When is alimony not alimony, and therefore not tax deductible? According to a recent case in the Tax Courts of Florida, one answer is, when it is made in a lump sum payment due as the result of a mediation agreement. Such was the case in the Marital Dissolution of John D. Nye and Rose M. Nye.
According to the IRS Tax Codes, a taxpayer may claim an above-the-line deduction for alimony or separate maintenance payments he makes during his tax year (Code Sec. 215). An alimony or separate maintenance payment is one that meets the following requirements:
- The payment must be made under a divorce or separation instrument; (Code Sec. 71(b)(1)(A))
- The instrument must not designate the payment as not includable in the recipient spouse’s gross income under Code Sec. 71 and not deductible by the payor spouse under Code Sec. 215; (Code Sec. 71(b)(1)(B))
- Legally separated spouses under a decree of divorce or separate maintenance must not be members of the same household when the payments are made; (Code Sec. 71(b)(1)(B)(C)) and
- The payor’s obligation to make the payment must end at the death of the payee spouse. (Code Sec. 71(b)(1)(D))
John and Alice Nye were divorced in Florida on Sept. 12, 1990. The court issuing the final judgment of dissolution of marriage incorporated a Separation and Property Settlement Agreement. It called for John to make alimony payments of $3,600 per month and a lump sum alimony payment of $10,000 to Alice. It also required John to obtain medical insurance for Alice, or if he couldn’t obtain such insurance, he pay her an additional $150 per month. Clearly under the Tax Codes, the $3600.00 in alimony, and the $150.00 per month medical payments were and are tax deductible. The problem occurred when, in late 2006, Alice filed papers with the divorce court to modify its prior judgment to increase the alimony payable to her and the $150 allowance for medical insurance.
Before the court could act on her request, John and Alice settled through Mediation. On Dec. 7, 2007 in lieu of any additional or future alimony payments, they signed a “Mediation Settlement Agreement” that called for John to make a lump sum payment of $350,000 to Alice and for Alice to relinquish a claim on a residential property to John. After these transfers, no further amounts would be due from either party.
On Jan. 28, 2008 John made the $350,000 payment to Alice. Thereafter, the divorce court modified the final judgment of dissolution of marriage to incorporate the Mediation Settlement Agreement.
John and his current wife then deducted the $350,000 as alimony on their 2008 joint tax return. The IRS disallowed $346,250 of the $350,000 of the payment. The $3,750 that it allowed represented the $3,600 monthly amount and the $150 amount for medical insurance.
Why did this happen? The IRS concluded the lump sum failed to meet the requirement of Code Sec. 71(b)(1)(D) that states the obligation to make the payment must end at the payee spouse’s death, and therefore did not qualify as an alimony payment.
The Nyes then went to Tax Court, and the Court found in favor of the IRS. Since the Mediation Agreement itself did not address what would happen if either party passed away between the time the Agreement was signed, and payment made, the court turned to Florida case law.
After examining several cases, the Tax Court concluded that, under Florida contract law, John’s obligation under the mediation agreement to make the $350,000 payment to Alice would not have terminated if she (or he) had died after Dec 7, 2007 and before the divorce court had decided what, if any, action to take with respect to her petition for modification of the dissolution judgment pending in that court. Therefore, it held that John and his current wife weren’t entitled to deduct the payment at issue as alimony under the Code.
It has yet to be said if John Nye and his attorneys will be appealing the decision.
Marital Dissolution issues can be emotional and quite complex. If you would like to benefit from our expertise in these areas or if you have further questions about alimony payments or any issue involving marital dissolution, do not hesitate to contact our Marital Dissolution specialists or call us at 1-800-239-1474.