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How to Properly Structure Alimony

Posted on 08 January 2013 by Mike Krauss

The Case of the Baseball Player Who Struck Out

By David W. Taklender, CPA

Alimony is a very contentious issue for many reasons in addition to the emotional aspects.

For our purposes we are concerned about the tax law implications.  What you need to know is that when divorces are taking place where children are involved, spousal support and child support are also being negotiated.

If you don’t already know, spousal support (alimony) is deductible by the payor and is considered taxable income by the payee.  On the flip side of that coin, child support is neither deductible by the payor, nor is it considered taxable for the recipient.

Therefore, it should become obvious that during divorce negotiations the payor usually always wants their payments to be structured as all or mostly alimony and the recipient would prefer it be referred to as 100% child support.

Usually, a combination of the two is the end result and we, as tax preparers, follow the divorce decrees signed by a judge to determine how to report the payments.  I say, “usually” we follow the divorce decree.  This is because over the years, the IRS and the tax courts have ruled that regardless of what a divorce decree states by a family court judge, if the payments do not follow specific requirements written in the tax code, then the payments will not be considered alimony, regardless of what the separation agreement says.

The requirements for payments by a spouse to a former spouse to be considered alimony are:

  1. Payments must be in cash or check/money order (transfer of property or services do not qualify)
  2. Payments must be received by spouse (or on behalf of spouse – i.e. indirect alimony)
  3. Must be received under divorce or written separation agreement (i.e. no voluntary payments)
  4. It is not alimony if the agreement designates the payments as excludable from payee spouse’s gross income
  5. Payee and payor spouse cannot live together (no joint return)
  6. Alimony must stop after payee spouse’s death

Child Support

Payments are NOT alimony if the agreement fixes part of any payment for child’s support

  1. in dollar amounts or
  2. as a percentage.

A payment IS child support (not alimony) IF the reduction occurs at a time “clearly associated with a contingency.”

Examples of a Clear Contingency include

  1. reduction occurring six months before or after a child attains age 18, 21, or majority age;
  2. reduction occurs more than one year before after two children reach the same age, and
  3. the child:
    • attaining a specified age,
    • dying,
    • leaving school,
    • marrying,
    • leaving home, or
    • gaining employment.

THE CASE OF THE BASEBALL PLAYER WHO STRUCK OUT – David LaPoint

Strike One - Signing away your rights.

Dave LaPoint ended his 11 year major league baseball career in 1991, the year after he married Laura Jean Clear.  In 1992, the couple signed a post-nuptial agreement which provided that in the event of divorce, Ms. Clear would receive: 1) rights to any monies Dave received from the Baseball Players Association resulting from any “collusion settlement”; 2) $50,000 per year as long as Dave was being paid to play or participate in baseball; and 3) health insurance and medical reimbursement.  Unfortuately for Dave, the post-nuptial agreement also contained language requiring that the agreement terms came to the benefit of, and were binding upon, “the parties herto, their heirs, exectuors, legal representatives and assigns.”

Strike Two – Dave gets divorced in 2002 and post-nuptial agreement becomes part of the decree.

The New York Supreme Court rejected Dave’s claim to have the post-nuptial agreement set aside and instead granted Ms. Clear’s motion to have the agreement incorporated into the judgment of divorce. Dave and Laura’s divorce was finalized in 2005 and all marital assets were divided in accordance with the post-nuptial agreement.

Strike Three – Collusion settlement payments made to ex-wife are NOT deductible alimony as no termination of death clause was present.

On his Federal income tax returns for 2002 and 2004, Dave reported as gross income collusion payments (funds that Dave will receive from the Baseball Players Association, aka “baseball collusion” monies) he received from MLB in the amount of $294,749 and $385,964, respectively.  Dave, in compliance with the post-nuptial agreement, handed over the income to his soon to be ex-wife. He then deducted the payments as alimony. But, because it was written that Ms. Clear’s rights to the MLB collusion payments would continue “even after her death,” meant no alimony for Dave….ouch!

What would have been a good solution? 

Well, because of something called the assignment of income doctrine, he couldn’t simply assign half of his income to his ex-wife and expect her to be taxed on it; so, the only possibility would have been for LaPoint to adjust his property settlement with his ex-wife during negotiations in order to equalize the situation by taking into consideration the tax he would pay on the money that his ex-wife receives on an after-tax basis.  His lawyer? I don’t know….sleeping maybe?  I’m sure after that he probably lost a client.

Ain’t love grand?!

Read more about David Taklender at www.dtakcpa.com

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