Despite a recent crackdown in the Tax Cuts and Jobs Act (TCJA), the alimony deduction is still “alive and kicking” for many existing divorce or separation agreements.
Moreover, the reach of this deduction may be greater than you think. A prime example can be found in a recent Tax Court case, Leyh, 157 TC No. 7, 10/4/21. First, some backhround.
Under prior law, alimony paid under a legally valid divorce or separation agreement was deductible by the payer and constituted taxable income to the recipient, if certain conditions were met. The deduction is claimed “above the line” so it is available whether or not the payer itemizes.
However, the deduction isn’t automatic either. Payments qualify as deductible alimony only if—
The spouses don't file a joint return with each other
The payment is in cash (or an equivalent like checks or money orders)
The payment is to or for a spouse or a former spouse made under a divorce or separation instrument
The divorce or separation instrument doesn't designate the payment as not alimony
The spouses aren't members of the same household when the payment is made
There's no liability to make the payment (in cash or property) after the death of the recipient spouse.
Notably, the TCJA eliminates the alimony deduction for the payer—and the corresponding inclusion in taxable income by the recipient—for agreements executed after December 31, 2018. But the prior rules continue to apply to pre-2019 agreements.
Facts of the new case: The taxpayer, a resident of Pennsylvania, entered into an agreement in 2014 where he agreed to pay the health and vision insurance for his spouse until their divorce was finalized. In 2015, he paid $10,683 for his spouse’s health insurance premiums as pretax payroll reductions from wages through his employer’s cafeteria plan.
On his 2015 return, the taxpayer excluded from his gross income the total amount of health care coverage premiums received through his employer’s cafeteria plan as well as claiming an alimony deduction. In other words, he wanted to have his cake and eat it, too.
Tax windfall: The Tax Court approved the alimony deduction. It determined that the taxpayer technically satisfied all the requirements for deductible alimony even though pretax payments were made through an employer-provided health insurance plan. The Court said it didn’t matter that the taxpayer also benefitted from the tax exclusion for health insurance. It also noted that the spouse reported the corresponding amount as taxable income on her separate return for 2015.
Be aware that the prior law continues to apply to a pre-2019 agreement even if it is modified as long as both sides consent to the arrangement. Conversely, the modifications may reflect the rules implemented by the TCJA. It’s imperative for divorced taxpayers to assess their situation in light of the latest rules.
Ken Berry, Esq., is a nationally known writer and editor specializing in tax, financial, and legal matters. During his long career, he has served as managing editor of a publisher of content-based marketing tools and vice president of an online continuing education company. As a freelance writer, Ken has authored thousands of articles for a...