Wednesday, August 1, 2012

The 'there is support and there is alimony' Case

A taxpayer was assessed due to having claimed $44,700 in payments made his spouse pursuant to temporary orders during the pre-divorce separation period. The orders did not specify the character of these payments as alimony or as not alimony, however, they did include wording close enough to running afoul of item B below to cause the tax court to deny alimony treatment of these payments. In my opinion, the divorce attorneys should have done a better job of making sure the payments would qualify as alimony. Depending on a person's tax rate, he or she may be better off paying more in support and obtaining a tax deduction. The recipient spouse may be at a much lower tax rate and therefore likewise better off because he/she will receive more after tax money than she would have if it were not treated as alimony.

Example: If the payee has a fed/state tax rate of 33% then a deductible $4000 payment would really cost $2680 after taxes. Assuming the recipient spouse has a fed/state tax rate of 21% this $4000 is worth $3160 after taxes. Both parties are better off with this arrangement than with a $3000 payment that is not deductible to the payee. Win win!

Unallocated family support payments are deductible as alimony or separate maintenance only if all four of the above conjunctive requirements are met

(A) such payment is received by (or on behalf of) a spouse under a divorce or separation instrument,

(B) the divorce or separation instrument does not designate such payment as a payment which is not includible in gross income of the recipient and/or not allowable as a deduction to the payee,

(C) in the case of an individual legally separated from his spouse under a decree of divorce or of separate maintenance, the payee spouse and the recipient spouse are not members of the same household at the time such payment is made, and

(D) there is 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.

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