Solving taxing alimony settlements.
By Melvin B. Frumkes (Florida)
Designation Of Support As Nontaxable, Nondeductible
Under the alimony provisions of the Code, a stream of payments paid under a divorce or separation instrument which is cash to or on behalf of a spouse, the obligation for which ceases upon the death of the payee for spouses living in separate households where the status of the marriage has changed, and not fixed as child support, will be taxable to the payee and deductible to the payor so long as the divorce or separation instrument does not designate such payment… (as) not includable in gross income under the (the alimony section of the Code 71) and not allowable as a deduction under Section 215.
There are three types of divorce or separation instruments. The term “divorce or separation instrument” is defined in LRC 71 (b)(2) as:
(A) a decree of divorce or separate maintenance or a written instrument incident to such a decree,
(B) a written separation agreement, or
(C) a decree (not described in sub-paragraph (A)) requiring a spouse to make payments for the support or maintenance of the other spouse.
The court in Richardson v Commissioner, 125 F2D S51, S56 (7th Cir. 1997), in footnote 3, observed:
Surprisingly, the Commissioner has not promulgated any regulations describing what a divorce or separation instrument must say, or what a divorce court must do, to “designate” the tax treatment to be afforded inter-spousal payments.
In Richardson, the court stated that in common usage, the term designate means “to make directly” (quoting from Webster’s Third New International Dictionary) and “to mark out and make known; to point out; to name; indicate” (quoting from Black’s Law Dictionary).
An election can therefore be made to keep the payments out of “alimony” treatment under the Code and thus be nontaxable to the payee and nondeductible to the payor. A designation that payments are taxable/deductible is meaningless as the payments will be taxable/deductible only if the criteria of the Code are met, not if designated as such.
Language in an order, decree, or agreement that the payor “shall be responsible for income taxes due” on the payments was held in Jaffe v Commissioner, 77 T.C.M. 2167 (1999) that it “does not suffice to constitute a designation” of nontaxability/nondeductibilty. Thus, the payee, Ms. Jaffe, was required to include payments to her as taxable income.
Since a court should take into consideration the net after-tax amount of alimony to a payee spouse, Lutgert v Lutgert, 362 So. 2d 58 (Fla. 2d DCA 1978), thought should be given to designating the payments as nontaxable to the payee and nondeductible to the payor. 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.
Under the Domestic Relations provisions of the Tax Reform Act of 1984, separate streams of payment under a judgment, agreement, or order for support can have a different tax effect; that is, one stream of payment can comply with the alimony rules and qualify as deductible/taxable while another stream of payments can be designated as nondeductible and nontaxable.
A copy of the instrument containing the designation of payments as not alimony or separate maintenance payments must be attached to the payee’s tax return (Form 1040) for each year in which the designation applies.
Designation By The Parties
The designation of nontaxability/nondeductibility must be made pursuant to a divorce or separation instrument, one of which, by its definition, is a written separation agreement. This, of course, is an agreement between the parties.
Temp. Treas. Reg. 1.71-1T, Q-8 inquires: “How many spouses designate that payments otherwise qualifying as alimony or separate maintenance payments shall be excludible from the gross income of the payee and nondeductible by the payor?”
The answer in A-8 is: “The spouses may designate that payments otherwise qualifying as alimony or separate maintenance payments shall be nondeductible by the payor and excludible from gross income by the payee by so providing in a divorce or separation instrument (as defined in section 71(b)(2)). If the spouse have executed a written separation agreement (as described in section 71(b)(2)(B)), any writing signed by both spouses which designates otherwise qualifying alimony or separate maintenance payments as nondeductible and excludible and which refers to the written separation agreement, will be treated as a written separation agreement (and thus a divorce or separation instrument) for purposes of the preceding sentence.”
Temporary Support Order, Designation By Court
An order for temporary support is a “(C)” type of divorce or separation instrument; i.e., “a decree (not a decree of divorce or separate maintenance) requiring a spouse to make payments for the support or maintenance of the other spouse.”
Thus, the designation of nontaxability/nondeductibility can be made in an order or decree for temporary or pendent lite support or maintenance. Temp. Treas. Reg. 1.71-1T A-8 so contemplates when it articulates that “If the spouses are subject to temporary support orders (as described in section 71(b)(2)(C)), the designation of otherwise qualifying alimony or separate payments as nondeductible and excludible must be made in the original or a subsequent temporary support order.
Final Decree Of Divorce Or Separate Maintenance, Designation By Court
A final decree of divorce or separate maintenance also comes within the definition of a divorce or separation instrument in which the designation of nontaxability/nondeductibility can be made.
I.R.C. 71(b)(2) uses the connective “or” in listing three types of divorce or separation instrument. Since the word “or” is a conjunctive “used to express a choice or a difference or to connect words or group of words of equal importance,” there should be little doubt that a trial judge in the final decree of judgment of a divorce or dissolution of the marriage has the right to make the designation of a stream of payments as being nontaxable, nondeductible.
Many courts so recognize. In Lowe v Lowe, 622 N.Y.S.2d 26 (App.Div. 1st Dept. 1995) it was held that “It is within the sound discretion of the court, pursuant to I.R.C. 71(b)(1)(B), to provide in its order that the maintenance payments be neither income to the plaintiff (wife) nor deductible to the defendant (husband).”
An Ohio appellate decision has recognized that the trial court, even over the objection of one of the parties, can designate a stream of payments as “nontaxable spousal support.” In Roddy v Roddy, 1999 WL 22589 (Ohio 4th Dist. 1999) the court said:
Not all court-ordered alimony and separate maintenance payments, however, fall within the federal statutory definition of “alimony or separate maintenance payment”…Pursuant to (I.R.C. 71(b)(1)(A) if a court designates a payment as not includible in the payee’s gross income pursuant to Section 71 and not deductible from the payor’s gross income pursuant to Section 215, then the payment, by definition, is not “alimony or separate maintenance.”
A Virginia trial court in Hamilton v Hamilton, 19 Va.Cir. 241, 1990 WL 751116 (Cir. Ct. of Va. 1990), in answering the question of whether the court may order a party, over his objection, to allocate the tax burden to him held that I.R.C. 71 contains no prohibition of such court action “and no conflict between state and federal law would be created.”
In Almodovar v Almodovar, 754 So. 2d 861 (Fla. 3d DCA 2000), the appellate court observed:
The usual treatment of alimony is to make the alimony taxable to the recipient and deductible by the payor. 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.
The Florida Supreme Court in holding that a designation of nontaxable/nondeductible is proper in a Final Judgment or decree recited:
[A] divorce decree may provide that alimony payments are to be excluded from the gross income of the payee and not deducted by the payor. In such a case, the payments do not constitute “alimony” for tax purposes, are not included in the gross income of the recipient, and are nontaxable to the recipient.
Thus, private ordering by the court in a temporary or final order, judgment or decree, or by the parties in their written agreement is appropriate.
Mel Frumkes is certified Marital and Family Law attorney with offices in Miami Florida and practices throughout the state od Florida. He is the author of Frumkes on Divorce Taxation and a member of the boards of editors of the Family Advocate (ABA). The Journals of both the AAML and the IAML.
Reprint with permission.