Income Tax Consequences of Alimony, Child Support and Property Settlements

What Is Alimony

Payments of cash by one spouse to another spouse that meet specific statutory requirements are classified as alimony. The payments of cash that qualify as alimony are included in the gross income of the recipient. If the payments are included in the gross income of the recipient as alimony, the payor is entitled to a deduction for such payments. 1

/Footnote/ 1 §71(a) and §215(a).

Note: Requiring alimony payments to be reported as income by the recipient and allowing the payor a deduction shifts the tax burden of income earned by the spouse who makes the alimony payments to the spouse who receives alimony payments. However, there is no tracing requirement. The payor spouse need not use his wages or interest income to make the payment. The alimony deduction is available for any payment classified as alimony, even if the source of the funds was nontaxable, such as out of savings.

The payor spouse can take the alimony deduction even if he uses the standard deduction (i.e., he does not itemize deductions) since the alimony deduction is taken when computing adjusted gross income. 2 Since alimony is deducted in computing adjusted gross income, it is not subject to the limitation on certain miscellaneous itemized deductions. 3

/Footnote/ 2 §62(a)(10).

/Footnote/ 3 See §67.

The test of what is alimony for tax purposes is made independent of the determination of whether a payment is alimony for state law purposes. 4 Thus, it is entirely possible for a payment to be treated as alimony for state law purposes and not for federal tax purposes. The converse, however, is not true. Where a state court's characterization of a lump-sum payment as a division of property is reasonable and consistent with state law, the IRS may not recharacterize that payment as alimony for federal tax purposes. 5

/Footnote/ 4 Before the Tax Reform Act of 1984, payments had to be made in discharge of a marital obligation imposed under local law to qualify as alimony. The 1984 Act eliminated this requirement with a view toward eliminating the administrative difficulties arising from differences in state laws and to provide a uniform federal standard. Consequently, the definition of alimony for federal tax purposes is not dependent on state law. See Regs. §1.71-1T(b), Q & A-3. In fact, in Nelson v. Comr., T.C. Memo 1998-268, the Tax Court held that because payments fit the statutory definition of alimony, they are deductible by the payor; the intended purpose for the payments being of no consequence.

/Footnote/ 5 Green v. Comr., 88-2 USTC ¶9473 (6th Cir. 1988).

As stated earlier, for a payment to be classified as alimony, it must satisfy a number of requirements prescribed by law. These requirements are discussed below.

1. Payment Must Be Made in Cash

Only cash payments (including checks and money orders payable on demand) qualify as alimony. The following do not qualify as alimony because they are not treated as cash: (1) the transfer of services; (2) the transfer of property including a debt instrument of a third party or an annuity contract; (3) the execution of a debt instrument by the payor; and (4) the use of the property belonging to the payor. 6

/Footnote/ 6 §71(b)(1) and Regs. §1.71-1T(b), Q & A-5. It is not clear whether the use of non-cash payments to satisfy alimony obligations is disqualify subsequent cash payments from treatment as alimony.

2. Payment Must Benefit Payee -- Third Party Payments

The payment must be received by the payee spouse or be made to a third party "on behalf of" the payee spouse. 7 A payment to a third party for the benefit of the payee spouse is alimony as long as the third party payments are made pursuant to a direction contained in the divorce decree or separation agreement. 8 Presumably, third party payments can satisfy any type of obligation the payee spouse incurs, from normal living expenses such as food, clothing, rent, medical and health insurance, to items not necessary for support such as vacations, education, and jewelry.

/Footnote/ 7 §71(b)(1)(A).

/Footnote/ 8 Regs. §1.71-1T(b), Q & A-6; PLR 8710089.

a. Payment of Housing Costs

If the payee spouse owns the house she is using as her residence, the payment of her mortgage, property taxes, property insurance and repairs by the payor spouse directly to the third parties is a payment "on behalf of" the payee. However, where the payee spouse's residence is owned by the payor spouse, the payments are not alimony payments even if the payee spouse is allowed to use the payor spouse's house as her residence pursuant to the terms of their divorce or separation. 9

/Footnote/ 9 Regs. §1.71-1T(b), Q & A-6. See Israel v. Comr., T.C. Memo 1995-500 (Husband's payment of wife's rent on former marital apartment satisfied §71(b) requirements for alimony status).

Query: Can alimony treatment be obtained for these payments if the payee spouse receives a fixed dollar amount and uses part of the receipts to rent the house from the payor spouse? Given that the rental payment will benefit the payor spouse as the owner of the house, that portion of the alimony payment used for rentals should be denied alimony treatment for tax purposes.

b. Payment of Life Insurance Premiums

Frequently, an agreement provides that the payor spouse's obligation to pay alimony will terminate on his death. In order to protect the payee spouse from the cessation of alimony payments, the agreement can provide for a life insurance policy on the payor's life with the payee spouse as beneficiary. If the payor spouse is required to pay the premiums on this policy, those payments are treated as alimony, but only to the extent that the payee spouse is the owner of the policy. 10 Where the payee spouse's ownership of the policy is not absolute or if she is a contingent beneficiary, alimony treatment is not available. 11 If the payee spouse's rights as beneficiary are subject to any contingency, such as surviving the insured spouse or remaining single, the payee spouse is not deemed to have received a measurable "economic benefit" and alimony treatment is not allowed. 12

/Footnote/ 10 Temp. Regs. §1.71-1T(b), Q & A-6.

/Footnote/ 11 Rev. Rul. 70-218, 1970-1 C.B. 19. See also Sperling v. Comr., 726 F.2d 948 (2d Cir. 1984); Auerbach v. Comr., T.C. Memo 1975-219; Wright v. Comr., 543 F.2d 593 (7th Cir. 1976); Griffith v. Comr., 349 F.2d 810 (3d Cir. 1966); Kiesling v. Comr., 349 F.2d 110 (3d Cir. 1965); Reeves v. Comr., T.C. Memo 1962-72; Steelman v. Comr., T.C. Memo 1959-92; Kinney v. Comr., T.C. Memo 1958-209; Smith Est. v. Comr., 208 F.2d 349 (3d Cir. 1953); and Bradley v. Comr., 30 T.C. 701 (1950).

/Footnote/ 12 Cosman v. U.S., 440 F.2d 1017 (Ct. Cl. 1971); Mandel v. Comr., 229 F.2d 382 (7th Cir. 1956); and Seligman v. Comr., 207 F.2d 489 (7th Cir. 1953).

Note: The assignment of the policy must be absolute and the payor spouse must surrender all incidents of ownership in the policy such as the right to borrow against its cash surrender value. If the payor spouse does not wish to give up all control or eliminate a contingency, he should increase the alimony payments by the amount of cash needed to pay the premiums and leave actual payment of the premiums to the beneficiary spouse.

c. Other Third Party Payments Not Specified in the Instrument

Even if the agreement or decree does not provide for third party payments, such payments can qualify as alimony if made pursuant to the written request, consent or ratification of the payee spouse. 13 The required writing must state that both spouses intend the third party payment to be treated as alimony for tax purposes and must be received by the payor spouse before the date the payor spouse's first tax return for the year of payment is filed. 14

/Footnote/ 13 Temp. Regs. §1.71-1T(b), Q & A-7.