Is It Alimony as Defined in IRC 71?
Alimony and separate maintenance payments can be deductible from income by the payor under I.R.C. §215 and includable in the income of the payee under I.R.C. §711 if structured properly, although such payments need not necessarily be taxable/deductible. 2
Since the support requirement of I.R.C. §71 is eliminated,3 if all other rules of the present Internal Revenue Code alimony requirements are met, it makes no difference whether the payments are for support or for the payment of property rights. Also, the present definitions of alimony and separate maintenance payments eliminate the requirement that payments must be “periodic.”4
For “alimony” to be deductible to the payor and taxable to the payee, the payments must meet all of the elements of I.R.C. §71. Just to meet the criteria for alimony under a state statute is not enough if any of the Internal Revenue Code required elements are missing.5
Summary of Provisions of I.R.C. §71 (the Seven Ds)
To be taxable/deductible adherence to the following rules must be observed:
1) Dollars: Cash received by or on behalf of a spouse.
2) Documents: Under a divorce or separation instrument.
3) Designation: Payments must not be designated as not includible in gross income under §71 and not allowable as a deduction under §215.
4) Distance: Where the status of the marriage is changed, i.e., where the parties are separated under a judgment of dissolution or legal separation, the spouses or former spouses are not members of the same household.
5) Death: Payments must cease upon the death of the payee.
6) Dependents: Payment may not be fixed as child support.
7) Dumping: The alimony payments cannot be front loaded in excess of the permissible amounts, otherwise the alimony will be subject to recomputation in the third post-separation year.6
Common Errors
Notwithstanding that the current system for taxable/deducible alimony under the Internal Revenue Code has been in existence since January 1, 1985, there are regretfully still many misunderstandings and misconceptions.
• If payments are made from one spouse or ex-spouse to the other for property (equitable distribution, a special equity, or otherwise), not for spousal support, it cannot be deducted from income tax as “alimony” by the payor.
Answer: Wrong.
The labeling of a payment or a stream of payments as “alimony” will not determine its legal effect either under state law or federal law governing income taxes.
Florida cases have held that when examining a clause awarding alimony, no matter what label is given to the award, its legal effect is determined not by what it is called, but by what it does.7 The mere use of the word “alimony” does not affect the tax consequences of payments.8
Florida courts, particularly in modification cases, have made a distinction between payments for alimony9 on one hand, and for property settlement on the other hand. If for property settlement, the payments are not subject to modification. If for spousal support, the payments are modifiable pursuant to F.S. §61.14.10
When in 1978 the Fourth DCA noted that a settlement agreement between the parties recited that “all payments provided in this paragraph shall be taxable to the wife and deductible by the husband,” and it opined that “such tax treatment would be allowable only if the payments were alimony and not part of a property settlement agreement,”11 it was correct from an income tax perspective.
The statement was correct because from 1942 to 1984 payments were taxable/deductible “alimony” only if they were “periodic,” or were made in the discharge of a legal obligation of the payor to support the payee arising out of a marital or family relationship.
The Deficit Reduction Act of 1984, which created the new “alimony rules” under the Internal Revenue Code12 affecting payments subsequent to December 31, 1984, eliminated both the “periodicity” requirement and the requirement that the payment must be made in a discharge of a legal obligation to support.13
Thus, in 1994 when the First DCA, in deciding whether a stream of payments was for a special equity or for support, noted that “we find it significant that both parties treated the payments as alimony for tax purposes,”14 it was wrong. So, too, was the Fourth DCA wrong in 1997 when determining the modifiability of a stream of payments wherein it looked to the fact that the parties treated the payments as support for income tax purposes as one of its criteria.15 The latter case cited as its authority the decision in Hyotlaine v. Hyotlaine, 356 So. 2d 1319 (Fla. 4th DCA 1978), which case predated the 1984 Deficit Reduction Act changing the alimony rules.
The only time the term “support” is used on I.R.C. §71 is with reference to an order for temporary support.16
Thus, a payment or a stream of payments can be for a property right and also be deductible/taxable so long as it meets various provisions of I.R.C. §71.17
In Nelson v. Commissioner, T.C. Memo 1998-268 (U.S. Tax Ct. 1998), the court agreed with the taxpayer’s argument that “because the payments fit within the definition of alimony for federal income tax purposes, the intended purpose for the payments is of no consequence.” It held “the possibility that the payments might have represented a division of marital property, makes no difference.”
Likewise, in Hopkinson v. Commissioner, T.C. Memo. 1999-154 (U.S. Tax Ct. 1999), the taxpayer unsuccessfully argued that she properly excluded the payments in issue from her gross income because they were intended by the parties to be a property settlement and not alimony.
• The payments are for support; therefore they are taxable to the payee and deductible to the payor.
Answer: Not necessarily.
Even if a stream of payments is for cash, to or on behalf of a spouse or former spouse, made under the provisions of a divorce or separation instrument, which obligation to make such payment or payments ceases upon the death of the payee, and not fixed as child support, it still may not necessarily be taxable/deductible. Either the parties or the court may designate a stream of payments as being “not taxable and not deductible,” thus disqualifying the stream of payments as such under the provisions of I.R.C. §71.
A specific provision of the Code indicates that to qualify as alimony, and thus to be taxable/deductible, “the divorce or separation instrument does not designate such payment as a payment which is not includable in the gross income under this section and not allowable as a deduction under section 215.”18
Likewise, the parties or a court may distinguish between two or more separate streams of payment designating one stream of payments as being not taxable/deductible. It cannot by the language of an agreement or order free the other streams of payment from being taxable/deductible where those designation words are not employed. If the other provisions of the Code are met the stream of payments will be taxable/deductible unless designated as not taxable/deductible. Thus, the parties or the court can elect out of alimony treatment under the act. Neither can elect into the act. To be covered by the act, all requirements of I.R.C. §71 must be met and if met it is “alimony” under the Code and is taxable/deductible.19
Since a court should take into consideration the net after tax amount of alimony to a payee spouse,20 thought should be given to designate the payments as nontaxable to the payee and nondeductible to the payor, particularly in a temporary support order. Such a designation could accomplish the court’s purpose of providing for all of the impecunious spouse’s needs, which needs may not be fully met unless the amount of taxes on the alimony are taken into consideration in determining that amount.
In Almodovar v. Almodovar, 25 Fla. L. Weekly D892 (Fla. 3d DCA April 12, 2000), the court stated that: “If the trial court wanted to avoid burdening the former wife with the tax consequences of the alimony payments the court has the discretion to provide that ‘the payor [former husband] will not deduct the alimony payments so that the payee [former wife] may then exclude the payments from gross income.’” Those are not exactly the words of the Code21 or temporary regulations,22 but it is a sufficient designation of nontaxability/deductibility. Notwithstanding, it is always best to use the exact nondesignation language of the Code or the Temporary Regulation to be tax safe.
• Since an impecunious spouse is entitled to maintain the same standard during the pendency of the proceedings, payment for support might as well be paid without having to bother either with an agreement or a temporary court order.
Answer: This is fine, however, it will not be taxable/deductible.
One of the rules to qualify a stream of payments as “alimony” under I.R.C. §71 is that the payments must be made pursuant to a divorce or separation instrument.
There are three types described in the Code:
“(A) A decree of divorce or separate maintenance or a written instrument incident to such a decree.
“(B) A written separation agreement.
“(C) A decree (not described in subparagraph (A) requiring a spouse to make payments for the support or maintenance of the other spouse.”23
A voluntarily payment from one spouse to the other by way of an informal arrangement or oral agreement will not qualify. There must be a written agreement or court order, and the payments must be made after the agreement is executed or a court order entered.
In Abood v. Commissioner, T.C.M. 1990-453, the husband felt morally obligated to provide for his former spouse after payments under the agreement ran out. His continuation of support was dismissed by the court as commendable but not significant. The court ruled “voluntary payments are not within the purview of sections 71 and 215.”
Likewise, the increase in alimony payments on the husband’s own volition did not qualify as alimony in Ellis v. Commissioner, T.C.M. 1990-456. Mr. Ellis’ claim of an oral modification was rejected because the court held that only a written document can control the amount of the alimony.
• If the agreement or order providing for support is later overturned, then the payor cannot deduct nor will the payee have to pay taxes on the “alimony.”
Answer: Wrong.
Neither the agreement nor the court order need be valid as long as the payments were made under its provisions.
Payments were made to the “wife” under the provision of a Dominican Republic ex-parte divorce decree. The husband and the wife were both residents of New York. Under New York law an ex-parte foreign divorce decree is not entitled to recognition and has been held in New York to be totally invalid for all purposes. Notwithstanding, it was determined in the Estate of Elaine E. Felt, T.C. Memo. 1987-465 that the payment met the criteria of being made under a divorce or separation instrument.
In Richardson v. Commissioner, 125 F.3d 551 (7th Cir. 1997), payments were made under an agreement the Illinois court later held to be invalid as the provisions were found to be unconscionable. Nevertheless, payments made under the agreement were taxable to the former wife, the court holding that “the general rule is that a contract unenforceable under state law can still be a valid written separation agreement for purposes of the Tax Code.”
•It is error for a court to award taxable/deductible alimony to the wife and require the husband to pay the tax which the wife will incur.
Answer: No, not if fully implemented.
When in Almodovar,24 the Third DCA held that it was error when the trial court ruled that the former husband “shall be responsible for payment of taxes on alimony payments but shall be entitled to applicable deductions,” it did not go on to give the reason why it said that the trial court erred, and thus made a statement which is misleading and contrary to accepted tax practices.
Prior to Congress restructuring the I.R.C. with reference to the taxation of alimony by the 1984 act, it was common practice to require the payor spouse to pay to the payee spouse the tax, albeit at a lower rate than that of the payor spouse, which the payee spouse would have to pay on the alimony. The 1984 act under which we presently operate did not abrogate that method of allowing the payor spouse to pay the payee’s obligation for tax that the alimony would generate. Instead it gave divorcing parties (and the courts) an additional tool: the right of designating a stream of payments as not taxable/not deductible.
Certainly requiring one former spouse to pay any liability of the other former spouse is not improper under Florida law. How many orders require the payment of the other spouse’s educational expenses, the mortgage payments or the electric bill? Why would the requirement for the payment of an income tax liability be any different?
The trial court in Almodovar may have erred in its ruling but not because it is impermissible to make one spouse responsible for the tax that the alimony paid to the other spouse would generate. The trial court erred because it did not go for enough in its ruling having failed to specify whether the tax the husband is to pay was limited to only that which the alimony would generate, in neglecting to establish the methodology of determining the amount of the tax and the cost of such determination and by not designating whether or not the tax the husband would pay would be nontaxable/nondeductible, which may be a preferred approach because the payment of the tax on wife’s alimony by the husband could be considered as additional taxable alimony.25
Next month further common errors will be discussed. q
1 See Blythe v. Blythe, 592 So. 2d 353 (Fla. 4th D.C.A. 1992) (The tax consequences of alimony as it affects the Wife’s needs and the Husband’s ability to pay should be considered by the court.)
2 Hereafter, when reference is made to a stream of payments being taxable to the payee and deductible to the payor the words “taxable/deductible” will be used.
3 Temp. Treas. Reg. A-3 of §1.71-1T.
4 Temp. Treas. Reg. A-3 of §1.71-1T.
5 Hoover v. Commissioner, 102 F.3d 842 (6th Cir. 1996).
6 Although this seventh of the “Ds” is not a requirement for the stream of cash payment or payments to qualify as “alimony” under I.R.C. §71, if “front loaded” there will be serious recapture problems resulting in “phantom income” to the payor and a non-carry-forwardable deduction to the payee.
7 Boyd v. Boyd, 478 So. 2d 356, 357 (Fla. 3d D.C.A. 1985); Karach v. Karach, 445 So. 2d 1077 (Fla. 3d D.C.A. 1984); and Zuccarello v. Zuccarello, 429 So. 2d 68 (Fla. 3d D.C.A. 1983).
8 It was held in Hoover v. Commissioner, 102 F.3d 842 (6th Cir. 1996), that although the property interest of divorcing parties are determined by state law, federal law governs the federal income tax treatment of that property. The mere use of the work “alimony” does not effect the tax consequences of payments. State law is looked to only to determine whether the payments cease upon the death of the payee.
9 Obviously for spousal support as referred to in Fla. Stat. §§61.08 and 61.09.
10 Petty v. Petty, 548 So. 2d 793, 796 (Fla. 1st D.C.A. 1989).
11 Hyotlaine v. Hyotlaine, 356 So. 2d 1319, 1321 (Fla. 4th D.C.A. 1978).
12 I.R.C. §71.
13 Temp. Treas. Reg. A-3 of § 1.71-1T.
14 Robinson v. Robinson, 647 So. 2d 160, 162 (Fla. 1st D.C.A. 1994).
15 Kidd v. Kidd, 695 So. 2d 439, 440 (Fla. 4th D.C.A. 1997).
16 I.R.C. §71(b)(2)(C).
17 See The Seven Ds section of this article. Of course, if payments are pursuant to an order for temporary support it must be support. In addition attention must be paid to the recomputation rules if recapture is to be avoided.
18 I.R.C. §71(b)(1)(B).
19 McKelvey v. McKelvey, 534 So. 2d 801 (Fla. 3d D.C.A. 1988).
20 Lutgert v. Lutgert, 362 So. 2d 58 (Fla. 2d D.C.A. 1978).
21 I.R.C. §71(b)(1)(B). “The divorce or separation instrument does not designate such payment as a payment which is not includible in gross income under this section [§71] and not allowable as a deduction under Section 215.”
22 “[M]ay designate that payments. . . shall be nondeductible by the payor and excludible from gross income by the payee.”
23 An order for temporary support.
24 Almodovar v. Almodovar, 25 Fla. L. Weekly D892 (Fla. 3d DCA April 12, 2000).
25 The payment of the tax on wife’s alimony by the husband would be considered additional alimony only if all the required elements under I.R.C. §71 are present. A major question is whether such obligation would cease on the payee’s death.
