37.1 Planning Alimony Agreements

You can arrange beforehand the way in which the costs of a divorce are to be borne. You may specifically state in the decree or agreement that the alimony is neither taxable to the payee-spouse (under IRC Section 71) nor deductible by the payer-spouse (under IRC Section 215). Such a statement effectively disqualifies payments that otherwise would be taxable to the payee-spouse and deductible by the payer-spouse. A copy of the agreement that contains the statement must be attached to the tax return of the payee-spouse for each year the statement is applicable.

The first step in planning the after-tax consequences of alimony is for both spouses to recognize that they may have a common financial interest; the second is projecting future tax consequences.

For example, assume that the husband is to make payments to the wife. If tax planning is approached from the viewpoint of each spouse separately, the tax deduction is an advantage for the husband; tax-free income is an advantage for the wife. However, both advantages cannot be achieved, and the couple must face the reality of the tax law, which allows the husband to deduct payments only if they are taxed as alimony to the wife. The husband and wife must compromise by setting amounts and tax consequences that balance their interests.

One approach is to view both spouses as a single economic tax unit. If this is done and the husband will be in a higher tax bracket during the payout period than the wife, an agreement should generally provide for taxable and deductible alimony. The tax savings provided by the deduction can conserve more of the husband’s assets while providing funds required by the wife. The final amount of alimony to be paid depends on the spouses’ tax brackets. Where their tax brackets are the same and are not likely to differ over the term of the agreement, there may be no advantage in making an agreement for taxable and deductible alimony when viewing the two parties as a unit.

Filing Instruction

Reporting Alimony

If you paid alimony in 2012 meeting the deductible tests, claim your deduction on Line 31a of Form 1040, and enter the recipient’s Social Security number. If you received qualifying alimony payments, report them on Line 11 of Form 1040.

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If you agree that one spouse is to pay deductible alimony and the other spouse is to report the alimony as income, these rules must be met:

• The alimony must be paid under a decree of divorce or legal separation, a written separation agreement or decree of support (37.2).
• The agreement must provide for cash payments (37.3). A noncash property settlement is not alimony. There is no minimum payout period for annual cash alimony payments of $15,000 or less. One payment of $15,000 can qualify as deductible and taxable alimony. There is also no minimum payout period for annual alimony payments exceeding $15,000. However, recapture of alimony deductions claimed in the first or second year may occur where annual payments of over $15,000 are scheduled and paid, but in the second or third year a reduced payment is made. To avoid recapture of deductions for payments over $15,000, carefully plan schedules of declining payments within the rules discussed at 37.7.
• In providing for the support of children, a specific allocation to their support or the setting of certain contingencies disqualifies payments as alimony, so such payments are not deductible by the payer and not taxable to the recipient (37.5).
• Divorced and legally separated parties must not live in the same household when payments are made. If they live in the same household, alimony payments are not deductible or taxable. However, there are these exceptions: A spouse who makes payments while preparing to leave the common residence may deduct payments made within one month before the departure. Also, where you are separated under a written agreement, but not legally separated under a decree of divorce or separate maintenance, you may deduct alimony payments even if you both are members of the same household.
• The payer spouse’s liability to pay alimony must end on the death of the payee spouse. The alimony agreement does not have to state expressly that payments end on death if liability ends under state law (37.4).

Planning Reminder

Property Transfers

A property transfer to a former spouse that is incident to a divorce is generally treated as a tax-free exchange (6.7).

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