Casestudy: keeping alimony from being reclassified as nondeductible payments.

• Author: Ellentuck, Albert B.

AFTER A MARRIED COUPLE HAS FILED A DIvorce petition, the higher-earning spouse often must make various types of support payments to the lower-earning spouse. Some of these payments represent alimony and separate maintenance payments (referred to simply as alimony in this column), which are deductible by the payer in arriving at adjusted gross income and are taxable income to the payee (Sees. 71(a) and 215(a)). Other payments represent nondeductible child support and/or property distribution payments.

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Taxpayers are free to choose the tax effect of alimony. It can either be deductible to the payer and taxable to the payee or receive the same tax treatment as child support if an "election out" is made. With child support payments or property settlements (i.e., payments that do not qualify as alimony), however, there is no option. Such payments are always nondeductible to the payer and nontaxable to the payee.

The following discussion of alimony applies to payments determined under post-1984 divorce or separation instruments and to pre-1985 instruments that have been amended to be made subject to these rules. Pre-1985 agreements that do not contain such an amendment are subject to Sec. 71 as it existed prior to enactment of the Tax Reform Act of 1984. These rules govern all divorce instruments written since January 1, 1985.

What Is Alimony or Spousal Support?

The Internal Revenue Code governs the federal tax treatment of alimony, not any divorce agreements or court orders. There are several definitions of alimony and/or spousal support. There are domestic relations statutes and bankruptcy statutes as well as the Code. Since each of these definitions is different, practitioners must take care not to assume that an item called alimony or spousal support qualifies as such under the Code. Thus, it is entirely possible for a divorce instrument to call a given payment alimony even though it does not qualify as alimony for income tax. It is also possible to have a payment that is treated as alimony for income tax purposes even though it does not qualify as alimony under state law.

For post-1984 divorce instruments, a payment is treated as alimony for federal tax purposes if all the following requirements are met (Sec. 71):

1. Divorce decree or written separation instrument: The payment must be made under a divorce decree (or a written instrument incident to such a decree) or a written separation agreement.

2. Spouses cannot live together after divorce: After the divorce or legal separation is final (i.e., the couple is no longer married for federal tax purposes), the paying spouse and receiving spouse cannot be members of the same household when the payment is made.

3. Cash: The payment must be in cash or cash equivalents.

4. Marriage relationship: The payment must be paid to or on behalf of a spouse or former spouse.

5. No contrary designation or election out of alimony: The...