Tax Considerations of Divorce
| Publication year | 1980 |
| Pages | 1544 |
1980, August, Pg. 1544. Tax Considerations of Divorce
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Thomas J. Barrett, Jr., J.D., C.P.A., and George V. Chesteen, J.D., LLM., Denver, are with the firm of Barrett Hoge & Co., P.C., Certified Public Accountants.
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A divorce proceeding has been accurately labeled as "an accelerated form of probate," i.e., all of the client's property and personal tax attributes are subject to review and disposition by the court.(fn1) This review and disposition in the area of taxation falls under the headings of alimony or separate maintenance, property settlements and deductions in divorce proceedings. A brief background of each area follows in this article. For convenience, the payee spouse will hereinafter be referred to as the "wife" and the spouse from whom she is divorced or separated as the "husband."
Alimony (called "maintenance" in Colorado) can be broadly defined as all payments, which arose out of the marital relationship including pre-divorce support, deductible from gross income of the husband and included in income of the wife.(fn2) Maintenance includes payments made directly to the wife and in certain instances, indirect payments such as expenses of residence or payments on life insurance policies.
Before any payment, whether made directly or indirectly to the wife, can be classified as maintenance, it must meet certain requirements. The payment must be periodic and made under a decree of divorce or separate maintenance, decree for support, or pursuant to a written separation.(fn3) Thus, pre-divorce payments can be maintenance only if the parties are separated and the maintenance is paid pursuant to a written instrument whether or not the instrument is legally enforceable.(fn4) An oral agreement that is later reduced to writing satisifies the written instrument requirement only as to payments made after the writing is executed, but not as to payments made before execution.(fn5)
Payments may be treated as periodic under one of two rules, depending on whether they are to continue for more than ten years. If the payments are to be made for a period of less than ten years, they must be based on a "contingency" to be periodic.(fn6) Making the payments subject to any one or more of the contingencies of death of either spouse, remarriage of a spouse, or change in the economic status of either spouse will result in the payments being treated as periodic even though a principal sum is arithmetically determinable.(fn7) Other examples are payments of a fixed amount (for example, $100) for an indefinite period(fn8) or payments of an indefinite amount (for example, 10 percent of a fluctuating income) for either a fixed or an indefinite period.(fn9)
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Maintenance payments that definitely extend for more than ten years from the date of decree, instrument or written separation agreement (e.g., where the maintenance is based on a principal sum payable in installments) are treated as periodic, regardless of whether the payments are subject to any contingency.(fn10) However, the payments are deductible only to the extent of 10 percent of the principal sum in any one year.(fn11) To determine the principal amount, all of the payments to be made are added together. For example, if $20,000 per year were to be paid for five years and $5,000 for ten years, the principal amount would be $150,000. Only $15,000 of the first five years' payments would be considered periodic. The remaining $5,000 would not be periodic and therefore, not deductible.(fn12) There is no carryover available for the unused deduction.
The 10 percent limitation applies to installment payments made in advance, but does not apply to delinquent installments.(fn13) Thus, there appears to be room for tax planning. If a payment were due in December, perhaps it could be deferred to January and deducted in addition to the other 10 percent payment.
In summary, if payments are to be made over a period of less than ten years and are not subject to a contingency, they are not treated as maintenance. In this case, the payments will be considered part of the property settlement. Thus, it is important to pass one of the two tests for "periodic."
If a residence is held as joint tenants with right of survivorship or as tenants by the entirety and the agreement decrees that the husband is to make the principal and interest payments on the mortgage of the property, an indebtedness for which both spouses are liable, then the wife must include in income and the husband may deduct one-half of each principal and interest payment, insurance payment and property tax payment.(fn14) The remaining half of the interest and tax payment may be deducted by the husband only if he itemizes deductions on his tax return.(fn15) The remaining half of the principal payment and insurance payment is a non-deductible expenditure and not taxable to the wife.(fn16)
If the residence is held as tenants-in-common, the wife owns one-half of the property. Therefore, the husband may deduct, as maintenance, one-half of the payments made for principal and interest on the...
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