Despite a recent crackdown on the Tax Cuts and Jobs Act (TCJA), the alimony deduction is still “alive” for many existing divorce or separation agreements.
Additionally, the range of this trigger 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 background.
Under previous law, alimony paid under a legally valid divorce or separation agreement was deductible by the payer and, under certain conditions, constituted taxable income for the recipient. The deduction is claimed “above the line” so that it is available regardless whether or not the payer provides an individual proof.
However, the deduction is not automatic either. Payments are only considered as deductible alimony if –
- The spouses do not file a joint declaration with each other
- Payment is in cash (or equivalent to checks or money orders)
- The payment is made to or on behalf of a spouse or ex-spouse made under a divorce or separation instrument
- Divorce or separation instrument does not designate the payment as non-alimony
- The spouses do not belong to the same household at the time of payment
- There is no obligation to make the payment (in cash or in kind) after the death of the receiving spouse.
In particular, the TCJA removes the payer alimony allowance – and the corresponding inclusion of the recipient in taxable income – for contracts entered into after December 31, 2018. For contracts before 2019, however, the previous rules continue to apply.
Facts on the new case: The taxpayer, a Pennsylvania resident, entered into an agreement in 2014 in which he pledged to pay health and vision insurance for his spouse until the divorce was finalized. In 2015, he paid $ 10,683 through his employer’s canteen plan for his spouse’s health insurance premiums as pre-tax wage cuts.
In his 2015 tax return, the taxpayer excluded the total amount of health insurance premiums that he had received through his employer’s canteen plan from his gross income and claimed a maintenance deduction. In other words, he wanted his cake and eat it too.
Tax blunder: The tax court approved the alimony allowance. It found that the taxpayer technically met all the requirements for deductible alimony, even though the input tax payments were made through a health insurance policy provided by the employer. It is irrelevant that the taxpayer also benefits from the tax exclusion for health insurance. It also noted that the spouse had reported the relevant amount as taxable income in their separate 2015 return.
Please note that for an agreement before 2019, the previous law will still apply, even if it is changed, as long as both sides agree to the agreement. Conversely, the changes may reflect the rules implemented by the TCJA. It is imperative for divorced taxpayers to assess their situation in the light of the latest regulations.
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