Taxation of Alimony
Trump's tax law will not require the recipient spouse to treat alimony payments as taxable income. The tax law change will apply to alimony mandated by divorce or separation agreements or court orders executed after December 31, 2018. Likewise, the new law eliminates the deduction to the payor spouse. This change in the tax treatment of alimony payments is required under divorce or separation instruments that are: (1) executed after Dec. 31, 2018; or (2) modified after that date if the modification specifically states that the alimony payments are to subject to the new tax law regime i.e., not deductible by the payer and not taxable income for the recipient.
Alimony required by divorce or separation agreements executed prior to December 31, 2018, will continue to be deductible to the payor and taxable income to the payee according to existing rules. These existing rules provide that alimony payments are includible in the payee's income under section 71 of the Internal Revenue Code. For tax purposes, payments qualify as alimony only if certain requirements are met. The requirements, see IRC section 71(b)(1), are as follows:
1. The payments are made in cash;
2. Payments are made under a divorce or separation order;
3. Payments are made on behalf of a spouse;
4. Payor and Payee may not be members of the same household;
5. Payment obligation of the payor spouse must terminate on the death of the payee spouse;
6. The order does not eliminate the tax consequences of the payments.
If alimony is taxable, the payor and payee are required to report taxable/deductible alimony on specific lines of their tax returns. The payor spouse must also provide the payee's spouse social security number on his/her tax return. If the amounts reported by the ex-spouses on their tax returns is not the same, the IRS will send a letter to both parties seeking explanation.--basically an audit. Therefore, the parties should state in their divorce agreement that they will provide the other spouse with the amount deducted and/or reported as income by a specific date each year (necessarily prior to the tax return due date). In addition, the divorce agreement should specifically describe all payments (e.g., periodic alimony, property division, alimony in gross, etc.) and whether they are taxable/deductible. Without clear guidelines, the parties may find themselves fighting to support their tax returns with the IRS. In such an event, one party will prevail over the other--i.e., the loser will owe the IRS money. The following discussion is an analysis of tax law and alimony treatment for divorce agreements and orders mandating alimony payments executed prior to December 31, 2018 with specific discussion of Alabama state law.
An absolute requirement in determining whether a payment is alimony is that the payments must terminate on the death of the payee spouse. I.R.C. 71(b)(1)(D). If the court-ordered payments continue for a time not ending on the death of the payee, then all the payments will be tainted, including those made both before and/or after death. Davidson v. Davidson, T.C. Memo 2018-38; Johanson v. Commissioner, 541 F.3d 973, 976-977 (9th Cir.2008). ‘To determine whether the payor has liability to continue payments after the payee’s death, we apply the following sequential approach: (1) the Court first looks for an unambiguous termination provision in the applicable divorce instrument; (2) if there is no unambiguous termination provision, then the Court looks to whether payments would terminate at the payee’s death by operation of State law; and (3) if State law is ambiguous as to termination of payments upon the death of the payee, the Court will look solely to the divorce instrument to determine whether the payments would terminate at the payee’s death.” Davidson v. Davidson, T.C. Memo 2018-38; Hoover v. Commissioner, 102 F.3d at 846-848; Okerson v. Commissioner, 123 T.C. 258, 264-265 (2004).
In the case of Webb v. Commissioner, TC Memo 1990-540, the court found that payments by husband to wife for her purchase of an automobile of $15,000 and $200,000 for her use were not taxable. The wife argued that the payment did not satisfy section 71(b)(1)(D) in that the Agreement imposed a liability to make two payments totaling $215,000 which would survive her death. The court, in Webb v. Commissioner, quoted the House Committee reports to the 1984 tax amendments stating that:
“[T]he committee bill attempts to define alimony in a way that would conform to general notions of what type of payments constitute alimony as distinguished from property settlements and to prevent the deduction of large, one-time lump-sum property settlements….In order to prevent the deduction of amounts which are in effect transfers of property unrelated to the support needs of the recipient, the bill provides that a payment qualifies as alimony only if the payor has no liability to make any such payment for any period following the death of the payee spouse.”
The court in Webb thought it significant that the Agreement provided that “The Husband shall pay” without mention of termination in the event of wife’s death. The court finding that “Unquestionably, this created a liability which would have been enforceable by Rosalie J. Webb’s estate had she died after the execution of the agreement but before the payments were actually made.” Webb v. Commissioner, 60 T.C.M. 1024 (1990). In the case of Rosenthal v. Commissioner, TC Memo 1995-603, the court relied upon I.R.C. section 71(b)(1)(D), stating “…that for payments to be considered alimony, there must be no liability to make any payment for any period after the death of the payee spouse and no liability to make any payment as a substitute for such payments after the death of the payee spouse.” The court noted that “[t]he same conclusion reached in Webb v. Commissioner, supra, has been reached in Stoufe v. Commissioner, T.C. Memo 1995-256; Heffreon v. Commissioner, T.C. Memo 1995-253; and Hoover v. Commissioner, T.C. Memo 1995-183. In Hoover v. C.I.R., 102 F.33d 842 (6th Cir. 1996), the court found that where the divorce decree contained no provision for termination of payments upon wife’s death, and applicable local law did not clearly provide such termination, the payments fail to meet the definition of alimony set forth in IRC section 71(b)(1) and cannot be deductible and/or taxable under IRC section 215.
An analysis of the taxation of payments pursuant to a divorce decree or divorce order will require knowledge of the applicable state law (i.e., the state of the parties' divorce). Under Alabama law, there exists two types of alimony: a) Periodic Alimony (payments for support); and b) Alimony in Gross (payments pursuant to property interests). Periodic alimony refers to payments made periodically for support and maintenance of the recipient spouse. The recipient spouse is taxed and the obligor receives a deduction for purposes of income taxes on periodic alimony. Periodic alimony remains modifiable by the court and may be terminated under certain circumstances. In Alabama, the term “periodic alimony,” by definition, means a payment to a spouse that will cease upon death, remarriage, or cohabitation. Section 30-2-55, Ala. Code 1975.
Alimony in gross is intended to provide a form of property settlement and is generally not modifiable. Ala. Code Section 30-2-55 (1975). Alimony in gross survives the remarriage of the recipient spouse. With alimony in gross the amount and time of payment is usually certain and the right to it vested. TenEyck v. TenEyck, 885 S. 2d 146,151 (Ala. Civ. App. 2003); Hager v. Hager, 293 Ala. 47, 299 So.2d 743 (1974). Payments are considered vested where there is no specification that the payments can be modified. Andrews v. Andrews, 2017, Ala. Civ. App. LEXIS 244 (Ala. Civ. App. December 15, 2017) (“[T] term ‘vested’ simply signifies that an award of ‘alimony in gross’ is not subject to modification.” Id. See Hager v. Hager, 293 Ala. at 54, 299 So.2d at 759 . Alimony in gross payments can be a lump-sum payment, a series of payments over a specific period of time or directed to satisfy a promissory note. Ex parte Rueter, 623 So. 2d 737 (Ala. 1993). The specific designation of an alimony award as being “in gross” is not necessary. There are also no restrictions on the way alimony in gross might be paid. McCrary v. McCrary, 408 So. 2d 523 9Ala. Civ. App 1981). Periodic alimony is also distinguishable from alimony in gross because it is treated as taxable income to the party receiving the award. Alimony in gross is not taxable income to the receiving party. Rose v. Rose, 70 So. 3d 429 (Ala. Civ. App. 2011).
In the case of State Dep’t of Revenue v. Pruitt, 711 So.2d 1014 (Ala. Civ. App. 1997), the court found that mortgage payments made by husband on wife’s residence were not taxable as alimony when he was required to make the payments regardless of his former wife’s status. The language in the divorce agreement stated as follows: “The real property described in paragraph 1 above [the former marital residence awarded to the wife] is subject to an outstanding mortgage to First Community Bank, which the husband assumes and agrees to pay, and the husband further agrees to hold the wife harmless against any claims made by the creditor against the wife to collect said indebtedness.” The court stated that “…we are certain that the bank to which Pruitt (husband) owes those payments would expect him to continue making them even if his former wife remarried or died.” Id. The Court decided that the mortgage payments were alimony in gross and non-taxable. In Lacey v. Lacey, 126 So.3d 1029 (Ala.Civ.App. 2013), the husband was to pay the wife $2,500 per month for 96 months with said payments to terminate earlier than 96 months only upon wife’s death. The court found that the payments were alimony in gross because the award did not terminate on husband’s death or wife’s remarriage. The court noted that “…the failure to label a provision of a judgment as alimony in gross will not defeat a provision which in substance provides for alimony in gross.” In Lacey, the language did not state that the payment was alimony in gross; but, the court found that the nature of the award was inferable from its language. Id.
Alimony in gross survives the remarriage of the recipient spouse. With alimony in gross the amount and time of payment is usually certain and the right to it vested. TenEyck v. TenEyck, 885 S. 2d 146,151 (Ala. Civ. App. 2003); Hager v. Hager, 293 Ala. 47, 299 So.2d 743 (1974). Payments are considered vested where there is no specification that the payments can be modified. Andrews v. Andrews, 2017, Ala. Civ. App. LEXIS 244 (Ala. Civ. App. December 15, 2017) (“[T]he term ‘vested’ simply signifies that an award of ‘alimony in gross’ is not subject to modification.” Id. See Hager v. Hager, 293 Ala. at 54, 299 So.2d at 759.
If you receive an IRS letter concerning alimony deductions or income included or excluded from your tax return, you should seek assistance from a tax professional with knowledge of state divorce law. The impact of IRS action is not just for the year under review, but for all future years where alimony is paid/received.
Bowman Law Firm, 200 Randolph Avenue, Huntsville, Alabama 35801
Gene M. Bowman, Attorney at Law, CPA