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When Is Alimony, Alimony…?

March 20, 2011

When I got a divorce in 1987 my divorce papers listed dollar amount for child support and indicated a zero for alimony. These days the wording of divorce decrees seem to be more confusing. Here is a case where the taxpayer was told one thing by Attorneys and Accountants but the reality was another.

Paul and Debbie married in 1980, but later divorced in July 2006. The couple entered into a Marital Settlement Agreement whereby Debbie was to receive one cash payment of $80,000 prior to the final judgment, a second cash payment of $20,000 within 90 days after the entry of judgment, and a third and final cash payment of $10,000 within 180 days after the entry of the final judgment. The first two payments were made timely to Debbie during the 2006 calendar year. Paul in turn claimed a deduction of $100,000 for “alimony paid” to Debbie. Prior to claiming the deduction on his return, Paul consulted an accountant and an attorney, and called the IRS hotline. All parties conveyed a certainty that the payments were deductible on Paul’s return. Paul, however, subsequently received a notice of deficiency relating to his 2006 tax return. The notice indicated that the payments were not alimony, the deduction for alimony was disallowed and, accuracy related penalties were assessed under the assertion that Paul had been negligent or disregarded the rules or regulations. Consequently, the IRS assessed Paul $25,000 of additional federal income tax and imposed a $5,000 accuracy realted penalty.

In determining whether payments may be claimed as alimony under s215, all four requirements of s71(b)(1) must be met. IRC s71(b)(12) specifies that any payment in cash will be considered alimony only if (1) the payment is received by (or on behalf of) a spouse under a divorce or separation agreement; (2) the agreement does not designate the payment as a payment which is not includible in gross income or allowable as a deduction under s215; (3) the payor and the payee are not members of the same household at the time payment is made: and 4) the liability to make the payments ends for any period after the death of payer.

 The agreement and payments made met all the first three requirements under s71(b)(1). The agreement was silent, however, regarding the fourth requirement. Accordingly, the Court looked to Florida state law to determine whether the liability would survive Debbie’s death. Under Florida state law, a lump sum alimony payment does not terminate with the death of the recipient. Therefore, Paul was denied a deduction for the lump sum alimony payments he made to Debbie in 2006. However, the accuracy-related penalty was abated. The Court took into consideration Paul’s efforts to determine the proper treatment of the payments, and concluded that Paul had acted in good faith and that his actions came within the reasonable cause exception of s6664(c)(1).

At GAI (www.gunwel.com) we are here to help you navigate your way  through the murky waters of tax law. We can help you figure out what is the right way to do things. Give us a call at 212-979-6830 or stop by for a visit. We are open Monday – Friday 8am – 8pm and Saturdays 8am – 5pm. You work hard for your money, let Gunwel work smart to help  you keep it. See you soon!

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