By Guest Blogger Donald Paris, CPA, MST, CDFA
Everyone knows that alimony (aka spousal support) paid is deductible by the spouse paying it, and income to the spouse receiving it. Most people think that all they need to do is to agree that alimony will be paid from one spouse to the other and it is deductible. Unfortunately, as one couple found out, that is not always the case. Certain things must be dealt with to make it so. One couple found out that just making a simple change to their agreement turned into a tax nightmare for the paying spouse.
So, what happened? John and Rose Nye were divorced in Florida on September 12, 1990. The court incorporated the couple’s Separation and Property Settlement Agreement into their final divorce judgment which called for John to make alimony payments of $3,600 per month and a lump sum payment of $10,000 to John’s former wife Alice. It also required John to obtain medical insurance for Alice or pay her an additional $150 per month. In late 2006, Alice went to court for an increase in her alimony. Before the court could reach a decision, John and Alice settled while signing a Mediation Settlement Agreement that called for John to make a lump sum payment of $350,000 to Alice and for Alice to turn over her rights to a piece of property to John. On January 28, 2009, John made the $350,000 payment to Alice, and the court incorporated the new mediation agreement into the final judgment of divorce. John and his current wife Rose deducted the $350,000 as alimony on their joint 2008 income tax returns. The IRS disallowed $346,250 of the $350,000, allowing $3,600 of the prior alimony amount plus the $150 in medical insurance reimbursement.
The Tax Court noted, in Memorandum 2013-166, that the mediation agreement did not discuss the issue of whether John’s obligation to make the $350,000 would have terminated if she or he had died after the agreement’s effective date but before the divorce court had decided on Alice’s petition for modification of her alimony. Because the mediation agreement did not address this issue, the Tax Court looked to Florida law for guidance and found that John’s obligation under the mediation agreement to make the $350,000 payment would not have terminated under that scenario. As a result, the Tax Court concluded that the payment did not satisfy the requirement under Internal Revenue Code section 215 that John’s obligation to make the payment must end at the death of Alice. Thus, John could not deduct the extra $346,250 lump sum payment to Alice as alimony on his tax return. Ouch!
So, what is our take-away from this? There are many not necessarily obvious factors that we need to consider during a divorce. Sure, we have to deal with the children, finances and the law, but too often the tax implications of divorce are ignored. In cases like this one, there are very large implications to this ignorance. That ignorance may have cost John $150,000 more than he anticipated. In order for everyone to have the outcome they want in the divorce, a coordinated team approach, which includes a well-seasoned tax professional, is money well spent.
To learn more, please visit http://donparis.com/index.php.