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Tax Aspects of Alimony, Spousal Support and Separate Maintenance Payments

The Taxpayer Relief Act of 1997 has provided significant changes to the income tax map for individuals and businesses. Some changes which affect the arena of separation and divorce are as follows:

  • The sale of a home is easier due to a new exclusion for capital gains.
  • The dependency exemption is more valuable because three new credits and a deduction are tied to it.
  • The lower capital gains income tax makes property with a low basis more valuable.
  • New IRA rules can make it easier to utilize IRA funds for alimony and equitable distribution.
  • The foregoing changes are incorporated in the following materials.

Alimony, Spousal Support and Separate Maintenance Payments.
  • State Law

    • The Pennsylvania Divorce Code provides that tax consequences of an alimony award are one of the seventeen factors to be considered in determining alimony. 23 Pa.C.S. ß3701(b).

    • Apparently, in accordance with the court’s holding in Dubin v. Dubin, 372 Pa. Super. 84, 538 A.2d 1362, 1363 (1988), regarding allocation of spousal support and child support, the Supreme Court has promulgated Rule 1910.16 providing that:

      • In an order awarding child support and spousal support, the court may on its own motion or upon the motion of either party
        • make an unallocated award in favor of the spouse and one or more children, or
        • state the amount of support allocable to the spouse and the amount allocable to each child.
      • An unallocated order in favor of the spouse and one or more children shall be a final order as to all claims covered in the order.

      The 1981 Rules neither endorsed nor discouraged allocation, although they recognized that allocation had impact on two substantive areas: federal income taxation and subsequent modification of the order. “With respect to taxation, the allocation will determine which party pays the federal income tax and thus, the actual amount of money available to the beneficiary of the order. With regard to subsequent modification of an order, the court will be able to determine whether modification is warranted if it knows the amount of support each beneficiary is receiving.” The 1989 Explanatory Comment to the Rule recognized that allocation of a support order may not be appropriate in all cases, but rather it is a determination to be “based upon the facts of the ease.” The allocation of an order may be inequitable and inconsistent with the provisions of the Guidelines (Rule 1910.16-1 et seq.). See Rule 1910.16-5(f), which sets forth a detailed discussion with respect to allocation. See also Holland vs. Holland, 444 Pa. Super. 251, 613 A.2d 768 (1995).

      The 1994 Explanatory Comment provided: “The decision to allocate a support order has federal income tax consequences and an effect upon subsequent modification of an order...Allocation of the order permits the court to determine more easily whether modification of the order is warranted.” On the other hand, the Guidelines assume that the order will be unallocated (taxable to payee and deductible to payor). Rule 1910.16-5(f). Allocation is generally the exception rather than the rule.

      An unallocated support or alimony pendente lite order for spouse and children is fully income taxable to the payee and income tax deductible to the payor. An order for child support is not taxable to the payee or deductible to the payor. Therefore, the tax considerations must not be overlooked when the parties are in higher income brackets. Secondly, where payee’s income is equal to or greater to obligor’s income, the support order should be for children only. The latest revisions to the Guidelines make this consideration easier to resolve by juxtaposition of both proposed awards.

  • Federal Income Taxation

    • Section 71 provides that “alimony or separate maintenance payments” (“alimony”) are includable in the gross income of the recipient spouse. Section 215 provides that alimony is deductible from the gross income of the payor spouse.
    • Because alimony payments are deductible to arrive at adjusted gross income pursuant to Section 62(a)(10), the deduction is available even to those taxpayers who do not itemize deductions. The deduction is not subject to any of the phaseouts or limitations which apply to itemized deductions.
    • Alimony payments are also deductible for purposes of the alternative minimum tax imposed by Section 55.

  • Alimony Requirements

    • Payment Must be Made in Cash.

      • Only cash payments, including checks and money orders payable on demand, constitute alimony. The transfer of property or services or the use of the payor’s property does not qualify.
      • The payment of cash to a third party for the benefit of the payee will qualify as alimony, but only if the payment is provided under the terms of the divorce or separation instrument or pursuant to a written request of the spouse which satisfies the requirements of Temp. Reg. ß1.71-1T(b) Q+A-7.
      • Payments to maintain property owned by the payor but used by the recipient spouse will not be treated as alimony.
      • If the marital residence is owned jointly but all of the expenses are paid by the payor, one-half of the expenses (i.e. the payee spouse’s half) should be deductible and includable as alimony, assuming all of the other requirements for alimony treatment are satisfied. Neither the Code nor the temporary regulations to Section 71 cover this point.

    • Payment Must Be Made Pursuant to a Divorce Decree, Written Agreement or Court Order.

      • A payment will not constitute alimony unless it is received by or on behalf of the payee under a “divorce or separation instrument.” ß71(b)(1)(A).
      • The term “divorce or separation instrument” is defined in Section 71(b)(2) as:
        • a decree of divorce or separate maintenance or a written instrument incident thereto;
        • a written separation agreement; or
        • a decree requiring a spouse to make payments for the support or maintenance of the other spouse.

    • Not Designated as Nondeductible and Excludable.

      • Payments which would otherwise qualify as alimony can be designated as nondeductible and excludable, pursuant to the authority of Section 71(b)(1)(B).
      • The parties may subsequently vary the tax treatment of these payments by signing a new writing which designates the payments as nondeductible and excludable or revoke such a designation.
      • The parties may elect the tax treatment of any payment otherwise qualifying as alimony and to vary this treatment prospectively from time- to-time, provided the designation requirements are met.

    • Divorced Parents are Not Members of the Same Household.

      • If the parties are “legally separated under a decree of divorce or separate maintenance,” payments made when both former spouses are members of the same household do not qualify as alimony. ß71(b)(1)(C). The parties cannot avoid this requirement by physically segregating themselves in the dwelling unit.
      • Under a limited exception to this rule, a payment made at a time when the divorced spouses reside in the same household can qualify as alimony if (a) either former spouse is preparing to depart from the household, and (b) that spouse in fact departs not more than one month after the payment. Temp. Reg. ß1.71-1T(b), Q+A-9.
      • This requirement applies only when the parties are legally separated under a decree of divorce or separate maintenance. Payments may qualify as alimony, even though the parties are still members of the same household, in a temporary support arrangement, until the legal separation of the parties pursuant to the decree of divorce.
      • Pennsylvania Support and Divorce law permits separation under the same roof:

        • A court does not have the power to issue a support order where the parties are living together in the same household unless the basic necessities of life are not being supplied. Shilling v. Shilling, 394 Pa. Super. 154, 575 A.2d 145 (1990); Com. v. George, 358 Pa. 118, 56 A.2d 228 (1948).
        • Although the husband and wife lived in the same house, they were separated so as to satisfy the requirements for an award of support to the wife. The parties shared only limited common areas of the house and had not spoken to each other in over a year. It was held that the lower court did not abuse its discretion in awarding the wife support even though the husband paid the joint household expenses since the wife had necessary expenses not being covered by the husband. Biler v. Biler, 353 Pa. Super. 49, 508 A.2d 1263 (1986). See Papale v. Papale, 139 P.L.J. 263 (1991).
        • 3.23 Pa.C.S. ßß 3103 and 3301(d) define “separate and apart” as “complete cessation of any and all cohabitation, whether living in the same residence or not.”

    • No Liability to Make Payments Following the Death of the Recipient.

      • A payment will not qualify as alimony if the payor is required to make the payment for any period after payee’s death or if there is any liability to make any payment as a substitute for such payment after the payee’s death. ß71(b)(1)(D).

    • Payments are Not Child Support.

      • Amounts which are fixed as child support under the terms of the divorce or separation instrument do not constitute alimony. ß71(c). Reductions in payments which occur in connection with or which can clearly be associated with a contingency relating to a child (e.g. attainment of a specified age, death, marriage, etc.) will be treated as having been fixed as child support.

    • No Joint Return Filed.

      • If the parties file a joint federal income tax return for a taxable year, no payments made by the payor to the spouse in that year will qualify as alimony.

  • Excess Front-Loading of Alimony.

    • Section 71(f) prescribes rules limiting the usefulness of “front- loading” alimony payments, whereby a portion of the payor’s alimony deductions are “recaptured” and the alimony recipient is afforded a deduction from gross income for the excess amount.

    • The recapture provisions only apply to the first and/or second “post-separation years.” No alimony payments made after the second post- separation year will be recaptured. Any recapture of excess alimony and the corresponding reduction for the payee occur in the third post-separation year. For this purpose, the first “post-separation year” is the calendar year in which the payor first makes alimony payments to which Section 71 applies, and the second and third post-separation years are the two succeeding calendar years, as follows:

      • First, the excess alimony payments for the second post- separation year are calculated. This is the amount, if any, by which alimony paid in the second post-separation year exceeds the sum of (i) alimony paid in the third post-separation year, plus (ii) $15,000.00.
      • Second, the excess alimony payments for the first post- separation year are calculated. This is the amount, if any, by which alimony is paid in the first post-separation year exceeds the sum of (i) the average of the alimony paid in the second post-separation year, reduced by the excess payments for the second post-separation year (as computed in the prior paragraph), and the alimony paid in the third post-separation year, plus (ii) $15,000.00.

    • The sum of the excess alimony payments, if any, for the first and second post-separation years, computed as described in the preceding paragraph, is included in the gross income of the payor and deductible by the payee in the third post-separation year.

    • Section 71(f)(5) provides for the following three exceptions to the recapture rules:

      • If alimony payments cease on the death of either spouse or the recipient’s remarriage, and the death or remarriage occurs prior to the end of the third post-separation year.
      • Payments made pursuant to a Section 71(b)(2)(C) decree (e.g. an order for temporary support) are not subject to recapture.
      • “Fluctuating payments” defined as those made pursuant to a continuing liability (for a period of at least three years) to pay a fixed portion of the income from a business, from property and/or from wages or net earnings from self-employment, are not subject to recapture.

    • Worksheet for Alimony Recapture Computation: It is recommended that the practitioner utilize the following “Recapture Worksheet” to mechanically apply the foregoing rules:

    • Step 1: Calculate Recapture for Year 2

      1. Alimony paid in year 2$________
      2. Alimony paid in year 3 $________ plus $15,000.00 $________
      3. Subtract line 2 from line 1
        (Not less than zero) $________

      Step 2: Calculate Recapture Base for Year 1

      1. Alimony paid year 2 $________
      2. Amount from line 3 above (Year 2 Recapture) $________
      3. Subtract line 5 from line 4
        (Not less than zero) $________
      4. Alimony paid year 3 $________
      5. Add lines 6 and 7 $________
      6. Divide line 8 by 2 $________
      7. Floor for recapture 15,000.00
      8. Add line 9 to line 10 $________

      Step 3: Calculate Recapture for Year 1

      1. Alimony paid year 1 $________
      2. Amount from line 11 above $________
      3. Subtract line 13 from line 12
        (Not less than zero) $________

      Step 4: Calculate Total Recapture

      1. Alimony paid year 3 __________
      2. Amount from line 4 __________
      3. Add line 15 to line 16$__________

      Line 17 is Total Recapture Amount

  • Alimony Trusts

    • Section 682 provides generally that a party who is divorced or legally separated under a decree of divorce, separate maintenance or who is separated under a written separation agreement and who is the beneficiary of a trust must include in gross income the amount of trust income which that party is entitled to receive from the trust. Otherwise, the trust income would be includable in the income of the spouse who created the trust. The spouse who created the trust for the other spouse’s benefit is not taxed on such income and is not entitled to an alimony deduction under Section 215(d) for such amounts.
    • In general, trust income taxable to a beneficiary retains the same character in the hands of the beneficiary as it had in the hands of the trust.

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