May 22, 2007

Tax and Divorce Planning

Houston Tax Attorney Blog

Houston Tax Attorney


Taxpayers often seek tax advice as a means of adding insult to injury in divorce proceedings. Private Letter Ruling 200720007 provides yet another example of how taxpayers can go about doing this.

The ex-wife requested this ruling from the IRS. The ruling requests a determination as to whether the payments the ex-wife received were not “alimony.” “Alimony” payments are generally taxable income to the recipient (in this case, the ex-wife) and tax deductible by the payor (in this case, the ex-husband).

The Code sets out several requirements for payments to qualify as “alimony” for federal income tax purposes, including:

  1. such payment is received by, or on behalf of, a spouse under a divorce or separation instrument;
  2. the divorce or separation instrument does not designate such payment as a payment which is not includible in gross income under section 71 and not allowable as a deduction under section 215;
  3. in the case of an individual legally separated from his spouse under a decree of divorce or of separate maintenance, the payee and payor are not members of the same household at the time such payment is made; and
  4. there is no liability to make such payment for any period after the death of the payee and no liability to make any payment as a substitute for such payments after the death of the payee.

Payments must meet all of these elements to qualify as “alimony” for federal income tax purposes.

The divorce agreement in this case indicated that the amounts paid were to qualify as “alimony” for federal income tax purposes, but the divorce agreement failed to specify that the payments were to terminate upon the death of the payee. The question then is, are the payments “alimony” if the agreement fails to address this “death of the payee” issue?

As the IRS ruling sets out, where the agreement is silent on this issue, it is necessary to look to state law to see if the state law specifies that the requirement to make “alimony” payments terminates upon the death of the payee. The state law in this case (the state was not disclosed), did not specify that “alimony” payments were to terminate upon the payee’s death. As a result, the payments did not qualify as “alimony” for tax purposes, despite the express provision in the divorce decree.

I wonder if the wife and wife’s tax counsel had this result in mind when they failed to include a provision in the divorce agreement for the “alimony” payments to end upon the wife’s death? If so, the tax planning saved the wife from having to report and pay income taxes on the “alimony” payments and it precluded the husband from being able to deduct the payments.