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Protect Alimony Deductions With Termination-At-Death Language

Protect Alimony Deductions With Termination-At-Death Language

Protect Alimony Deductions With Termination-At-Death Language

A recent Tax Court case emphasizes the importance of a clause in divorce decrees or agreements to terminate alimony payments in the event of the death of the recipient; otherwise, the payments may turn into a nondeductible property settlement.

In order to qualify as tax-deductible alimony by the payor and taxable income to the payee, support payments to a former spouse must meet the following requirements:

1. Payments must be made in cash;

2. Payments must be received by the payee spouse under a divorce or separation instrument;

3. The divorce or separation agreement must not designate such payments as being non-taxable;

4. If legally separated, the spouses cannot be members of the same household;

5. There is no liability to make payments after the death of the spouse.

Although there is no requirement that the divorce or separation instrument specifically provides that payments will terminate upon death, it is advisable to do so as a result of the Tax Court’s recent ruling in Linda Hoover T.C. Memo 1995-183. The Tax Court held that failure to include language terminating alimony payments at death converted the payments into a non-deductible property settlement.

Mrs. Hoover received “alimony as division of equity” in the amount of approximately $521,000 which was payable by Mr. Hoover in a lump sum of $30,000 and monthly payments of not less than $3,000. A preliminary draft of the divorce decree specified that all payments would cease upon Mrs. Hoover’s death or remarriage, but the parties later agreed to remove that language. At the time of the divorce, the term “alimony as division of equity” could be used under the prevailing state law to refer to an equitable distribution of marital property as well as to support payments made to an ex-spouse.

Mr. Hoover unsuccessfully argued that alimony as a division of equity was a “term of art” under state law meaning “sustenance alimony,” and that he agreed to increase the amount of the payments in the final decree in return for Mrs. Hoover’s agreement to structure the payments as taxable alimony. Mrs. Hoover argued that the parties intended to make a property settlement rather than to provide for taxable alimony.

In ruling that the payments were a property settlement, the Court concluded that Mr. Hoover essentially gave away his deduction for the payments made to Mrs. Hoover when he agreed to remove the termination-upon-death language from the final decree. Although Mr. Hoover’s tax accountant correctly advised Mr. Hoover that termination-at-death language was not technically required, it opened the door for the IRS to successfully deny him the deduction.

To protect the payor’s alimony deductions, it is advisable to specify in the agreement or decree that the payments will terminate upon the death of the recipient. If left out, the IRS may disallow the deduction to the payor and include the payments in the payee’s income, which keeps the IRS from being whipsawed while the parties argue with each other about the intent of their agreement. If alimony treatment is not desired, the instrument should state that the payments are not to be treated as taxable (or tax deductible) alimony.

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