Two taxpayers lose income tax deductions for spousal support payments

• Loeb & Loeb LLP write:

Two recent Tax Court cases serve as a reminder that the income tax deduction for the payment of spousal support is subject to some very specific rules. In John D. Nye and Rose M. Nye (July 15, 2013), John Nye was divorced from his first wife Alice Nye in 1990. An agreement between them that was incorporated by the judge in his order required John to pay Alice spousal support in the amount of $3,600 per month.

In 2006, Alice went back to court and sought an increase in the monthly spousal support payments. Subsequently, the parties agreed that John would pay Alice a single lump-sum payment of $350,000 in exchange for which Alice would waive her right to any further spousal support. John paid the $350,000 in 2008 and took an income tax deduction for spousal support, which the IRS disallowed upon audit. The Tax Court agreed with the IRS and upheld the denial of the deduction.

The fact that the alimony was settled through a lump sum payment was not the problem. The Internal Revenue Code does contain rules prohibiting lump sum spousal support payments, but they only apply to the first three post-separation years. Since the Nyes were divorced in 1990, those rules were not applicable.

One of the requirements for spousal support payments to be deductible is that the payments must terminate upon the death of the payee spouse. In this case, it was possible that Alice could have died between the time the agreement was signed on December 7, 2007, and the time that John paid her on January 28, 2008. There was nothing in their agreement that would have cancelled the payment had Alice died, and the Tax Court determined there was also no provision of state law (Florida) that would have cancelled the payment. Therefore, the payment did not qualify as deductible spousal support.

The second spousal support case is James J. Faylor (June 5, 2013). In this case, another of the requirements for deductible spousal support payments was violated. While the attorneys for the taxpayer and his wife were negotiating a support and property settlement agreement, the taxpayer paid his spouse $20,000 in payments for temporary support. The agreement under negotiation was never finalized, but the court eventually issued an order dissolving the marriage and requiring prospective spousal support payments.

James claimed a deduction for the $20,000 he had paid as temporary support before the court order was issued. The IRS denied his deduction on the basis that deductible spousal support must be paid pursuant to “a divorce or separation instrument.” The court’s order did not cover the $20,000 paid as temporary support, and the agreement under which it was paid was never finalized and signed by the parties. Therefore the Tax Court agreed with the IRS that the payment had not been made pursuant to a divorce or separation instrument.

This case may serve as a reminder of the old saying “no good turn goes unpunished.” In any event, it does, along with the Nye case, serve as a reminder that very specific rules must be followed in order for payments of spousal support to be tax deductible. The Tax Court showed in both cases that it requires strict compliance with these rules.