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Just Compensation, a Bridge to Normalcy, or the Ransom You Pay the Devil?

IRS Views on Alimony: Just Compensation, a Bridge to Normalcy, or The Ransom You Pay the Devil?

For centuries, husbands and wives have debated the fundamental fairness of alimony.  Robin Williams is just one famous example of an alimony-paying man who publicly spoke out against the evils of alimony.  On the other side of the coin, there are countless talented ex-wives and mothers (or ex-husband’s and fathers) who sacrificed their careers to take care of their children, who sacrificed their dreams to support their husband’s (or wive’s) careers—which would not have been possible otherwise, and for whom even lifetime maintenance is a small pittance compared with the lost time and the unrecognized and unrecoverable contributions they selflessly made to a failed marriage and a divided family.

Alimony can be justified as compensation for “lost opportunities” and “foregone careers” during a period of singular devotion to family affairs, or as necessary support needed to permit a smooth transition by the dependent spouse to independence after a long period of dependence.  More traditionally and historically, alimony was compensation for a breach of the marital contract, which in bygone days (and simpler ones), came with an expectation of the husband’s lifelong financial support for the wife—which, in a divorce stemming from infidelity, violence or neglect, where no fault for the deterioration of the marriage existed on the part of the innocent wife—was needed to remedy the breach of that fundamental contractual and societal expectation.  Today, in a world where there are more women than men in the workforce, that misogynistic and outdated formulation is no longer descriptive of the modern alimony concept.  For its critics, alimony is most heavily criticized for its frequent use as a tool for emotionally wounded spouses to seek vengance and exact punishment through their former spouse’s wallet.  In other words, legalized torture and debt slavery.

Certainly, the alimony landscape is shifting.  "In general, now spouses are getting approximately one year of maintenance for every two years of marriage," said Marguerite Royer, a respected divorce lawyer at Moses & Singer in New York City.  Indeed, today’s divorce attorneys themselves sometimes decry overreaching on the part of alimony recipients.  Michael Douglas’s ex-spouse, Diandra Douglas, who received a $45 million dollar settlement, recently went after Michael while he was battling cancer for profits from “Wall Street 2: Money Never Sleeps.”  The film’s theme of unmitigated greed at the expense of the children is ironic and prescient.  Famed veteran New York divorce attorney Raoul Felder appropriately called the move an “example of greed gone wild and irrational.”

The age old debate rages on.  The IRS, however, does not take sides.  For the IRS, alimony is not a philosophical or political issue – it is a taxable issue.  Section 71 of the Internal Revenue Code provides, in part, that “[g]ross income includes amounts received as alimony….” Therefore, alimony is taxable to the recipient of the amounts paid. Moreover, Sec. 215 states that “[i]n the case of an individual, there shall be allowed as a deduction an amount equal to the alimony…paid during such individual’s taxable year.” Thus, the payor of alimony is entitled to a deduction for the amounts paid.  This leaves little room for confusion.  Any time there is a payment from the ex-husband to the ex-wife, or vice versa, it is the income of the recipient and taxable only to the recipient.  For tracking purposes, however, a legal fiction is created whereby the payor spouse takes a deduction and the payee spouse reflects another category of income received.  Why are 1099s not used?  That is a good question, but with technological progress, I think the use of 1099s and other enhanced reporting is not far off.

The reason the legal fiction of deduction and inclusion is necessary because the IRS needs to be able to determine the discrepancy between income received by W2 or 1099 from wages and salaries, and any income tax withheld, and to reconcile that against amounts paid out to the recipient spouse. 

An excerpt from a 2003 MD Court of Special Appeals decision is particularly instructive.

In the ordinary course, alimony payments are included as “gross income” to the payee and are deductible by the payor for federal income tax purposes. See Internal Revenue Code, 26 U.S.C. §§ 71;  215(a); see also Lewis v. Lewis, 256 Md. 45, 53, 259 A.2d 246 (1969) (noting that alimony is “deductible in the computation of net income for federal tax purposes”); Groves v. Alexander, 255 Md. 715, 719 n. 2, 259 A.2d 285 (1969) (“Sections 71 and 215 [of the Internal Revenue Code] speak of payments by the husband to the wife and of the deductibility by the husband and includibility in the income of the wife.”).

In this case, the court explicitly designated the payment of $3,500 per month as “alimony.” If the payment is designated as “alimony,” it constitutes “gross income.” Under that circumstance, it is error to designate the receipt of alimony as tax-free to appellee and taxable to appellant (emphasis added). 

 

Till Death Do Us Part…

I said earlier that the IRS doesn’t take sides.  Well, sometimes they do.  If a wife has an intrepid attorney who takes a strident position and gets a provision inserted into a Separation Agreement extending alimony beyond the payee spouse’s death, or achieves a judgment of like effect for past due spousal support arrears under State law, it is possible that the ex-husband will become accountable for tax on the payments, forefeiting the deduction which applies only to “alimony” ending upon death.  A perverse and unintended consequence, to be sure, but one wielded in interesting ways by the IRS and by the Tax Court and by the attorneys who pen the agreements subject to scrutiny in these forums.

Sec. 71 of the Internal Revenue Code has four (4) conditions that must be met in order for a payment to be considered “alimony” under the Internal Revenue Code.  The four (4) conditions of Sec. 71(b)(1) are as follows:

(b) Alimony or separate maintenance payments defined

For purposes of this section—

(1) In general the term “alimony or separate maintenance payment” means any payment in cash if—

(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 under this section and not allowable as a deduction under section 215,

(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 payor 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.

So “alimony” payments must be contractually determined under a separation agreement, that does not specifically designate the payments as “not includible in gross income,” the ex-spouses must actually be separated and not part of the same household, and the payments must end with the death of the payee spouse.

Of these four criteria, the 1st and the 3rd prongs provide few problems.  No one pays “alimony” without a formal agreement to do so, and divorcing ex-spouses who have representation know enough to move out of the marital residence—which is the default instinct to begin with.

State law also plays an important role.  A divorce or separation agreement executed after December 31, 1984, does not need to expressly state that payments cease upon the death of the payee spouse as long as State law provides for automatic termination of payments upon the death of the payee spouse. See Tax Reform Act of 1986, Pub. L. No. 99-514, sec. 1843(b), 100 Stat. at 2853.  But, the divorce or separation agreement cannot expressly state otherwise.

By far, the most probelmatic of the four criteria is the “no liability to make any such payments…after the death of the payee spouse” provision.  For instance, in Iglicki v. Commissioner, TC Memo. 2015-80, the Tax Court held that a taxpayer was not entitled to the alimony deduction.  The separation agreement indicated that upon default, the spousal support would continue until Mr. Iglicki died, until his wife died, or until 36 monthly payments were made.  Default occurred and a judgment for spousal support arrears was entered under Colorado law.  There is a distinction under Colorado law between spousal support and support arrears with regard to how the payments may be enforced and collected under State law.  Future support payments terminate upon death.  The award of support arrears, reduced to a final judgment, and recoverable against Mr. Iglicki’s wages on a garnishment order, was indeed, recoverable against his estate, would not automatically terminate upon his death, and therefore was not “alimony,” because it did not meet the 4th prong of Sec. 71(b)(1).  Thus, adding insult to injury, the payments were found to be non-taxable (to Mrs. Iglicki) and non-deductible (to Mr. Iglicki).

In Esther P. Crabtree v. Commissioner, T.C. Memo. 2015-163 (filed August 17, 2015), the Court applied Delaware law to a provision in a divorce agreement, determining it inpermissibly created an obligation to make payments after the death of the payee spouse.  The provision stated:

“Dr. Girard will continue to tender unallocated alimony/ child support in the monthly sum of $5,232.00 for a continued 8 year period with the provision as long as Mrs. Girard should not remarry or cohabitate.”

The Tax Court analyzed that the plain lanugage of the contract and determined that the payments were to last for a minimum of 8 years, and nothing in the agreement specified that the payments would terminate sooner if Mr. Girard died.  Thus, the payments were found to be non-taxable (to Mrs. Crabtree) and non-deductible (to Mr. Girard).

Topic 452 – https://www.irs.gov/taxtopics/tc452.html

Publication 18 - https://www.irs.gov/publications/p17/ch18.html

Alimony in All Its Glorious Forms

There is permanent alimony, limited duration alimony, rehabilitative alimony, pendente lite alimony, reimbursable alimony, and other designations that creative divorce attorneys come up with every day.  But, just as a rose by any other name would smell as sweet, alimony by any other name would still pay the bills.

The historical shift in the treatment of alimony by the Courts is certainly instructive.  But, even more interesting are the statutory factors the Court considers when determining how much alimony is due. See N.J.S.A. 2A:34-23(b). 

These factors are: 1) the actual need of one party and ability of the other party to pay; 2) the length of the marriage or civil union; 3) ages of the parties and their emotional and physical health; 4) The parties standard of living established during the marriage or civil union and whether each party can maintain a reasonably comparable standard of living; 5) each parties’ earning ability, educational levels, occupational skills and employability; 6)The length of absence from the job market of the party seeking maintenance; 7) a party’s parental responsibilities for their children; 8) The time and cost needed to acquire enough education or training to enable the party seeking support to find suitable employment, the availability of the training and employment, and the prospect for future attainment of capital assets and income; 9) the record of financial and non-financial contributions to the marriage by both party including contributions to the care and education of the children and disruption of individual careers or educational opportunities; 10) the distribution of property ordered and any payouts on said distribution, directly or indirectly, out of current income, to the extent this consideration is reasonable, just and equitable; 11) any investment income available to either party from of any assets held by them; 12) The tax treatment and cost to both parties of any alimony award, including the description of all or a part of the payment as a non-taxable payment;13) any other factor the Court finds relevant.

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