Alimony Question

[gfizer]

Taxpayer was obligated to pay the following items to his ex-wife pursuant to their divorce agreement:

$48000.00 lump sum maintenance

$22000.00 automobile allowance (i.e. he had to pay for the purchase of a car up to the 22,000 limit)

Health insurance premiums for three years or until she had employer provided coverage, whichever was earlier.

Would all three of these items be deductible as alimony on his tax return? The agreement does not specifically call them alimony but it also does not say they are not alimony payments.

Any thoughts or suggestions?

Thanx!

[BulldogTom]

Taxpayer was obligated to pay the following items to his ex-wife pursuant to their divorce agreement:

$48000.00 lump sum maintenance

$22000.00 automobile allowance (i.e. he had to pay for the purchase of a car up to the 22,000 limit)

Health insurance premiums for three years or until she had employer provided coverage, whichever was earlier.

Would all three of these items be deductible as alimony on his tax return? The agreement does not specifically call them alimony but it also does not say they are not alimony payments.

Any thoughts or suggestions?

Thanx!

Totally unresearched - BEWARE.

It looks like the first 2 items are property settlements, and if the spouse was my client, that is the position I would take.

Tom

Lodi, CA

[kcjenkins]

Payments made under divorce executed after 1984 are deemed to be alimony if they meet six criteria.

First, payments must be made in cash. Code Section 71((1).

Second, they must be required under a written divorce or separation instrument. Code Section 71((1)(A).

Third, the divorce or separation instrument cannot designate payments as non-deductible by the payor or excluded from the payee's gross income. Code Section 71((1)(.

Fourth, if the parties were separated under a decree of divorce or legal separation, they cannot be members of the same household when payments are made. Code Section 71((1)©.

Fifth, the payor cannot be liable for payments (including any substitute for required payments) after the death of the payee. Code Section 71((1)(D).

Sixth, payments cannot be for child support. Code Section 71©(1).

If all these criteria are satisfied, the payments are characterized as alimony for federal income tax purposes. Thus, payments may be characterized as alimony even if state law would characterize the payments as something other than alimony, such as part of a property settlement. So, what you have to determine is if any or all of them meet ALL six of the tests. Read the complete divorce papers, because you have to be sure that the third test is not covered somewhere else in the paperwork, either before or after the section where the financial details are set out. If she has a decent lawyer, it should be there somewhere.

[jainen]

>>six criteria<<

KC, there is another requirement that is probably relevant here. The alimony payments can't drop by more than $15000 in the second and third year.

[Pacun]

It seems that, in this case, they are splitting their wealth because they are divorcing. Alimony is an allowance for support and not money to pay for a car. I think one spouse had a car that cost about 22K and the judge said that the other spouse should also receive a car.

You should also read careful about the lump sum payment.

[kcjenkins]

Jainen, I forgot about that one. That would eliminate the first two for sure, wouldn't it?

[gfizer]

Jainen, I forgot about that one. That would eliminate the first two for sure, wouldn't it?

Would it really eliminate them or would he just be subject to the recapture rules?

[kcjenkins]

Well, yes, he'd be subject to the recapture rules, so why would you take the deduction when you already know that he's not going to be eligible for the deduction, and will have to pay it back with interest. Also, when there is no question, up front, that it is not qualified as alimony, I'd worry, with the new rules, that taking it could make the preparer subject to the penalties for taking an unreasonable position on the return. At a minimum you would need to disclose the position, which the client would not like. I do not see any benefit at all from this, from the client's point, and an actual negative, from the preparers point.

The recapture rules are intended for situations where it looks, up front, like it's valid alimony, but due to some significant change, it no longer qualifies. Not for taking it knowing at the start that it is not going to qualify at the end of three years.

[jainen]

>>At a minimum you would need to disclose the position<<

California did a study this year comparing alimony deductions with reported income. 40% of each side were erroneous, so naturally they plan to expand the audit program substantially. I'm sure the IRS is taking notes too -- it seems like pretty easy pickings.

[gfizer]

Well, yes, he'd be subject to the recapture rules, so why would you take the deduction when you already know that he's not going to be eligible for the deduction, and will have to pay it back with interest. Also, when there is no question, up front, that it is not qualified as alimony, I'd worry, with the new rules, that taking it could make the preparer subject to the penalties for taking an unreasonable position on the return. At a minimum you would need to disclose the position, which the client would not like. I do not see any benefit at all from this, from the client's point, and an actual negative, from the preparers point.

The recapture rules are intended for situations where it looks, up front, like it's valid alimony, but due to some significant change, it no longer qualifies. Not for taking it knowing at the start that it is not going to qualify at the end of three years.

This question arose because the IRS is questioning the taxpayers deductions for alimony on his 2005 tax return. The taxpayer prepared the return himself which probably wasn't the wisest thing but is water under the bridge at this point.

In a nutshell they are disallowing everything except for one $2000 maintenance payment he made by check. His mediation agreement which was entered as the parties' separation agreement and incorporated into the final decree stated that he was to pay his ex $2000 a month for 24 months months for a total of $48,000 in maintenance and a $22,000.00 automobile allowance. He was also to pay her health insurance premiums for a period of three years and was to pay her $7000 which was to be applied toward her personal credit card debt.

The maintenance payments were to begin in October 04 and the balance of the $48,000 (less payments already made), together with the auto allowance (less any payments he had made if she purchased a car prior to the sale of the home), was to be paid to his ex from the sale proceeds of the marital home. The home sold in February 2005. She had already purchased a car (in October 04) prior to the sale of the home and he began making the payments on it at that time and then the balance of the $22000 was paid from the sale proceeds. He paid $2000 maintenance in January 05 which they are allowing but they are saying that the balance paid from the sale proceeds of the home are property settlement and not alimony. He is willing to concede this because he understands their reasoning but believes he should be able to deduct the amounts he paid for her health insurance premiums, the $7000 payment and the car payments he made for her prior to the sale of the home since these things meet all the requirements to be considered alimony. He wants to go on and pay the amount they say is due ($25000+) in order to stop the accrual of penalties and insterest and then argue with the IRS about these things. Would it be wise for him to do this? I'm assuming if he does he would need to mark his payment as "paid under protest" or something of that nature.

As a side note, regarding the recapture issue, if the balances of the $48000 maintenance payment and the $22000 auto allowance paid from the home sale proceeds are excluded as the IRS proposes then his payments for the other things over the three years will be fairly equal and may not trigger the recapture.

[jainen]

>>he understands their reasoning<<

The do have pretty good reasoning, so he needs to bring in other issues such as judicial precedents and administrative procedure. The appeals office won't like the idea of compromise because if he wins they have to start all over again with the ex-spouse. So he has to plan to go to Tax Court. (Since he is willing to prepay the bill he could go to district court instead, but $25,000 probably isn't enough to make that worthwhile.)

He needs to carefully document the timing of every single letter, phone call, and other contact with the IRS, as well as every detail of his absolute compliance with the audit process. If he does this, the burden of proof will shift off of him and onto the IRS in court, a huge advantage.

Even more important, he has to find some previous cases that define alimony in his terms. Come on, a lot of people have gotten divorced!

Most important of all, he has to find a way to chart the financial terms on a single page so it will be INSTANTLY clear to the judge that his payments were made solely from his own share of the marital property that was otherwise divided equitably.

[BulldogTom]

The do have pretty good reasoning, so he needs to bring in other issues such as judicial precedents and administrative procedure.

Most important of all, he has to find a way to chart the financial terms on a single page so it will be INSTANTLY clear to the judge that his payments were made solely from his own share of the marital property that was otherwise divided equitably.

Listen to Jainen,

Make it simple and easy to follow. Concede on the property settlement portion and fight like a dog for the rest. A paper trail of regular, even payments in accordance with the decree underneath a 1 page summary of the terms of the divorce and the payments made in compliance with those terms might be enough to win.

Good luck.

Tom

Lodi, CA