Top Attorneys and CPAs will convene at the Bellagio Hotel in Las Vegas for the AAML/AAICPA Conference on Divorce on April 24 and 25th. At this conference, Don DeGrazia, CPA, and I will be talking on the subject of Divorce Tax Traps (scheduled for Friday April 25th at 2:55 p.m). In preparing for this program, I relied on Frumkes on Divorce Taxation. The author of this treatise, Mel Frumkes, died last week. He was a long time friend and colleague of both me and my father, Stuart B. Walzer. Mel was a loyal friend of my parents. Mel was 85 years old and still an active family lawyer. Mel wrote many articles and achieved so many professional accomplishments that they are too numerous to mention. He was one of the “greats” in family law and beloved by many. I honor him here as a friend and a professional.
I dedicate our program “Divorce Tax Traps” to Mel who has given this presentation many times. At our program, we will start off with the simple stuff – the taxation of alimony. (We will work up to the more complex questions of tax loss carry forwards and so forth) There are eight simple rules that one must follow to qualify alimony as tax deductible. For alimony to be tax deductible it must be:
- To/for a spouse or ex
- Paid in cash
- Under an instrument
- Doesn’t say non-taxable
- Parties don’t live together
- Terminates on payee’s death
- Not fixed as child support
- Joint return not filed
This sounds simple, right? Okay, let’s deal with some hypothetical problems. What if the court order says, Jack shall pay to Jill $1,500 per month in permanent spousal support to his wife Jill? (That is it – nothing more). I could tell you to come to our program to find out the answer and win a prize, but I won’t. The court would first look to see if the order terminates on Jill’s death. Since it does not terminate on her death, the court will look to see if it would terminate at her death under State law. (See for example, California Family Code sec. 4337). If it does, the “permanent spousal support” will be deductible. So what if the parties agree in writing that “Jack will pay $10,000 to Jill’s attorney.” Can Jack deduct the payment as alimony and are they included in Jill’s income? No, the payment does not terminate on Jill’s death – a mandatory requirement, and since the payments are not designated as alimony, spousal support, or maintenance, State law would not save Jack. (Stedman v. Commissioner, T.C. Memo. 2008-239) And, if the agreement to pay to pay fees, says “as and for additional maintenance”, it will likely be deductible because State law could be applied to make the order deductible.
Retroactive Spousal Support Payments
Now what happens if Jill had been making spousal support payments to Jack since January 1, 2009 under an oral agreement? The parties stipulate to a court order on August 1, 2009, formally setting spousal support and agreeing that the court order is retroactive to January 1, 2009. Are the payments made between January and July 31st deductible by Jill and included in Jack’s income? The answer is no. The decree or written instrument must be in existence at the time that the support payments are made. (Ali v. Commissioner (2004) T.C. Memo. 2004-284.) Payments made before the existence of divorce or separation instrument are not deductible, even if the instruments retroactively characterizes those prior payments as spousal support. (Id.; Rafferty v. U.S. (D. Colo. 2008) 2008 WL 2705192; 26 C.F.R., § 1.71-1T(a), Q-4, A-4.)
This makes it very tricky to settle the issue of retro alimony when court hearings are delayed from month to month. The remedy is to “tax-effect the alimony” – in other words, take into account that there will not be a deduction and it will not be included in income. This can be calculated on most support software or consult with your friendly accountant.
That covers just three of the seventeen hypos we will be discussing on April 25th. We will be giving out prizes to those who get the right answers. See you in Vegas!
– Peter M. Walzer, Attorney at Law