Deeper in Taxes in Divorce

Okay, hang on! This material on tax in divorce is technical. You can get lost in it. Don’t. Just look for the pieces that are relevant to you and hone in on them. Ignore the stuff that doesn’t apply to you and your spouse.

There are some decisions you and your spouse can make in divorce that will cut down on taxes. The savings for one of you may be enough to be worth doing, even though they may work to the disadvantage of the other spouse. If you’re able to stay in control and cooperate with your spouse, though, you can make decisions together that will work well for both of you.

The one who enjoys a tax advantage simply needs to compensate the other spouse for the burden he or she is assuming. You can both be better off. Trust me. You’ll be proud later to tell your friends how you worked together to save on taxes.

Note: this is an HTML version of a paper on taxes in divorce. You’ll quickly notice two things:

  • It sounds a good bit stuffier than most of the material on this web site. That’s because I wrote it primarily for lawyers and CPA’s, not for real people.
  • It doesn’t have the nice formatting that most of the pages on this site have. That’s because it’s simply a “Save as Web Page” version of a long word processing document.

I.     Introduction

One of the roles of the lawyer, accountant, or mediator in divorce is to help the divorcing couple understand the options available to them to minimize their overall tax burden. These decisions may help one spouse at the expense of the other, for example shifting taxable income from a higher income bracket spouse to a lower income bracket spouse. This makes sense if the higher income bracket spouse is willing to extend additional benefit to the lower income bracket spouse to compensate for the tax disadvantage, and both spouses can be better off.

 II.  Exchange of Property Incident to Divorce

A.  Pre-1984 Law.

Before 1984, the characterization of a transfer between divorcing spouses followed the so-called Davis rule.[1]The Davis rule looked primarily to state law. If state law indicated that the spouse receiving property already owned an interest in it before the transfer, the transfer would be characterized as non-taxable. On the other hand, if state law indicated that the receiving spouse did not have an interest in the property before the transfer, the transferring spouse would be required to include any gain realized in gross income. Davis and its progeny produced a confusing array of inconsistent results, depending on whether the state was a community property state, an equitable distribution state, or a simple common law state. Congress enacted §1041 in 1984 to simplify and clarify the treatment of transfers between spouses incident to a divorce.

B.  §1041.

  • 1041 provides that neither the transferor nor the transferee are to recognize gain or loss on a transfer of property[2]to a spouse or, if the transfer is incident to a divorce, to a former spouse.[3]If the transfer meets the §1041 test, it will be treated as a gift.[4] The transferee spouse will take a carryover basis in the transferred property (equal to the transferor’s adjusted basis).[5] §1041 treatment is mandatory. There is no opt-out provision analogous to I.R.C. §71(b)(1)(B), which allows spouses to elect non-alimony treatment for payments that otherwise would constitute alimony.[6]

C.  Transfers that Qualify for §1041.

To fall under §1041, a transfer must either (1) occur within one year after the marriage ceases, or (2) be “related to the cessation of the marriage.” The Service construes the first qualification liberally, the second more narrowly.

1.    Within One Year After Marriage Ceases.

The Regulations say this applies even to property acquired after the marriage ceases,[7] and that a transfer occurring within one year after the marriage ceases need not have any connection with the divorce.[8]

2.    Related to the Cessation of the Marriage.

A transfer will meet this standard only if it is both pursuant to a divorce or separation agreement and occurring within six years after the marriage ceases.[9]

3.    Transfers to Third Parties.

A transfer to a third party on behalf[10] of the spouse or former spouse can qualify for §1041 treatment, provided it meets one of three tests:

  • It is required by a divorce or separation agreement;
  • The other spouse or former spouse requests it in writing; or
  • The other spouse or former spouse ratifies it in writing after the fact. The ratification must state that the parties intend the transfer to qualify for §1041. And the transferor must receive the ratification before the transferor files a return for the year in which the transfer occurred.

Note that the §1041 treatment applies only to the transfer between the spouses; the “deemed” transfer from the transferee spouse to the third party is a taxable event.[11]

4.    Consequences of §1041 Treatment.

Neither the transferor (which can be either the couple or the one of the spouses individually) nor the transferee recognizes gain or loss on any transfer covered by §1041.[12] The transferee inherits a basis in the property equal to the basis of the property in the hands of the transferor just before the transfer,[13] even if there are liabilities encumbering the property that exceed the basis.[14]

D.  Qualified Domestic Relations Orders.

The rules related to a qualified retirement plan generally provide that the benefits under the plan may not be assigned, alienated, garnished, attached, or pledged as collateral for a loan.[15] There are several exceptions to this principle, the best-known and most significant of which deals with Qualified Domestic Relations Orders (QDRO’s).[16]

1.    Definitions.

The Code defines a “Domestic Relations Order” as any judgment, decree, or order (including approval of a property settlement agreement) that (a) relates to the provision of child support, alimony, or marital property rights to a spouse, former spouse, child, or other dependent of the participant, and (b) is made under a state domestic relations law.[17] A “Qualified Domestic Relations Order” is a Domestic Relations Order that recognizes or creates a right of an alternate payee to enjoy all or a portion of a participant’s interest in a qualified retirement plan, so long as it does not alter the amount or form of the participant’s benefit,[18] and so long as it states the following facts:[19]

a)   the name and last known mailing address of the participant and each alternate payee;

b)   the amount or percentage of the participant’s benefits to be paid to each alternate payee or the manner in which the amount or percentage is to be determined;

c)    the number of payments or the period to which the order applies; and

d)   each plan to which the order applies.

2.    Treatment of Former Spouse as Surviving Spouse.

To the extent provided in the QDRO, the plan will treat the former spouse of a participant as the participant’s surviving spouse as it relates to the requirement to pay a surviving spouse a joint and survivor annuity or preretirement survivor annuity.[20]

III. Marital Home

A.  Introduction.

The marital home, along with retirement plan interests, is often among the most valuable assets to be disposed of in a divorce. Typically, one spouse conveys his or her interest in the home to the other spouse, who may own the home for months or years before selling it. The transfer of an interest in the home from one spouse to another in a divorce qualifies as a §1041 tax-free exchange. The transferee spouse takes a basis in the home equal to the basis held previously by the transferor and transferee together.

B.  Normal Rule.

When the transferee spouse sells the home, Code §1001 provides that, in the absence of any exception, the transferee spouse will owe tax for the year of the sale on the difference between the amount realized from the sale and the transferee spouse’s adjusted basis.[21]

C.  Sales Before May 7, 1997.

For all sales of a personal residence before May 7, 1997, there is an arcane set of principles that leave the seller vulnerable to paying income tax on the capital gain unless he or she buys a house of equal or greater value within two years of the sale. Full details of these principals are available on DivorceInfo at

D.  Sales On or After May 7, 1997.

A taxpayer selling a personal residence on or after May 7, 1997 may exclude up to $250,000 of the gain from the sale from his or her taxable income.[22] The house must have been the taxpayer’s principal residence for at least two of the five years preceding the sale.[23] If both spouses in a married couple meet the residency requirement, the maximum exclusion is $500,000.[24]

1.    Restriction on Repeated Sales

The exclusion is available so long as the taxpayer hasn’t excluded capital gains on a sale that occurred after May 7, 1997 but within two years of the subject sale.[25] There’s a saving provision, however, for taxpayers who have sold a house recently and are selling another house because of changes in employment, health, or unforeseen circumstances.[26] The taxpayer may exclude the gain that would otherwise be excluded, multiplied by a fraction whose denominator is 2 and whose numerator is the fractional number of years that elapse between sales.

2.    Divorce Related Provisions

There are two provisions of particular interest to divorcing taxpayers, related to the calculation of the two years’ residency requirement. A taxpayer who received the property from a spouse or former spouse in a §1041(a) tax-free transfer may include the spouse’s period of residence for purposes of the two years’ requirement.[27] Also, for purposes of determining the two years’ requirement, a taxpayer will be deemed to be using the house as his or her personal residence for any period during which his or her former spouse is granted the right to right to live in the house pursuant to a divorce or written separation agreement.[28]

3.    Opt Out Provision

The exclusion of capital gains from the sale of a home is not mandatory. A taxpayer may opt out.[29]

IV.Continuing Support

A.  Introduction.

Alimony (or “Separate Maintenance”) is included in the gross income of the payee spouse[30] and deductible to the payor spouse.[31] Child Support, on the other hand, is not included in the gross income of the payee spouse and not deductible to the payor spouse. Child Support is specifically excluded from the definition of Alimony.[32]

The tax treatment of continuing support introduces an unavoidable measure of tension between the payor spouse (who prefers that payments be characterized as deductible alimony) and the payee spouse (who prefers that the same payments be characterized as child support or property settlement so they need not be included in the payee spouse’s income). The payment of the costs of housing, particularly as the payment relates to the cost of maintaining the marital home, also presents tax issues, property settlement issues, and alimony issues.

B.  Alimony.

1.    Requirements.

The terms “alimony” and “separate maintenance” are used interchangeably in the Internal Revenue Code, and characterization as alimony does not depend on state law. Alimony must have six characteristics:

a)   Payments must be in cash.[33] Checks or money orders payable on demand are acceptable, but not debt, property, or services.[34]

b)   Payments must be under a divorce or written separation agreement.[35]

c)    Payments must not be designated as not alimony.[36]

d)   Generally, payments may not be made while the payor and payee spouses live together.[37]

e)   Liability to make payments (or any substitute payments) must stop when the payee spouse dies.[38]

f)     Payments may not occur in a year for which the spouses file a joint tax return with each other.[39]

2.    Alimony Need Not Be Periodic.[40]

3.    Alimony Can Be Paid Directly to a Third Party

A payment of cash by the payor spouse to a third party under the terms of the divorce or separation instrument can qualify as a payment “on behalf of a spouse.”[41] So can payments to a third party made at the request of the payee spouse.[42]

4.    Payment of Life Insurance.

Payment of life insurance premiums on the life of the payor spouse under a qualifying divorce instrument will constitute alimony to the extent that the payee spouse owns the policy.[43]

5.    Excess Alimony.

Congress recognized the temptation to characterize property settlements as alimony, so the 1984 Tax Reform Act contains provisions calling for the recapture of “excess” alimony (that looks too much like a property settlement).[44] Specifically, the rules provide that if alimony is excessively “front-loaded” (concentrated too much in the first two years of payments), the payor spouse must recapture it (include it in the payor spouse’s gross income).

a)   The Excess Alimony rules are limited in their effect to the first three years in which the payor spouse makes payments. The first measurement year is the calendar year in which alimony[45] is first paid (called the 1st post-separation year). The second and third years are the immediately following calendar years (called the 2nd and 3rd post-separation years, respectively).

b)   Only the excess alimony paid in the 1st and 2nd post-separation years is subject to recapture. There is no such thing as excess alimony paid in the 3rd post-separation year or subsequent years.

c)    The calculation of the front-loading rules[46] is a five-step process, working in reverse chronological order:

(1) Step 1 is to determine the excess of the alimony paid in the 2nd post-separation year over the sum of alimony paid in the 3rdpost-separation year plus $15,000.
(2) Step 2 is to reduce the alimony paid in the 2nd post-separation year by any excess calculated in Step 1.
(3) Step 3 is to find the average of the alimony paid in the 2nd post-separation year (after reduction in Step 2) and the alimony paid in the third post-separation year.
(4) Step 4 is to determine the excess of the alimony paid in the 1st post-separation year over the sum of the average calculated in Step 3 and $15,000.
(5) Step 5 is to add the results of Step 1 and Step 4. The sum of these two figures is the excess alimony that must be reported as income by the payor spouse and may be claimed as a deduction by the payee spouse, in the 3rd post-separation year.

d)   Here are the calculations of the front-loading rules, assuming payments in the 1st, 2nd, and 3rd post-separation years of $75,000, $60,000, and $40,000, respectively:

1st post- 2nd post- 3rd post-
sep year sep year sep year Total
Payments 75,000 60,000 40,000 175,000
Decrease in 3rd post-separation year 20,000
Permitted Decrease 15,000
2nd post-separation year excess (Step 1) 5,000
2nd post-separation year non-excess (Step 2) 55,000
Avg. of 3rd year & non-excess 2nd year (Step 3) 47,500
1st year’s payment less the average 27,500
Less $15,000 permitted decrease (Step 4) 12,500
1st year excess payments 12,500
2nd year excess payments 5,000
Total excess payments (Step 5) 17,500

e)   The front-loading rules do not apply to payments that change because of the death or remarriage of the payee spouse,[47] or to payments that are calculated as a portion of the income from a business or property or from compensation for employment or self-employment.[48] They also do not apply to temporary support payments pursuant to Code §71(b)(2)©.[49]

C.  Alimony “Fixed” as Child Support

When the divorce decree or separation agreement identifies a specific amount of continuing support as child support, the amount so designated will not be treated as alimony.[50] Payments can be characterized as child support even though they are for the support of an adult child.[51] In addition to the specific designation of a child support amount, a payment will be treated as child support to the extent it is subject to reduction (1) on the occurrence of a specified contingency relating to the child, or (2) at a time that can clearly be associated with such a contingency.[52]

1.    Contingency Related to the Child

The Regulations include the following contingencies: the child’s attaining a specified age or income level, dying, marrying, leaving school, leaving the spouse’s household, or gaining employment.[53]

2.    Reduction “Associated with” Child-Related Contingency

The statutory language in Code §71©(2)(B) could arguably be interpreted to mean that any reduction in alimony that might fall anywhere near any date of significance related to a child could be enough to change the tax treatment. The Regulations, however, break the issue down to two tests, both of which can be calculated with certainty.[54]

a)   The first test is simpler to explain and apply than the second. It concerns itself with whether any reduction in alimony comes within six months of the 18th or 21st birthday of a child, or in Alabama, the 19th birthday.[55]

b)   The second test cannot come into play unless there are at least two children and at least two dates on which reductions take place. It concerns itself with whether payments are to be reduced on two or more occasions that occur within a year before or after two or more children attain a particular age between 18 and 24 years. The measuring age must be the same for each child, but it need not be one of whole years.[56]

c)    If a reduction satisfies one or both of the tests, the payment will be rebuttably presumed to be child support to the extent the reduction coincides with the contingency related to the child. Rebutting the presumption requires a showing (either by the taxpayer or by the IRS) that the date of the reduction is set independently of a contingency related to a child.[57]

D.  Housing Costs.

Whenever one party is obligated in a divorce property settlement to make mortgage payments or to pay property taxes on a residence, the double considerations of mortgage interest and property tax become relevant, with alimony as an umbrella concept.

1.    Mortgage Interest.

a)   It is not unusual for one of the spouses to be required to make mortgage payments on the marital home even though he or she does not live in it. Mortgage interest must be paid with respect to a “qualified residence” to be deductible.[58] Code §163(h)(5) states that a “qualified residence” must be either the principal residence[59]or “1 other residence of the taxpayer which is . . . used by the taxpayer as a residence (within the meaning of section 280A(d)(1)).” Section 280A(d)(1) says the taxpayer uses the dwelling as a residence if he uses it for 14 days within the year, or for 10 percent of the time it is rented, whichever is greater.

b)   It is helpful that the taxpayer is deemed to have used the unit to the extent that he or “any member of the family of the taxpayer” uses it. So if the payor spouse’s child or children live in the home, the requirement is probably satisfied. If not, it is doubtful whether an ex-wife constitutes “any member of the family.”[60] Note that even if the payment cannot be deducted as mortgage interest, it may be deductible as alimony.[61]

c)    Payments of mortgage principal are not deductible.[62]

2.    Property Tax

The person who pays state, local, or foreign real property taxes for which he or she is responsible is entitled to claim those payments as an itemized deduction.[63] If the property is sold in the middle of the year, the tax is deemed to be apportioned between the seller and the purchaser and will be prorated based on the portion of the year during which each party owned the property.[64] If one spouse pays property taxes owed by the other spouse (or former spouse), the payments may constitute alimony if properly structured.[65]

E.  Child Care Costs

Code §21(a) allows certain taxpayers to claim a tax credit equal to from 20% to 30% of certain employment-related dependent care expenses. The credit is available to taxpayers who maintain a household[66] that includes one or more dependents who are either below the age of 13 or incapable of caring for themselves.[67]The credit applies to expenses of household services and care for dependents that enable the taxpayer to be gainfully employed. [68] In divorce, this credit is available only to the parent who has custody for a greater portion of the year.[69]

V.  Tax Filing, Exemptions, and Liability

A.  Tax Exemptions for Children

1.    Value of the Exemption

The value of the exemption to each parent is the sum of two values: the exemption itself and the $500 child credit. There’s a full description of the value at each level of income at The exemption is also a prerequisite to claiming the Hope Scholarship Credit and the Lifetime Learning Credit for college tuition costs.

2.    Pre-1984 Law

Before the 1984 changes, the custodial parent was entitled to the exemption for each child unless the noncustodial parent satisfied specific annual support requirements. The protracted questions and inter-spousal conflict generated by this approach convinced Congress in 1984 to simplify the rules and make them more certain.

3.    General Rule

The Code[70] now provides that a custodial[71] parent after a divorce is entitled to the dependency exemption for his or her child[72] even though the noncustodial parent pays more than half the support for the child.

4.    Exceptions to General Rule

The rule does not apply where the custodial parent releases his or her claim to the exemption for the year.[73]It also does not apply if more than half of the support is deemed received under a multiple support agreement.[74] And it does not apply if a pre-1985 divorce or separation agreement is in effect that has not been modified to apply the current statutory rules.[75]

5.    Statutory Requirements

a)   Either (i) the child must be younger than 19 (or a student who is younger than 24) at the end of the year; or (ii) the child’s gross income for the tax year must be less than the exemption amount for that year.[76]

b)   The child may not have filed a joint return with his or her spouse for the tax year.[77]

c)    The child must receive more than half the child’s support from one or both parents.[78]

d)   Generally, the child must be a citizen, national, or resident of the United States.[79]

B.  Filing Status

1.    Marital Status

Marital status is determined on the last day of the tax year (or on the date of death if one of the spouses dies during the year). The questions whether and when a divorce is effective are matters of state law.[80]

a)   Legal Separation. Persons who are legally separated under a decree of divorce or of separate maintenance are considered not to be married for tax purposes.[81] Note, however, that a decree of support or temporary alimony alone is not considered a decree of divorce or separate maintenance for purposes of establishing a non-marital state,[82] nor is a voluntary separation, even pursuant to a written separation agreement.[83]

b)   The “Abandoned Spouse[84]” Rule. A person who is still formally married can nevertheless file as a single person if he or she meets the following requirements:

(1) The person must file a separate return.[85]
(2) The person must maintain as his or her home a household where a child for whom the person may claim a dependency deduction lives for more than half the year.
(3) The person must provide more than half the cost of maintaining the household during the year.
(4) During the last six months of the year, the person’s spouse must not live in the same house.[86]

c)    Common Law Marriages. If local law recognizes a common law marriage, so will the IRS. If a couple validly marries in a state that recognizes common law marriages, and then moves to a state that does not recognize common law marriages, their marriage remains valid even in the new state.[87]

2.    Filing Categories.

a)   The marginal tax rates generally are lowest for married individuals filing jointly.[88] They progressively increase for each category as follows: head of household; individual, married filing separately.

b)   Married filing jointly. This produces the lowest tax rates and the highest standard deduction. Filing jointly makes it impossible to pay alimony,[89] however, and it also introduces the specter of joint and several liability. Subject to the Innocent Spouse Rule,[90] taxpayers filing a joint return are jointly and severally liable for any tax, penalties, and interest arising out of the return. An indemnity agreement in which one spouse holds the other harmless for tax deficiencies (or another similar undertaking) may be binding as between the husband and wife but is not binding on the IRS.[91]

c)    Head of Household. Persons filing Head of Household enjoy a tax rate lower than that for single taxpayers but higher than that for married persons filing jointly. To file as head of household, the taxpayer must be unmarried at the end of the year,[92] must maintain as his or her home a household where a child lives for more than half the year, and must pay over half the expenses of maintaining the home.[93]

d)   Married Filing Separately. Married persons filing separately pay the highest tax rates.[94] The main advantages of filing a separate return are to avoid joint and several liability and to enable deduction for alimony while the taxpayer is still married.

VI. Gift and Estate Tax Ramifications

The payor spouse who makes payments to his spouse or children may not feel that he is making a voluntary gift, but the test to determine whether a gift has occurred doesn’t look to his intent. The focus of the test is purely objective, that is, whether the transfer is for “less than an adequate consideration in money or money’s worth.”[95] Consequently, quite a few of the payments made during and after divorce would, absent some exception, constitute gifts. Luckily, there are several exceptions.

A.  Deemed Adequate Consideration

Even if a transfer is for less than adequate consideration, it will be deemed to be supported by adequate consideration if it satisfies four requirements:

1.    Written Agreement

The parties’ agreement to the payments must be a written agreement.[96]

2.    Payments Required by Agreement

The payments must be required in the agreement.[97]

3.    Agreement 2 Yr. Before or 1 Yr. After Divorce

The agreement must become effective within two years before or one year after an actual divorce is final.[98]There is no requirement, however, that the agreement be incorporated into the divorce decree.[99]

4.    Payments for Support of Wife or Minor Child

Only those payments in satisfaction of the marital support and marital property rights of a spouse and the support rights of a minor child qualify. Payments for other purposes, for example the support of an adult child, are not deemed to be for adequate consideration.[100] The payments can be made, however, to a trust without affecting the qualification for the test.[101]

B.  Payments Pursuant to Court Order

Payments that do not qualify under the §2516 “deemed adequate consideration” test can nevertheless be treated as non-gifts if they are ordered by a court. The theory is that a gift must be a voluntary transfer, and a transfer ordered by a court is not voluntary. If the transfer is not voluntary, then, it is irrelevant whether it is supported by adequate consideration, even if it is for the support of an adult child. The seminal case in this area is Harris v. Com.[102] The court held in Harris that when a divorce court incorporated a settlement agreement between a husband and a wife into a divorce decree, it could have changed it. Consequently, the payments required by the agreement were not gifts because they were court-ordered. The IRS has attempted to restrict the effect ofHarris,[103] and courts have been supportive,[104] but the essential principle remains.

Also, payments can be pursuant to a court order and receive non-gift treatment even though they would fail the §2516 test because an actual divorce never occurred.

C.  Satisfaction of Support Obligations

Any married person has an obligation under state law to support his wife and minor children. Consequently, a payment to a spouse or minor child for support during marriage is not a gift, even if there is no consideration paid in return. The same principle applies after divorce to the extent the person still has obligations of support under state law.[105]

D.  Payment of Tuition and Medical Expenses

Code §2503 specifically excludes from gift tax liability any direct payment of tuition costs[106] or medical expenses[107] of any individual. The exclusion is available regardless of family relationship or lack thereof[108] and regardless of any legal responsibility or lack thereof.[109] Consequently, it would apply to payment of expenses of an adult child, a stepchild, or even a friend. The payment must be made directly to the provider, however. Payments cannot be made directly to the person benefited, either before or after such person pays the provider.[110] Nor can they be made to a trust that pays them to the provider.[111]

E.  Unlimited Marital Deduction

If an outright transfer occurs between spouses while they are still married, the transfer can be free of gift tax because it qualifies for the unlimited gift tax marital deduction.[112] The key requirements here are that the transfer occur while the spouses are still married and that it not be a terminable interest. For example, if the transfer occurs after a divorce is final, it is not eligible for the marital deduction. Also if a spouse receives only a life estate, with the remainder to a third party (for example, a child), the transfer will not qualify for the marital deduction unless the grantor spouse makes a QTIP election.[113]


[1] U.S. v. Davis, 370 U.S. 65 (1962).

[2] The property may be real or personal, tangible or intangible.  Services are not included.  Reg. §1.1041-1T, Q&A 4.

[3] I.R.C. §1041(a).  The same result holds true if the transfer is not directly to the spouse but to a trust for the spouse’s benefit.  Id.

[4] For the application of gift tax to the transfers between spouses incident to a divorce, see “Gift and Estate Tax Ramifications” note 95 below.

[5] I.R.C. §1041(b).

[6] See page 4, Note 36

[7] Reg. §1.1041-1T, Q&A 5.

[8] Id., Q&A 6.

[9] Id., Q&A 7.  A transfer not meeting both these tests is rebuttably presumed to be not related to the cessation of the marriage.  Rebutting the presumption requires a showing that the transfer was made to effect the division of property owned by the former spouses when the marriage ended, for example by showing that the transfer was hampered by legal or business impediments and that the transfer occurred as soon as these impediments were resolved.  Id.

[10] The question whether a transfer is “on behalf of” the transferee spouse has generated considerable litigation and commentary.  See Arnes v. U.S., 91-1 USTC ¶50207 (W.D. Wash. 1991, aff’d, 981 F.2d 456 (9th Cir. 1992).  See also the discussion in BNA T.M. Portfolio 515, Divorce and Separation, at A-19-20.

[11] Reg. §1.1041-1T, Q&A 9.

[12] Id., Q&A 10.

[13] Id., Q&A 11.

[14] Id., Q&A 12.

[15] I.R.C. §401(a)(13).

[16] Id. §401(a)(13)(B).

[17] Id. §414(p)(1)(B).

[18] Id. §414(p)(3).  A QDRO may not (A) require a plan to pay a type or form of benefit not otherwise provided under the plan; (B) require the plan to pay more than the actuarial value of the participant’s benefit; or (C) pay benefits to an alternate payee that are already required to be paid to another alternate payee under an earlier QDRO.  The Code allows exceptions to this rule, however.  Specifically, a QDRO can provide that benefits can begin for the alternate payee after the earliest retirement age of the participant (generally, the date the participant could begin receiving benefits) even if the participant continues working.  I.R.C. §414(p)(4).

[19] I.R.C. §414(p)(1)(A), §414(p)(2).

[20] I.R.C. §414(p)(5); §401(a)(11).

[21] Even though gain on the sale of a personal residence is recognizable and taxable, loss on the sale of a personal residence isn’t deductible, because it’s not considered a loss on a transaction entered into for profit.  Reg. §1.165-9(a).  And it won’t help to combine the property with one sold at a gain; loss on one residence can’t be used to offset the gain on the sale of another residence.  Koehn v. Com., 16 TC 378 (1951).  But if the taxpayer begins using a personal residence for business purposes and is using it for business purposes at the time of the sale, loss on its sale is allowable as a deduction.  Reg. §1.165-9(b).  Also, the author understands informally that the Conference Committee version of the current proposed Tax Reform legislation would make losses on the sale of a personal residence deductible.

[22] IRC §121. The exclusion applies to gain occurring as the result of depreciation taken on the house before May 7, 1997, but it does not apply to depreciation taken after that date.

[23] IRC §121(a).

[24] IRC §121(b)(2).

[25] IRC §121(b)(3).

[26] IRC §121(c).

[27] IRC §121(d)(3)(A).

[28] IRC §121(d)(3)(B).

[29] IRC §121(f).

[30] I.R.C. §71(a).

[31] I.R.C. §215(a).

[32] I.R.C. §71(c).

[33] I.R.C. §71(b)(1).

[34] Regs. 1.71-1T(b), Q&A 5

[35] I.R.C. §71(b)(1)(A).  The code section includes three kinds of agreements that qualify:  (A) a divorce decree or a separate maintenance agreement incident to a divorce decree; (B) a written separation agreement; or (C) any other decree (e.g., a temporary or pendente lite support order) requiring a spouse to make support payments.  A frequent issue here is timing:  to what extent can the spouses make a support agreement retroactive so they can recharacterize payments made in the past as deductible alimony?  The answer seems to be, not much.  The term “under” has been strictly construed to require that the agreement precede the payments.  Taylor v. Com., 55 TC 1134 (1971).

[36] I.R.C. §71(b)(1)(B).  Spouses may want to make this designation where it would reduce their overall tax burden, for example where the payor spouse’s income is tax-exempt or sheltered and therefore the deduction would be useless or relatively useless.  The regulations imply that the non-alimony designation may appear in a follow-up support order and still be effective.  Reg. 1.71-1T(b), Q&A 8.

[37] I.R.C. §71(b)(1)(C).  This applies if the two spouses are living in the same residence they previously shared as husband and wife, even if they confine themselves to separate areas within the residence.  Alimony treatment will not be upset, however, if the spouses are still in the same residence, one of them is preparing to leave, and in fact does leave within a month of the payment.  Note, however, that this rule does not apply to payments made under a temporary support order or a written separation agreement.  Reg. §1.71-1T(b), Q&A 9, I.R.C. §71(b)(2)(C).

[38] I.R.C. §71(b)(1)(D).  It’s not necessary that the divorce decree state that payments stop on the payee spouse’s death, so long as the liability to make payments would end under state law.  Id.  Senate Committee Report on P.L. 99-514 (Tax Reform Act of 1986).  If payments to be paid through other channels (e.g., trusts) begin, increase in amount, or become accelerated on the death of the payee spouse, however, they may be construed as continuing alimony, which would upset alimony treatment.  Reg. §1.71-1T(b), Q&A 14.

[39] I.R.C. §71(e).

[40] Reg. §1.71-1T(a), Q&A 3.  Beware, however, of the Excess Alimony rules in I.R.C. §71(f).  See section 5below.

[41] Reg. §1.71-1T(b), Q&A 6.  The Regulations list as examples cash payments of rent, mortgage, tax, or tuition.  However, payments to preserve or maintain property owned by the payor spouse and used by the payee spouse (e.g., mortgage payments on a home that the payor owns and the payee lives in) are not payments on behalf of a spouse even if they are pursuant to a divorce or separation agreement.  Id.  I.R.C. §71(b)(1)(A).

[42] Reg. §1.71-1T(b), Q&A 7.  The request, consent, or ratification of the payee spouse must be in writing, must state that the parties intend the payment to be treated as alimony subject to I.R.C. §71, and must be received by the payor spouse before the filing date of the payor spouse’s return for the subject tax year.  Id.

[43] Reg. §1.71-1T(b), Q&A 6.  This applies whether the insurance is term or ordinary life coverage.  Where the payor spouse is the original owner of the policy, the payor spouse can assign all ownership and control of the policy to the payee spouse using an absolute assignment of the policy.  Rev. Rul. 70-218, 1970-1 CB 19.  But if the payee spouse retains ownership and control of a second policy that names the children as beneficiaries and the payee spouse as a contingent beneficiary, the premiums on this second policy do not constitute alimony and are therefore not deductible.  Id.

[44] I.R.C. §71(f).

[45] This must be alimony that meets the requirements of I.R.C. §71.  If the divorce decree requires payment of alimony beginning in 1995, but the two spouses file a joint return for 1995, for example, so that the first payments that qualify as alimony are those made in 1996, the 1st post-separation year is 1996.

[46] I.R.C. §71(f).

[47] I.R.C. §71(f)(5)(A).

[48] I.R.C. §71(f)(5)(C).

[49] I.R.C. §71(f)(5)(B).

[50] Reg. §1.71-1T(c), Q&A 15.

[51] Emmons v. Com., 36 TC 728 (1961).

[52] I.R.C. §71(c)(2).

[53] Reg. §1.71-1T(c), Q&A 17.

[54] Reg. §1.71-1T(c), Q&A 18.

[55] Id.  Ala. Code §26-1-1.

[56] §1.71-1T(c), Q&A 18.  The calculations necessary to satisfy the second test are almost comically complex, too complex to reproduce in this text.  The author has (and probably others have) committed them to spreadsheets, however, and testing is generally available.

[57] Reg. §1.71-1T(c), Q&A 18.

[58] I.R.C. §163(h)(3).

[59] §1034 principles apply.  See page Error! Bookmark not defined., notes Error! Bookmark not defined.Error! Bookmark not defined..

[60] The standard is I.R.C. §267(a)(4), which is limited to brothers and sisters, spouse, ancestors, and lineal descendants.

[61] But note that alimony must be pursuant to a divorce decree or settlement agreement and that the obligation to make payments must cease when the payee spouse dies.  See notes 35 and 38, page 4.  If the payor spouse makes the payments voluntarily or is obligated to continue making them after the spouse dies, they will not qualify as alimony.

[62] I.R.C. §263(a)(1).  Properly structured as alimony, however, payments from a payor spouse to a payee spouse could be used by the payee spouse to pay off mortgage principal (after including them in the payee spouse’s taxable income) yet still deducted from the income of the payor spouse.

[63] I.R.C. §164(a)(1).

[64] I.R.C. §164(d).

[65] See notes 33-39, page 4.

[66] I.R.C. §21(e).

[67] I.R. C. §21(b).

[68] I.R.C. §21(b)(2).

[69] I.R.C. §21(e)(5); I.R.C. §152(e)(1).

[70] I.R.C. §152(e)

[71] The parent having “custody” according to the divorce decree or written separation agreement is defined as the custodial parent.  If the decree or agreement doesn’t clearly delineate who has custody, or if the question of custody is in dispute on the last day of the year, the custodial parent is the one who had physical custody of the child for the greater portion of the calendar year.  Reg. §1.152-4(b).

[72] The definitions would include a son, stepson, daughter, stepdaughter, adopted son, adopted daughter, or, under certain conditions, a foster child or a child in the process of being adopted.  They also include siblings, parents, stepparents, nephews and nieces, and in-laws.  I.R.C. §152(a)(1). A dependent must be an American citizen or legal resident. I.R.C. §152(b)(3).

[73] I.R.C. §152(e)(2).  The custodial parent will execute a written declaration releasing the claim to the exemption (typically on Form 8332), and the noncustodial parent claiming the exemption will attach it to his or her return for that year.  The Regulations state that a custodial spouse may release the exemption for a single year, for a number of specified years (for example, alternate years), or for all future years.  Reg. §1.152-4T(a), Q&A 4.

[74] I.R.C. §152(c).  When no single person provides more than one half the support for a child, yet a combination of persons provides more than one half the support, they can agree to assign the exemption to one of the persons in the group, so long as that person individually contributes at least 10% of the support. I.R.C. §152(c).

[75] I.R.C. §152(e)(4).

[76] I.R.C. §151(c)(1).

[77] I.R.C. §151(c)(2).

[78] I.R.C. §152(a).

[79] I.R.C. §152(b)(3).

[80] Capodanno v. Com., 69 TC 638 (1978).

[81] I.R.C. §7703(a)(2).

[82] Boyer v. Com., 732 F.2d 191 (D.C. Cir 1984); Dunn v. Com., 70 TC 361 (1978).

[83] Kellner v. Com., 30 CCH Tax Ct. Mem. 448 (1971), aff’d without opinion, 468 F.2d 627 (2d. Cir. 1972).

[84] I.R.C. §7703(b). The term “abandoned spouse” is in common use but is misleading. The statute requires no abandonment, just technical compliance with the stated requirements. It’s even possible for both spouses to qualify under this provision.

[85] I.R.C. §7703(b)(1).

[86] The spouses must live in different residences; separate bedrooms and bathrooms aren’t enough.  Lyddan v. U.S., 82-2 USTC ¶9701 (D.Conn., 1982), aff’d, 721 F.2d 873 (2d Cir. 1983).  The district court opinion at 82-2 USTC ¶9701 makes for entertaining reading, if the reader has a few minutes.

[87] Rev. Rul. 58-66, 1958-1 CB 60. The recent exception to this general principle is the well-known “Defense of Marriage Act” (PL 104-199, 9/21/96) that defines marriage as a union of one man and one woman as husband and wife and declares that “spouse” refers only to a person of the opposite sex.

[88] The exception to this rule is the married couple in which both spouses enjoy high salaries, particularly if one or both of them has significant miscellaneous deductions that would be limited by the 2% of AGI test (the much-discussed “marriage penalty”).

[89] See note 39, page 4.

[90] I.R.C. §6013(e).  The innocent spouse rule requires the following:  (a) a joint return; (b) understatement of tax by more than $500 attributable to omission of an item from gross income or any claim of a deduction, credit, or basis in an amount for which there is no basis in fact or law; (c) establishment by the other spouse that he or she did not know, and had no reason to know, that there was such substantial understatement; and (d) a finding that, under all the facts and circumstances, it is inequitable to hold the other spouse liable for the deficiency.  When these conditions are met, the other spouse is relieved of liability for tax, interest, and penalties to the extent such liability is attributable to the understatement.  Id.

[91] Pesch v. Com., 78 TC 100 (1982).

[92] Status as an abandoned spouse under I.R.C. §7703(b) is sufficient.

[93] I.R.C. §2(b).  Husbands and wives cannot trade the head of household status back and forth as they can the exemption for a child.

[94] I.R.C. §1(d).

[95] I.R.C. §2512(b).  This is “full and adequate consideration,” not to be confused with the minimal consideration necessary to support an enforceable contract.  Moreover, “a consideration not reducible to a value in money or money’s worth, as love and affection, promise of marriage, etc., is to be wholly disregarded, and the entire value of the property transferred constitutes the amount of the gift.”  Reg. §25.2512-8.

[96] I.R.C. §2516.  A  letter describing an oral agreement is not sufficient.

[97] Id.

[98] Id.  Reg. §25.2516-1(a).  The Regulations require a final divorce, not simply an interlocutory decree.  Id.

[99] I.R.C. §2516.

[100] I.R.C. §2516(2).  Spruance v. Com., 60 TC 141 (1973), aff’d without opinion, 505 F.2d 731 (3d Cir. 1974).  Payments made to an adult child do not qualify under the §2516 test even though the agreement requiring the payments was effective when the child was a minor.  I.R.C. §2516(2).  But see the exclusion stated below for payments pursuant to court order, which can include payments for the support of an adult child.

[101] Rev. Rul. 75-73, 1975-1 CB 313.  However, if a portion of the trust is subject to the trustee’s discretion to use it for the benefit of persons other than the wife and minor children, such portion would constitute a gift. Id.  See also the special trust valuation rules of I.R.C. §2072.

[102] 340 U.S. 106 (1950).

[103] Rev. Rul. 60-160, 1960-1 CB 374.  The IRS stated that unless the divorce court has the power to change the divorce settlement agreement, mere incorporation of the agreement into the decree of divorce will not insulate the transfer from gift tax exposure.

[104] McMurtry v. Com., 203 F.2d 659 (1st Cir. 1953).  Even though the McMurtry court ruled against the IRS and treated the subject transfers as non-taxable, it did so only after embracing the test suggested by the IRS, namely that the question should turn on the extent to which the obligation to make the transfer grew out of the court decree rather than the agreement of the parties.  See also Spruancesupra note 100, at 153-54.

[105] Rev. Rul. 68-379, 1968-2 CB 414.  Note, however, that to the extent these payments exceed the amounts required for support, they constitute gifts.  Rev. Rul. 77-314, 1977-2 CB 349.

[106] The payments must be to an educational institution that qualifies under I.R.C. §170(b)(A)(ii), which means merely that it must normally maintain a regular faculty and curriculum and normally have a regularly enrolled student body in attendance at the place where it normally conducts its educational activities.

[107] The payment must be for “medical care” as defined in I.R.C. §213(d)(1), which means for diagnosis, treatment, and prevention, for essential transportation, and/or for medical insurance.

[108] Reg. §25.2503-6(a).

[109] I.R.C. §2503(e).

[110] Reg. §25.2503-6(c), Example 4.

[111] Id., Example 2.

[112] I.R.C. §2523(a).

[113] I.R.C. §2056(b)(7).  The QTIP election allows the donor to control disposition of the trust property after the death of the surviving spouse, and it also allows some flexibility, because the QTIP election can be made for less than all the trust property.  Parenthetically, the donor spouse could also make the transfer qualify for the marital deduction by giving the donee spouse a general power of appointment over the remainder.  This would seem, however, to destroy any benefit of bifurcating the interest.

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