Continued from Tax Matters for Alimony and Maintenance - Part 1
Requirement of Divorce or Separation Instrument
To qualify as alimony or a separate maintenance payment, a payment must be received under a divorce decree or separation agreement. Such documents include:
- A decree of divorce or separate maintenance or a written court document describing the status of divorce
- A written separation agreement
- A decree requiring support or maintenance payments
Tip: The requirement of a divorce decree or separation agreement makes it imperative that during the separation period, the spouses put in writing their agreement on support until a more formal agreement is negotiated or until the divorce or separation is settled by the courts and a divorce decree is issued by the court.
A writing is all the more important in light of the fact that the courts can not go back and recharacterize payments as deductible alimony. So, if the payor makes payments that intended to be alimony and there is no written agreement for payments, the payor will not be able to take a deduction for the payments.
Which Instruments Qualify as a "Divorce or Separation Instrument?"
To qualify as alimony or maintenance, payments must be made under a divorce or separation instrument that divorces or legally separates the spouses, or under a written instrument arising out of the spouses' divorce or legal separation status. "Divorce instruments" include a decree of divorce, a decree of separate maintenance or a written instrument incident to the status of divorce. The term ''decree'' also includes court orders and judgments.
Instruments "incident to" the status of divorce include, among other things:
- Post-divorce written agreements that modify initial written alimony or support and maintenance obligations
- Post-divorce written agreements that modify a prior oral support agreement
- Decrees issued many years after the initial divorce decree
A ''written separation agreement'' requires a clear statement in written form memorializing or describing the terms of support between the parties. An oral agreement does not qualify, nor does an oral modification, or change, to a written agreement. In addition, payments made under a written separation agreement will be treated as alimony or maintenance payments even if the agreement is legally unenforceable under state law with respect to other, non-alimony matters covered by the agreement.
A "decree for support or maintenance of the other spouse" includes any type of court order or decree, such as interlocutory decree of divorce, which requires one spouse to make payments for the other spouse's support or maintenance. It is not necessary that the spouses be legally separated or divorced under a court order or decree, nor is it necessary for the order or decree for support to be for the purpose of enforcing the written separation agreement. A temporary support order can qualify as type of instrument.
What about payments made prior to the entry of a qualifying divorce or separation instrument? Such payments are not deductible as alimony.
Example: If H voluntarily paid support to W during a separation period, the voluntary payments are not deductible; a later, written separation agreement or court order attempting to recharacterize them, or specifically labeling them as "alimony" will have no effect.
There is one exception to the no-retroactivity rule. A nunc pro tunc court order will be given retroactive effect for federal tax purposes if it corrects a court decree that mistakenly failed to reflect the court's true intention at the time the initial decree was entered.
Requirement of Designating Payments
In order for a payment to be treated as alimony or a separate maintenance payment, the divorce decree or separation agreement cannot designate the payment as something other than alimony.
It is possible, then, for taxpayer-spouses to designate that payments otherwise qualifying as alimony or separate maintenance payments are nondeductible by the payor and excludible from gross income by the payee. The applicable tax regulations do not state exactly what a divorce or separation instrument must say, or what a divorce court must do, to "designate" non-alimony tax treatment of a payment.
Courts have stated that the instrument must contain a clear, explicit and express direction to that effect. Courts have not required that the designation mimic the statutory language or even specifically refer to IRC § 71 or § 215. All that is required is that the instrument contain the substance of a non-alimony designation.
Example: A statement that a payment "does not constitute, nor shall it be interpreted to be, any form of spousal support, alimony or child support," was a sufficient designation to make the payment non-alimony.
Tip: Given the ease of making an explicit designation of payments as non-alimony, there is no excuse for not doing so, if that is the parties' intent. An adequate statement would be: The [insert description of the specific payments] shall not be deductible as alimony by the payor under IRC § 215, and shall be excludable from the payee's gross income under IRC § 71.
Requirement of Living Apart
If spouses are legally separated under a decree of divorce or separate maintenance, a payment can qualify as alimony or a separate maintenance payment only if they are not members of the same household at the time the payment is made.This requirement does not apply if there is not a decree of divorce or legal separation.
A dwelling unit that was once the shared property of both spouses is not considered two separate households even if the spouses physically separate themselves within the dwelling unit. Internal Revenue Service regulations allow a one-month exception where spouses, who are legally separated under a decree of divorce or separate maintenance, can treat payments as alimony or separate maintenance even if they live in the same household.
Requirement that Payments Must Stop on Payee Spouse's Death
A payment can qualify as alimony or a separate maintenance payment only if the obligation to pay ends when the recipient spouse dies. If the payor spouse is obligated to continue making any part of those payments after the recipient's death, then none of those payments qualify as alimony or separate maintenance payments, whether made before or after the payee spouse's death.
Example: H is required by an instrument to make monthly payments of $2,000 to W for ten years. The instrument states that if W dies, the payments will be reduced to $800 per month. Of the payments made in all years, $1,200 are deductible by H and taxable to W, but $800 are neither deductible nor taxable because there is continued liability to make those payments after W's death.
It is not required that the divorce or separation instrument state explicitly that payments cease upon the payee spouse's death in order for this requirement to be met. If the document is silent on that matter, courts will turn to state law for guidance. If state law does not provide that alimony or separate maintenance payments terminate on the payee spouse's death, however, the divorce or separation instrument must do so, or the payments will not be treated as alimony for tax purposes.
Tip: Although not required, an explicit statement that the alimony payments terminate upon the payee spouse's death should always be included in a divorce or separation instrument. That way, there will be no need to rely on state law, which can be vague on the matter.
Alimony or maintenance payments are not deductible if the payor spouse is required to make any payment after the death of the payee spouse as a substitute for the continuation of pre-death payments. A payment is viewed as a substitute or continuation of payments that would otherwise qualify as alimony or separate maintenance to the extent it is to be made, increased, or accelerated as a result of the payee spouse's death.
Example: A divorce decree provides that H is to make monthly alimony payments of $800 to W for a period of ten years. The payments are to stop in the event of W's death. If she dies, however, H is to make payments of $500 per month to a trust for the children of H and W for a period ending ten years after execution of the instrument. The $500 payments to the children's trust are considered a ''substitute'' for $500 of the alimony payable to W. Consequently, only $300 of the payments to W are deductible as alimony.
Requirement that Payment Cannot be Child Support
To qualify as alimony or a separate maintenance payment, a payment cannot be for child support. If a divorce decree or separation agreement does not specifically fix a sum as payable for the support of the children, amounts paid that the children benefit from can be treated as alimony.
Example: The payment of utilities of the home where a payee spouse and children reside are deductible in full by the payor spouse if the divorce decree or separation agreement does not specifically fix a portion of the payments as child support.
Delinquent Alimony Payments
Alimony or spousal support payments that are delinquent continue to be deductible as alimony. So, if your alimony payments meet the above test, your eligibility for the deduction is not altered simply because you make a late payment to your former spouse.
Are you prepared?
As you can see, the taxability of alimony payments and receipts can be a complicated issue. There are numerous, stringent requirements that must be met before payments will be treated as alimony, and there are several ways that such tax treatment can be foiled. It is critical that you understand this test and requirements before you deduct payments you make or include as gross income the amounts you receive. A tax attorney, or an attorney with experience in family law matters, can be an invaluable resource if you are uncertain.