Payments to an ex-spouse are often part of a divorce. If you find yourself in that boat, consider treating some or all of the payments as tax-deductible alimony.
Watch Out for the Alimony Recapture Rule
Let’s assume you’ve successfully cleared the seven hurdles and payments to your ex-spouse qualify as deductible alimony.
That’s great, but you still have one more hurdle to go.
It’s the so-called alimony recapture rule. Under this rule, you must determine whether your deductible alimony payments are excessively front-loaded during the first two calendar years. Front loading refers to paying a large amount of alimony in the first two years.
If the payments are excessively front-loaded, 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 for the third year.
Correspondingly, your ex gets to claim a tax deduction for the recaptured amount for the relevant year.
Important: Only payments that are deducted as alimony in the first two years are subject to the 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 any alimony recapture.
The drawback is that your ex must report the alimony as taxable income.
The issue: Specific tax-law requirements must be met for payments to qualify as deductible alimony. It’s not enough for your divorce papers to say that certain payments are supposed to be deductible alimony. The intent of you and your ex is irrelevant. If you fail to set things up properly before you sign off on your divorce papers, it may be too late to salvage tax deductions.
For a payment to your ex to qualify as deductible alimony, you must meet the following seven requirements:
- The payment must be made under a written divorce or separation agreement.
- Your obligation to make payment (other than payment of delinquent amounts) must cease if your ex dies. If the divorce papers are silent on this issue, applicable state law determines if the requirement is met.
- The divorce papers cannot say the payment is something other than alimony.
- The payment must be in cash or cash equivalent.
- The payment must be made to or on behalf of your ex. Payments to such third parties as attorneys and mortgage lenders qualify if they are made on behalf of your ex as a requirement of the divorce or separation agreement or at the written request of your ex-spouse.
- The payment cannot be considered actual or deemed child support.
- After you are divorced or legally separated (considered divorced for federal income tax purposes), you and your ex cannot live in the same household or file a joint federal income tax return.
Key Point: Only payments that meet all these requirements will count 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 these requirements will be treated as either part of the divorce property settlement or as child support — both of which are nondeductible for you and tax-free for your ex.
Related Tax Court Decisions
This taxpayer lost: A Florida taxpayer ended his 40-year marriage by entering into a divorce settlement that included:
- A mutual waiver of alimony by both parties;
- An agreement on the distribution of marital assets, and
- A $40,000 equalization payment to his soon-to-be-ex.
The settlement stated that the $40,000 payment was “for equalization of the distribution of marital assets.” In other words, it was intended to achieve an equitable split of property. The taxpayer claimed an alimony deduction for the payment.
However, there was a question of whether the payment met the second and third requirements to qualify as deductible alimony: The obligation must end if the ex dies and the divorce papers cannot call the payment anything other than alimony. The IRS said they were not and denied the $40,000 alimony deduction.
The unhappy taxpayer took his case to the Tax Court, which agreed with the IRS.
According to the court, the requirement that the payment obligation must cease if the former spouse dies was not met because:
- The settlement agreement was silent on the subject, and
- Under Florida state law, the taxpayer’s payment obligation would not have terminated upon the death of his ex-wife.
The third requirement was not met, the court stated, because the settlement agreement described the $40,000 equalization payment as part of the couple’s property settlement rather than as alimony. (Roscoe McNealy, Tax Court Summary Opinion 2014-14)
This taxpayer won: An Oregon taxpayer paid 11 months of spousal support to his ex-wife in the year she died. He deducted the payments as alimony, but the IRS disallowed the deduction and hit the taxpayer with the 20% accuracy-related penalty. The disgruntled taxpayer took his case to U.S. Tax Court.
The question was whether the taxpayer met the requirement for payment obligations to cease upon his ex-wife’s death. His divorce decree was silent on the subject, so the court had to review applicable Oregon state law to resolve the issue.
According to the court, Oregon common law provided that the obligation to make spousal support payments terminates upon the recipient’s death. Therefore, the taxpayer’s 2008 spousal support payments qualified as deductible alimony, and he did not owe the 20% accuracy-related penalty. (Bradley Wignal, TC Memo 2014-22)
Key Point: Failure to specify in the divorce papers that payments will terminate if the recipient ex-spouse dies is probably the most-common reason that divorce-related payments unexpectedly fail to qualify as deductible alimony. This issue has been the subject of non-stop litigation over the years, and the beat goes on as these two court decisions illustrate.
Lessons for Other Taxpayers
Simply calling payments alimony in your divorce papers won’t entitle you to tax deductions. Instead, you must jump through specific tax-law hoops to secure the write-offs you are hoping for. You must also avoid the alimony recapture rule (see box above).
To get the best tax results when significant dollars are at stake, consult with your attorney and your tax advisor.