Divorce Can Be Very Taxing on You
The Tax Man Cometh: Avoiding Tax Pitfalls in Alimony Arrangements
By statute, Congress has specifically defined, for tax purposes, what constitutes alimony under Section 71 of the tax code. Because of the specificity of this section of the tax code, courts have interpreted the statute literally, without much flexibility. As a result, there can be serious tax consequences of a divorce or separation agreement.
It is first worth noting what alimony is and what it is not:
- Income (for the person receiving alimony payments).
- Payment in cash, not property.
- Subject to a formal divorce or separation agreement.
- Deductible (for the person making alimony payments).
Alimony is NOT:
- Child support payments
- A way to transfer marital property
- An informal or verbal agreement between parties
- Payable after receiving spouse dies
The IRS looks very closely at alimony payments. Because alimony is deductible from income under Section 215, the payor of alimony could reap enormous tax benefits if he or she attempted to treat a child support payment or the transfer of marital property as alimony. (Imagine one party making a cash payment of half the value of a retirement account, for example, and then trying to deduct the whole amount from his or her taxes. This would deprive the Government of revenue by lowering, or even eliminating, that party’s income that is subject to taxation.) The IRS will also enforce the excess front-loading provisions of Section 71. Excess front-loading is where the yearly amount in alimony paid in the first three years fluctuates to a degree that additional taxes will be incurred for past years. The inference from front-loading is that payments are too excessive to be accounting for only alimony. The method of determining front-loading, however, if very rigid, specific, and concise and thus can easily be avoided through proper preparation and planning. This is why it is so important that divorce agreements be properly drafted – to avoid the visit from the taxman.
In recent years, taxpayers have lost court cases to the IRS where the divorce agreements were ambiguous; that is, the agreements weren’t drafted by the parties’ attorneys with the specific requirements set out under Section 71. In one such case, the former husband was denied the ability to deduct his alimony payments because the agreement suggested that payments would not cease upon the death of his ex-wife. Section 71 states that alimony is NOT payments that continue after a spouse dies. Courts are not prone to show flexibility where the statute is so explicit.
Fred Antenberg is an Family Law Attorney in Columbia, Maryland that handles divorce and family law matters in Howard County, Maryland and surrounding counties. CONTACT Fred for your FREE CONSULTATION at 410-730-4404.