets to claim a deduction for the recaptured amount on his or her return for that year.
Important Point: Only payments that are deducted as alimony in the first two years are subject to the alimony recapture rule. However, payments in the third year must be taken into account in calculating if you have any alimony recapture. Payments in the fourth year and beyond do not affect the alimony recapture calculation.
Facts of the Tax Court Case
Dan Vladimir Nicolas was formerly married to Marta Euginia Nicolas. An Oregon court entered judgment to dissolve their marriage and ordered the husband to pay his ex-wife $400 per month for eight months. The court granted the ex-wife’s request for $6,829 of attorney fees and costs from Mr. Nicolas.
The Tax Court ruled that the husband’s court-ordered payments to cover his ex-wife’s attorney fees did not qualify as tax-deductible alimony because the divorce papers did not specify that the payment obligation would cease if the ex-wife died. Therefore, requirement number 2 (from the above list of seven requirements) was not met. (Dan Vladimir Nicolas, TC Summary Opinion 2011-91)
Observation: Failure to specify that payments are not required to continue after an ex-spouse dies is probably the most-common reason that divorce-related payments unexpected fail to qualify as deductible alimony.
Just calling payments deductible alimony in your divorce papers will not get the job done. Instead, you must jump through some tax law hoops to secure the write-offs. Plus you’ll need to spread out the payments in order to avoid the alimony recapture rule.
To get the best tax results when significant dollars are at stake, consult with your attorney or tax adviser.