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# 81 - When is it alimony (for income tax purposes)? And when is it not?

LDG Monograph # 81                                             July, 2014 --ver. 3.1

WHEN IS IT ALIMONY (for income tax purposes)?
AND WHEN IS IT NOT?

© Lawrence D. Gorin, Attorney at Law, Beaverton, Oregon

Contents

1.   Introduction
2.  Overview
3.  Uncle Sam says......
4.  Spousal support vs. property division
5.  Spousal support intended to be “alimony” for income tax purposes
6.  Spousal support not intended to be “alimony” for income
      tax purposes
7.  Lump sum money award to equalize division of marital property
8.  Lump sum award of “in gross” spousal support.
9.  Other payments not intended to be “alimony” for
      income tax purposes.  
10.  Avoiding unintended alimony
11.  Requirement for termination on death of payee spouse
12.  Will it be alimony or will it be not?  Examples to consider
13.  Other examples
14.  Not, not & not:  Requirement that divorce instrument not
        designate the payment as not deductible for the payor and not
        taxable for the payee
15.  If it’s child support, it’s not alimony
16.  Practicality vs. legality
17.  Conclusion (and word of advice to Oregon practitioners)


1.  Introduction

    Marital settlement agreements and dissolution judgments typically include provisions establishing obligations for the payment of money by one spouse to the other.  Such obligations usually fall into one of three classifications: child support, spousal support or property division.  How such obligations will be treated for purposes of Oregon domestic relations law is a matter for state law determination.  In contrast, how such obligations will be treated for income tax purposes is a matter controlled by federal law. 

    Here we focus on the classifications of spousal support and property division and the treatment of such obligations for income tax purposes.  Understanding the underlying concepts, principles and rules of law, coupled with careful planning, draftsmanship and use or proper wording, will enable practitioners to better serve their clients, and to rest easier at night.

 2.  Overview

    Under Oregon domestic relations law, as explained in
Moak and Moak, 64 Or App 487, 668 P2d 1249 (1983), spousal support may be modified based on evidence establishing a change of circumstances, ORS 107.135(1)(a), but a division of property may not.  The distinction between spousal support and property division is not always clear.  And when that occurs, the court will determine the appropriate classification based on the underlying facts of the case.  Horesky and Horesky, 30 Or App 941, 569 P2d 34 (1977), rev den 281 Or 1 (1978).  The labels used by the parties are not decisive nor binding on the court.  Schaffer v. Schaffer, 57 Or App 43, 643 P2d 1300 (1982).  Rather, the controlling issue is "the nature and purpose of the award."  Fletcher and Fletcher, 72 Or App 708, 696 P2d 1182 (1985).

    However, regardless of the classification made by the state court, a payment of money from one spouse to the other under the terms of a dissolution judgment or marital settlement agreement, whether labeled as spousal support or property division, will be deemed and treated by the Internal Revenue Service (IRS) as “alimony” for federal income tax purposes unless, under the criteria of
Internal Revenue Code (IRC) § 71(a), 26 USC § 71(a), the payment is disqualified from such treatment.  If deemed and treated under federal law as “alimony,” the payment will be tax deductible for the payor and taxable income to the payee, in accord IRC §§ 71 and 215 (26 USC §§ 71 and 215).

    Thus, money paid to a former spouse pursuant to a court-ordered obligation deemed as “spousal support” for state law purposes (and therefore subject to future modification) may or may not end-up being treated by the IRS as “alimony” for income tax purposes.  And the same is true for money paid to a former spouse as “property division” for state law purposes (and therefore not subject to future modification).  As lawyers are prone to say when answering tough legal questions, “Well, it all depends.......

    Consequently, when drafting marital dissolution judgments and settlement agreements that establish money payment obligations, problems will be avoided if the intentions of the parties (and the court) regarding the payment classification for state divorce law purposes, as well as the intended income tax treatment and effect, are clearly expressed by the language used in the controlling document.  Failure to do so may result in consequences unintended or undesired by the parties and the court.

3.  Uncle Sam says.......

    Under federal income tax law,
Internal Revenue Code (IRC) § 71(b)(1), a payment to or for the benefit of a spouse or former spouse under a divorce or separation instrument will qualify and be deemed and treated by the Internal Revenue Service (IRS) as “alimony” for income tax purposes and thus will be tax deductible from the payor’s gross income, IRC § 215, and taxable income to the payee, IRC § 71, if all of the following requirements are met:

  • The payment is received by (or on behalf of) a spouse under a divorce or separation instrument.  IRC § 71(b)(1)(A).
  • The divorce or separation instrument does not designate the payment as “a payment that is not includible in gross income under IRC § 71 and not allowable as a deduction under IRC § 215.”  IRC § 71(b)(1)(B).
  • The spouses are not members of the same household at the time the payment is made.  IRC § 71(b)(1)(C).
  • There is no liability to make any payment (in cash or property) after the death of the recipient (payee) spouse.  IRC § 71(b)(1)(D).

In addition (and no less important):

  • The payment must be in cash (or check or money order) [rather than property or services].
  • The spouses do not file a joint return with each other.
  • The payment is not designated as or treated as child support.

    As declared by the U.S. Tax Court: "If a payment satisfies all of these factors then the payment is alimony; if it fails to satisfy any one of these factors then the payment is not alimony.Baker v. Comm., 79 TCM 2050 (2000).

    “Spouse” as used in IRC § 71 includes a former spouse.  See
IRC § 71(d).
    “Divorce or separation instrument” means a decree of divorce or separate maintenance or a written instrument incident to such a decree, or a written separation agreement, or a decree requiring a spouse to make payments for the support or maintenance of the other spouse.  See
IRC § 71(b)(2).

4.  Spousal support vs. property division

    So far as the Internal Revenue Service is concerned (with the exception of a payment specifically designated as “child support”), the label, designation or classification, if any, given to a court-ordered money payment obligation (be it “spousal support,” “property division” or “alimony”), without more, is not necessarily controlling or determinative as to the tax consequences of the obligation.  Indeed, while it may be inferred from the labels used that the court and the parties had tax considerations in mind, such labels alone do not “clearly, explicitly and expressly” say anything, one way or the other, as to the tax treatment to be accorded by the IRS to the payment obligation. 
Richardson v. Commissioner, 125 F3d 551, 556 (7th Cir 1997).

    It is therefore important when drafting marital dissolution judgments and settlement agreements that establish money payment obligations to use specific language, in accord with the criteria set forth in IRC § 71, to “clearly, explicitly and expressly” convey the actual tax treatment and tax effect that is intended to be accorded by the IRS to payments made pursuant to the court-ordered obligation.

    Further, under the federal income tax code, the phrase "nondeductible alimony" is an oxymoron.  A payment received by the payor’s spouse that meets the test of  "alimony" under IRC § 71 is -- per se -- tax deductible for the payor, IRC § 215, and taxable income to the payee, IRC § 71.  Careful draftsmanship requires careful attention to the criteria of IRC § 71.

    On the other hand, pursuant to
IRC § 1041, “no gain or loss shall be recognized on a transfer of property” from one former spouse to the other former spouse “but only if the transfer is incident to the divorce.”  Again, careful draftsmanship is needed to assure that a money payment intended as a transfer to property be disqualified from being deemed and treated by the IRS as alimony.

5.  Spousal support intended to be “alimony” for income tax purposes

    If a “spousal support” obligation made pursuant to
ORS 107.105(1)(d) is intended to qualify and be treated as “alimony” for income tax purposes, as is typically the case, a carefully drafted dissolution judgment should (1) expressly declare the intended tax effect and (2) should also include appropriate “termination on death” language.  The qualifying "magic words" should be included both in the main text of the judgment document as well as the "money award" section at the end of the document.  One possible format:

    Spousal support intended as alimony.  Payments herein designated as spousal support are intended to qualify and be treated as “alimony” for income tax purposes pursuant to Internal Revenue Code §§ 71 and 215 and shall therefore be deductible from the gross income of the payor and includable in the gross income of the payee.  Further, the obligation for the payment of spousal support designated by this judgment shall terminate upon the death of husband or wife, whichever death first occurs, and the payor spouse shall have no liability to make any such payment for any period after the death of the payee spouse nor any liability to make any payment (in cash or property) as a substitute for such payments after the death of the payee spouse.


6.  Spousal support not intended to be “alimony” for income tax purposes

    Spousal support as allowed under
ORS 107.105(1)(d) is not required to be “alimony” for income tax purposes.  If it is intended that the payments, even though labeled in the judgment as “spousal support,” not be treated as “alimony” for income tax purposes, appropriate disqualifying language will do the trick.  Consider the following:

    Spousal support not treated as alimony.  Payments herein designated as spousal support are NOT intended to qualify and be treated as “alimony” for income tax purposes pursuant to Internal Revenue Code §§ 71 and 215.  Accordingly, payments of spousal support made pursuant to the obligation established by this paragraph [or provision] are hereby expressly designated as payments that are not includable in gross income of the payee under IRC § 71 and not allowable as a deduction for the payor under IRC § 215.

7.  Lump-sum money award to equalize division of marital property

    ORS
107.105(1)(f) authorizes the court to divide property between the parties “as may be just and proper in all the circumstances.”  Property division often involves the use of an “equalizing money award,” typically being a lump-sum fixed-dollar amount, due and payable upon entry of the dissolution judgment or by a specified future due date (often with a provision allowing the debtor to satisfy the obligation by making a single in-full payment or a series of partial payments, usually on a monthly basis, doing so until the obligation has been fully paid).

    Typically, a money award made for the purpose of equalizing the division of marital property is not intended to be treated as spousal support and, as such, would not be subject to post-judgment modification.
Further, such an award is typically intended to be treated as a transfer of propety to a spouse incident to dissolution of marriage and therefore, in accord with
26 USC § 1041, not deductible for the payor nor taxable for the payee.  Payment of the obligation is so recognized and treated by the parties, their attorneys and the court.  Not so, however, for the IRS.  A survey of U.S. Tax Court decisions reveals a number of cases in which a lump-sum property division money award was deemed by the IRS as tax deductible alimony.

    The problem is usually the result of a dissolution judgment that, although labeling the award as being for purposes of equalizing the division of marital property, fails to include appropriate language clearly disqualifying payments made pursuant to the award from satisfying the “alimony” criteria of the federal tax code.  Husband (as payor, for example) then claims the payments made pursuant to the judgment as tax deductible alimony on his tax return.  Wife files her tax return and does not include the payments in her gross income.  This results in the IRS (and ultimately, perhaps, the U.S. Tax Court) having to determine, one way or the other, whether the payment is or is not alimony for income tax purposes.

    This is a problem that can and should be avoided.  If the intent of the parties is that a lump-sum property division money award NOT be treated by the IRS as alimony for income tax purposes, appropriate “alimony disqualifying language” expressing the parties’ intent should be included in the judgment provision that establishes the obligation.  Don’t leave it to IRS to engage in a guessing game as to the parties’ intent.  More often than not, it seems, when IRS guesses, it guesses wrong.  Consider the following provision (which should be included in both the main body of the judgment document as well as in the "money award" section at the end of the document):

    Equalizing property division judgment not intended as alimony. The equalizing money award herein established, and the payment(s) made pursuant thereto, is intended by the parties and the court as a transfer of property to a former spouse incident to divorce in accord with Internal Revenue Code (IRC) § 1041.  Accordingly, all payments of money by husband to wife (or to a third party on behalf of wife) pursuant to the aforesaid money award are NOT intended as “alimony” for income tax purposes pursuant to IRC §§ 71 and 215 and such payments are hereby designated as not includible in the gross income of the payee under IRC § 71 and not allowable as a deduction for the payor under IRC § 215.  Husband's liability for payment of the aforesaid money award shall continue notwithstanding his death or the death of the payee spouse.  Further, husband shall not claim any payments made pursuant to the aforesaid money award as “alimony paid” on his federal income tax return.


8.  “In gross” spousal support

   
ORS 107.105(1)(d) allows for an award of spousal support “in gross.”  An in gross spousal support award typically refers to a lump-sum total amount payable through a series of periodic payments continuing until the total obligation is fully paid.  An award of spousal support “in gross” is typically made in order to fully satisfy and "buy-out" the spousal support rights and claims that might otherwise be asserted by the recipient spouse.   As such, it is akin to a property division award in that payment obligation (1) is not subject to future modification and (2) does not terminate upon the date of the recipient spouse (nor upon the death of the payor spouse).   Consequently, such an obligation is generally not "alimony" for income tax purposes and is therefore not deductible for the payor nor includible as income for the payee.

     However, a pre-determined and fixed sum, referred to as "spousal support in gross," may qualify as alimony for federal income tax purposes if provision is made for termination of any remaining unpaid balance owing at the time of the death of the recipient (payee) spouse and, of course, the obligation otherwise satisfies the requirements of IRC § 71.

    CAUTION:  If an award of spousal support "in gross" is intended to qualify as alimony for income tax purposes, the payment obligation must be carefully structured so as avoid the "alimony recapture" rules of IRC § 71(f), which are intended to prevent front-loading of alimony.  IRC § 71(f) provides for "recapture" of excess payments that were treated as alimony in the first two years after the date of the parties' dissolution judgment.  In sum, payments intended as alimony payments are subject to recapture if the alimony paid in the third year decreases from the prior year by more than $15,000, or if the alimony paid in the second and third years decreases significantly from the amount of alimony paid in the first year.

    To avoid unintended and unwanted recapture tax consequences, the judgment establishing a spousal support “in gross” award should include language that clearly and explicitly expresses the intent of the parties, with the language pertaining to the amount and timing of payments being carefully structured.   Best advice:  Consult with a tax professional before reaching agreement as to an award of spousal support "in gross."

    Conversely, if the in gross spousal support judgment is intended not to be alimony for federal income tax purpose (and thus be tax-free and not subject to the alimony recapture rules), appropriate alimony disqualifying language should be included in the provision of the judgment that establishes the obligation.  Specifically, the judgment should expressly designate the payment obligation as not includilbe in gross income for the payee under IRS Code § 71 and not allowable as a deduction for the payor under IRS Code § 215.  For example:

   “In gross” spousal support not alimony for tax purposes.  The award of “in gross”  (or "lump sum") spousal support herein established and the payment obligation thereby established is intended by the parties and the court as a non-taxable transaction.   Accordingly, all payments of money by husband to wife (or to a third party on behalf of wife) pursuant to the aforesaid award of “in gross”  (or "lump sum") spousal support are NOT intended as “alimony” for income tax purposes pursuant to IRC §§ 71 and 215 and such payments are hereby designated as not includible in the gross income of the payee under IRC § 71 and not allowable as a deduction for the payor under IRC § 215.  Further, husband shall not claim any payments made pursuant to the aforesaid money award as “alimony paid” on his federal income tax return.


9.  Other payments not intended to be “alimony” for income tax purposes.  

    Court-ordered money payment obligations established by dissolution judgments come in all shapes and sizes.  Obligations labeled as “spousal support” are typically intended to have tax consequences, while obligations designated as “child support” or classified as “property division” are intended to be “tax-free,” being neither deductible for the payor nor taxable to the payee.  Examples of the latter include money awards intended to equalize the division of marital property (payable either as a lump sum or in a series of payments), as well as provisions requiring one spouse to pay the other spouse's rent or mortgage, or pay debt obligations that are owed by the other spouse, or pay the premiums on a life insurance policy that is owned by the other spouse.

    All too often the specific tax consequences of such obligations are not considered at the time of the dissolution proceeding and the dissolution judgment fails to include any language that expresses the parties’ intent regarding the tax treatment and tax effect to be given to the obligation.  Unintended or undesired consequences may result.

    For example, a cash payment from one spouse to the other (or to a third party on the other's behalf) that is made pursuant to a dissolution judgment (“divorce instrument” in IRS parlance) may qualify as "alimony" for income tax purposes, and thus be deductible for the payor and taxable to the payee, even though not so intended, if, inter alia, the payment obligation terminates upon the death of the recipient (payee) spouse, with no liability to make any payment (in cash or property) thereafter,
26 USC § 71(b)(1)(D), AND the divorce instrument “does not designate such payment as a payment that is not includable in gross income [for the payee] under section 71 and not allowable as a deduction [for the payor] under section 215.”  26 USC § 71(b)(1)(B).  Words matter.  It is important to use them, wisely and correctly.

10.  Avoiding unintended alimony

    To guard against “unintended alimony,” it is advisable to include a "cover all the bases" provision in the dissolution judgment that will disqualify the payment from being treated as alimony for income tax purposes.  Consider the following language:

    Tax treatment of money payments.  Except and unless otherwise specifically and expressly so provided by the terms of this judgment, all payments of money by either party to the other, or to third parties on behalf of the other, pursuant to this judgment are NOT intended to qualify and be treated as “alimony” for income tax purposes pursuant to Internal Revenue Code §§ 71 and 215, and such payments are hereby designated as not includible in gross income of the payee under IRC § 71 and not allowable as a deduction for the payor under IRC § 215.  Further, the party making any such payment(s) shall NOT claim such payment(s) as “alimony paid” on said party’s federal income tax return, it being the intent of the parties and the court that such payment(s) be deemed and treated as a transfer of property to a former spouse incident to divorce, in accord with IRC § 1041.


11.  Requirement for termination on death of payee spouse

    To qualify as “alimony” under
IRC § 71(b)(1)(D), there must be no liability to make any payment (in cash or property) after the death of the recipient (payee) spouse.  This requirement will be deemed as satisfied if (1) the dissolution judgment expressly so declares or (2) the payor's payment liability ceases upon the death of the payee spouse by operation of law.  Either or both.

    [Note:  For several years prior to 1987, IRC § 71(b)(1)(D) required the qualifying factor of “no liability for payment after payee’s death” to be specifically stated in the divorce or separation instrument.  Omission of such an express declaration from the divorce or separation instrument effectively disqualified the payment obligation from being deemed as alimony, thus eliminating the payments from being tax deductible to the payor.  However, section 1843(b) of the Tax Reform Act of 1986, Pub L 99-514, amended 26 USC § 71(b)(1)(D) so as to delete from the statute the words “and the divorce or separation instrument states that there is no such liability.”  Under present IRC § 71(b)(1)(D), all that is required is that there be “no liability to make any such payment for any period after the death of the payee spouse and there is no liability to make any payment (in cash or property) as a substitute for such payments after the death of the payee spouse.”]


    The general rule of Oregon domestic relations law is that an obligation to pay spousal support is a personal debt that does not survive the debtor.  See Schaffer v. Schaffer, 57 Or App 43, 643 P2d 1300 (1982).  Further, under Oregon law spousal support is deemed to terminate upon death of payee spouse absent a provision in the judgment providing otherwise.  Kemp v. Dept. of Rev., OTC-RD No 4241, WL 477958 (July 27, 1998) (unpublished opinion).      Further, “a hallmark of spousal support is that the beneficiary's death terminates the obligation.” 
Miller and Miller, 207 Or App 198, 203, 140 P3d 1172 (2006).  This appears to be quite reasonable, given that the underlying function and purpose of spousal support is to support a spouse (or former spouse), not to support a former spouse’s estate.  Once deceased, there is generally no further need for spousal support.

    Given Oregon case law, it is apparent that the obligation of payment of court-ordered spousal support terminates by operation of law upon the death of the payor or the payee, whichever death first occurs.  Nonetheless, if a spousal support award is intended to be alimony for income tax purposes, better practice for Oregon divorce purposes is to expressly declare in the dissolution judgment (both in the main body of the document as well as the “money award” section as the end of the document) that the obligation terminates on the death of either payee or payor, whichever first occurs.

    Conversely, if a money payment obligation created by a dissolution judgment --- whether designated a spousal support or otherwise --- is not intended to be alimony for income tax purposes, practitioners need to consider whether the obligation is one that will terminate upon the payee’s death by operation of law even though “termination on death” language is intentionally omitted for the judgment document.  If such would occur, the obligation may end up being deemed as alimony for income tax purposes even though not so intended.  To avoid such a result, precautions need to be taken, such as inclusion of language in the dissolution judgment expressly designating the payment obligation as “not includible in gross income under IRC § 71 and not allowable as a deduction under IRC § 215.”

12.  Will it be alimony or will it be not?  Examples to consider

    In
Proctor v. Comm., 129 TC No. 12 (2007), the parties’ divorce decree awarded wife a portion of husband’s military pension, referring to the payment obligation as a division of the marital property.  Husband thereafter made payments to wife in compliance with the court’s property division award. (Wife did not qualify for direct payments from DFAS, the military’s payroll agency, because of the marriage was of less than ten years’ duration.)  Husband then filed a tax return, claiming the amount paid to wife as tax deductible alimony (thus resulting in taxable income for wife).  Deeming the payments to wife as property division, in accord with the divorce decree, and therefore not alimony under IRC § 71, the IRS rejected husband tax deduction claim.  Husband appealed.  The U.S. Tax Court agreed with husband and upheld the husband’s tax deduction claim.

    The Tax Court explained that although the divorce decree referred to the payment obligation as part of a division of the marital property, that classification, without more, did not amount to a "clear, explicit and express direction" designating the payment obligation as not includable as income to wife and not allowable as a deduction for husband. “Labels attached to payments mandated by a decree of divorce or marriage settlement agreement are not controlling.”  The requirement of
IRC § 71(b)(1)(B) (that the payment not be designated as not taxable to the payee and not deductible for the payor) was satisfied.  Further, as to termination on death of the payee, the court cited 10 USC § 1408(c)(2), the provision of the Uniformed Services Former Spouses' Protection Act (USFSPA) the says that a divorce court’s division and award of a military pension to a retiree’s former spouse “does not create any right, title, or interest which can be sold, assigned, transferred, or otherwise disposed of (including by inheritance) by a spouse or former spouse.” Thus, by operation of law, wife’s right to receive the court-awarded share of husband’s military retirement will terminate upon her death, with husband thereafter having no further liability.  Consequently, the payments husband made directly to wife while she was alive met the “termination upon payee’s death” requirement of IRC § 71(b)(1)(D) and therefore qualified as tax deductible alimony.

    In
Aday v. Dept. of Rev., ____ OTC-MD_____ (1/17/2006), the parties’ property settlement agreement, incorporated into a dissolution judgment, specifically recited that neither party shall pay spousal support.  The agreement also provided that husband pay wife monthly payments ($706 per month) for 25 years but with the obligation to make payments ending with wife’s death.  Wife did not include and report as “alimony received” the payments received from husband.  The Oregon Dept. of Revenue then assessed a deficiency for unpaid taxes.  Wife appealed.  HELD:  The payments received by wife were alimony for income tax purposes.  Said the court:

    “The payments to plaintiffs satisfied all the requirements of IRC section 71(b)(1). They were made under a divorce or separation instrument. The instrument did not designate the payments as not includible in gross income. The payor and payee were not members of the same household at the time the payments were made. A provision in the instrument expressly provides for the termination of payments upon the death of the payee spouse. The payments to plaintiffs are therefore alimony.”


    As for the provision of the agreement that specifically declared that the payments were not spousal support, the court said: “This court has previously held that the labels the parties attach to the payments are not as compelling as their characteristics, and that the court must apply the current version of the Internal Revenue Code.”  (Citing Kemp v. Dept. of Rev., an unpublished Oregon Tax Court opinion (July 27, 1998) holding that under Oregon law spousal support is deemed to terminate upon death of payee spouse absent a provision in the judgment providing otherwise.)

13.  Other examples

    There are many other types of court-awarded payment obligations that will terminate upon the payee’s death by operation of law, thus allowing payments made pursuant to the obligation to be treated as alimony for income tax purposes (assuming the payment otherwise qualifies as alimony under the tax code).

    For example, as security for a child support obligation payable to wife, husband may be ordered to pay the cost of a life insurance policy on his life, with wife being the owner of the policy. As explained in
IRS Publication 504, "Alimony [for federal income tax purposes] includes premiums you must pay under your divorce or separation instrument for insurance on your life to the extent your spouse or former spouse owns the policy."  Upon wife’s death, husband's obligation to pay the premiums for a life insurance policy on his life that is owned by wife, as security for his child support obligation owing to her, would terminate by operation of law.  (Once dead, wife would no longer be entitled to child support from husband and would no longer need the life insurance protection; nor would she any longer be the owner of the policy.)  If husband claims the premium payments as deductible “alimony paid” on this tax return, wife would be required to report the payments on her tax return as “alimony received” and pay any resulting income tax.

    Another situation:  Husband is ordered to pay the balance due on wife's federally insured student loan.  Under
20 USC § 1087dd(c)(1)(F), the liability for repayment of such a loan is automatically canceled upon the death of the borrower.  Thus, husband’s court-ordered payment obligation would terminate upon wife’s death by operation of law.  Husband makes monthly payments on the loan and claims the payments on his federal tax return as “alimony paid.”  Wife ends up having to report the payments on her income tax return as “alimony received” and pay income taxes thereon.

    Another situation:  Dissolution judgment requires husband is provide health insurance for wife and pay the cost thereof.  Obviously, once wife dies, there would be no need or basis to continue to provide health insurance for her benefit, so the obligation would therefore terminate upon her death by operation of law.

    In all such situations, unless appropriate precautions are taken, payments made pursuant to the divorce instrument may qualify as tax deductible alimony for the payor under the Internal Revenue Code.  And if tax deductible alimony for the payor, the payments become tax includable income for the payee.

14.  Not, not & not:  Requirement that divorce instrument not designate the payment as not deductible for the payor and not taxable for the payee

    A cash payment will satisfy the “alimony” criterion of
26 USC § 71(b)(1)(B) if the dissolution judgment requiring the payment does not designate the payment as “a payment that is not includable in gross income under 26 USC § 71 and not allowable as a deduction under 26 USC § 215.”  (Note the "triple negative" language.)

    To satisfy this statutory requirement and disqualify the payment obligation from being treated as alimony for income tax purposes, the language used in the divorce instrument must  “clearly, explicitly and expressly” designate (or “make known directly”) that a spouse's payments are not to be treated as income. 
Richardson v. Commissioner, 125 F3d 551, 556 (7th Cir. 1997), cited and followed by the US Tax Court in Dato-Nodurft v. Comm., 2004 TC Memo 119 (2004); Maloney v. Comm., 80 TCM 53 (2000) (instrument must contain a clear and explicit designation that the payment is not includable in the recipient's income under section 71 or deductible by the payor under section 215, although it need not refer expressly to section 71 or section 215); Baker v. Comm., 79 TCM 2050 (2000) (designation of payment as "property settlement" with no further clarification would be a “designation by uncertain implication” rather than by “clear, explicit, and express direction”); Estate of Goldman v. Comm., 112 TC 317 (1999) (statutory requirement satisfied by designating monthly $20,000 payments as “transfers of property subject to the provisions of Section 1041”).

    In
Baker v. Comm., 79 TCM 2050 (2000), the tax court rejected a former wife’s claim that the payments received by her from her former husband from his military pension, paid to her pursuant to a divorce judgment that specifically designated the payments as a “property settlement,” should be treated as “nonalimony” and thus not taxable income under IRC § 71(b)(1)(B).  The tax court noted that the statutory language of IRC § 71 (b)(1)(B) does not allow designations by “attenuated implication.”  Citing Richardson v. Commissioner, 125 F3d 551, 556 (7th Cir. 1997), and prior tax court cases, the court declared that the dissolution judgment must contain a “clear, explicit and express direction" that the payments are not to be treated as income for income tax purposes.  The court concluded that labeling the payments as a “property settlement,” with nothing more, was not a “clear, explicit, and express direction that the payments are not includable in petitioner's gross income and are not deductible by Mr. Baker.” 

    “In making our determination, we note that in divorce instruments parties may characterize payments in different ways, such as alimony, periodic alimony, alimony in gross, property settlement, division of property, etc. The meaning of these terms may vary from State to State.  Moreover, the effect that such classifications may have in each State may be dependent upon the intent of the parties or other factual circumstances. As we noted above, Congress specifically revised section 71 in order to eliminate the subjective inquiries into the nature of payments.  * * * The label of "property settlement", with no further clarification, does not clearly inform us that the parties considered the Federal income tax consequences of the payments under sections 71, 215, and/or 1041.”  Baker v. Comm., 79 TCM at 2053.


    To be on the safe side (whichever side that may be), it is advisable when establishing a money payment obligation, whether designated as spousal support or otherwise, to expressly declare the parties' intent regarding the tax treatment and tax effect to be to accorded to the obligation, using the statutory verbiage of IRC § 71(b)(1)(B).  If the obligation is intended to be tax deductible for the payor under IRC § 215 and taxable income for the payee under IRC § 71, say so.  And if it is not so intended, say that too.  (“Payments made pursuant to this obligation are hereby expressly designated as not includible in gross income of the payee under IRC § 71 and not allowable as a deduction for the payor under IRC § 215.”)

15.  If it’s child support, it’s not alimony

    Unlike alimony payments, child support payments are not tax deductible for the payor (obligor) nor taxable income for the payee (obligee).  While the label given to a particular payment obligation (e.g., “property division” or “spousal support”) is generally by itself not controlling or determinative as to the tax treatment to be accorded, “child support” is an exception.  Pursuant to
IRC § 71(c)(1), if a divorce or separation instrument expressly designates a payment obligation as “child support” it will automatically disqualify the payment from being deemed or treated as alimony for income tax purposes.

    Further, a payment obligation that might otherwise qualify as alimony under IRC § 71 will be disqualified as alimony if the payment is “treated as child support.”  A payment obligation will be “treated as child support” if the obligation will be reduced (A) on the happening of a contingency specified in the instrument relating to the payor's  child (such as attaining a specified age, marrying, dying, leaving school or a similar contingency) or (B) at a time that can “clearly be associated” with such a contingency.  IRC § 71(c)(2)(A) and (B).  The amount of the reduction would be treated as child support and therefore not as alimony.

   
IRC Regulation 1.71-1T (26 CFR § 1.71-1T), at Q&A 18, sets forth the two situations that will “clearly be associated” with a contingency relating to a child. The first situation occurs when “the payments are to be reduced not more than six months before or after the date the child is to attain the age of 18, 21, or the local age of majority.”  The second situation occurs when “the payments are to be reduced on two or more occasions which occur not more than one year before or after a different child of the payor spouse attains a certain age between the ages of 18 and 24, inclusive.  The certain age referred to in the preceding sentence must be the same for each such child, but need not be a whole number of years.”

    If the parties to a dissolution proceeding are contemplating an award of spousal support pursuant to ORS 107.105(1)(d) and they have children, care needs to be taken so as to avoid alimony disqualification due to the application of IRC § 71(c)(2).  For further discussion and illustration of the problem, see Linder v. Dept. of Rev., 18 OTR 11 (2004) (Dissolution court awarded wife $2,300 per month spousal support, with a reduction of $800  to occur on February 1, 2002, a date that was within six months of the parties’ eldest daughter attaining age 21, followed by a $500 reduction to occur on May 1, 2007, a date that was within six months of the youngest daughter attaining age of 18;  Oregon Tax Court ruled the reduction amounts as nondeductible child support and denied husband’s tax deduction claim).

16.  Practicality vs. legality

    As a matter of practicality, the strict application of the alimony rules of IRC §§ 71 and 215 will arise only in the event a dispute arises when a payor spouse claims a deduction for “alimony paid” (see IRS Form 1040, line 31a) and a corresponding amount is not reported by the payee spouse as “alimony received” (see IRS Form 1040, line 11).  So long as the two tax returns are “in sync” with one another, the IRS processing computer will be happy and, absent other problems, both returns will be accepted and not questioned.

    On the other hand, if the payor claims a deduction for “alimony paid” that is not correspondingly reported by the payee as “alimony received,” it will inevitably cause a problem the requires IRS resolution.  And in doing so, IRS will strictly apply the Internal Revenue Code statutes, 26 USC §§ 71 and 215, and the IRS Regulations, 26 CFR §§
1.71-1, 1.71 1T, 1.215-1 and 1.215.1-T.

17.  Conclusion (and word of advice to Oregon practitioners)

    Many if not most of the problems, real or potential, involving the tax consequences of court-ordered money payment obligations can and will be avoided if the parties and their attorneys, and the court, reach a clear understanding and agreement, at the time the marital dissolution proceeding is occurring, as to the intended tax treatment and tax effect of each payment obligation being established, and include in the dissolution judgment or separation agreement appropriate language expressing that intent, in compliance with applicable IRS statutes and regulations.  Failure to do so may result in an unwanted tax obligation for one spouse or the other and, for the attorney involved, an unwanted “Personal and Confidential” letter from the PLF.

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LAWRENCE D. GORIN
Attorney at Law
6700 S.W. 105th Ave., Suite 320
Beaverton, Oregon  97008
Phone:  503-716-8756
E-mail:  LDGorin@LDGorin

Website: www.ldgorin.com