A Lost Alimony Deduction by Linking to Child Support
Watch out for those hurried, last minute North Carolina agreements that link alimony and child support termination; you could get an unintended tax consequence and the loss of the tax deduction.
While the Johnson case, discussed herein, is not a North Carolina case, it could be. Guys and gals, you simply cannot link alimony reductions to a child-related event. It doesn’t work; that is, if you want the deduction.
Many late nights in Greensboro mediations, many attorneys write alimony agreements and do not checklist the agreement against the Internal Revenue Code. Sure, it is sensible to reduce alimony when a child gets out of high school. Mom can go back to work. That probably “tubes” the alimony deduction for dad. See what happened in Johnson:
Johnson v. Comm’r, T.C. Memo. 2014-67, 2014 WL 1420403 (2014)
(a) Facts: A Minnesota divorce decree orders the husband to pay $6,068 per month in alimony, plus 40% of his gross bonus. The obligation terminated upon the death of either party, the remarriage of the wife, or the youngest child’s graduation from high school. The payments were expressly labeled as alimony for tax purposes. The agreement established a separate obligation of $500 per month for child support.
A Minnesota court later modified the alimony down to $4,000 per month, and the child support down to $200 per month, with the same terminating conditions.
The husband paid the alimony required and took an alimony deduction. The IRS assessed a deficiency, and the husband appealed to the Tax Court.
(b) Issue: Was the husband entitled to an alimony deduction?
(c) Answer to Issue: No.
(d) Summary of Rationale: The payments were labeled as alimony and stopped upon the death of the parties. The key issue was, therefore, whether the payments were fixed as child support. The payments were not expressly fixed as child support, but payments are implicitly fixed as child support to the extent that their amount is reduced upon the occurrence of a child-related event. This is true, even where the agreement contains a separate express child support provision.
The present payment obligation terminated entirely upon the youngest child’s emancipation. Because that was a child-related event, the husband was not entitled to any alimony deduction. The husband argued that the emancipation of the child was simply a convenient ending point for terminating alimony, but his argument did not matter. Regardless of the intent of the parties, payments that reduce in amount upon the occurrence of a child-related event are not alimony for federal tax purposes.
The husband was not liable for an accuracy-related penalty, as he reasonably relied upon the advice of the CPA who prepared his tax return.
Lesson: If you intend to allow an alimony payor to take a federal tax deduction for alimony paid, never, ever provide that alimony terminates upon emancipation of a child. Such a provision will prevent any alimony deduction, regardless of the subjective intent of the parties. This is a dangerous tax trap that has ensnared even tax professionals, such as the CPA who prepared the husband’s return in Johnson.
The alimony deduction will be denied even if the same instrument contains a separate child support obligation that is reasonable in amount. This point is especially counterintuitive, and a reasonable argument exists that changes in alimony occurring upon child-related events should not be treated as child support where reasonable child support is already being paid. But that is not what federal law presently provides.
by Carolyn J. Woodruff, JD, CPA, CVA