Who Pays Tax on Money Awarded in a Divorce

My question involves marriage in the state of: Texas. My ex-husband receives a $6000.00 disability retirement check from his past employer. Our divorce decree states that he is to send me $1600.00 NET each month. Taxes have been taken out before he receives the check each month and before he sends me my portion. I just found out that he has been claiming the amount he sends me as alimony, so he can make that adjustment to his income. However, our divorce decree says he is to send me $ 1600.00 NET. Furthermore, the decree says, "Nothing in this decree stipulates Alimony or spousal support as it pertains to federal taxes". My question is: Since the taxes were paid before my ex received his check, the divorce decree states the NET amount to be sent to me and that it is not alimony, am I liable for the taxes on the amount I receive? Yes, I realize it is income to me, but the divorce decree states that it is a NET amount each month.

I was audited in the Fall and the IRS wanted backtaxes for the taxes, penalty, and interest from 2011 which was 5 thousand dollars. I sent them a letter explaining the situation and also sent them a copy of the divorce decree. They responded that although it is not considered "alimony", it is considered income to me and therefore, I am responsible for the taxes on my amount. I would agree with the IRS except for the wording in the decree that says my ex husband is required to send me $1600 NET.
I recently paid the 5000 dollars to the IRS for the 2011 tax year. I am now claiming the full $19200.00 as income on my future tax returns. However, I am not sure that I am legally responsible for the taxes on this money due to the wording in our divorce decree. Also, I am afraid that the IRS will also want backtaxes for 2012 and 2013. Thank you for your time and consideration.

The answer turns on the exact language of the divorce judgment.

If in fact the divorce judgment provides that the payment is in the form of spousal support (alimony), the payment is taxable to the recipient. A provision of the divorce judgment that for some reason describes a spousal support as "net" does not change the federal tax liablity that would fall upon the recipient.

If the judgment makes the payment part of the property settlement, then it's not spousal support and would be paid out of the payor's post-tax income.

We cannot interpret judgment language that we have no opportunity to review. You should have your divorce lawyer explain the judgment to you.

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Quoting Mr. Knowitall

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The answer turns on the exact language of the divorce judgment.

If in fact the divorce judgment provides that the payment is in the form of spousal support (alimony), the payment is taxable to the recipient. A provision of the divorce judgment that for some reason describes a spousal support as "net" does not change the federal tax liablity that would fall upon the recipient.

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Not exactly. What is alimony for federal tax purposes may be different than what a state court designates as alimony. The federal tax law sets out the following criteria for what constitutes alimony:

• The payment is in cash.
• The instrument does not designate the payment as not alimony.
• The spouses are not members of the same household at the time the payments are made. This requirement applies only if the spouses are legally separated under a decree of divorce or separate maintenance.
• There is no liability to make any payment (in cash or property) after the death of the recipient spouse.
• The payment is not treated as child support.

See page 15 of IRS Publication 504, which starts the discussion of each of these elements.

Note in particular that if the divorce instrument says that the payment is not alimony for federal tax purposes then it is not going to be taxed as alimony even though it may be alimony under state law. Since the decree specifically states that “Nothing in this decree stipulates Alimony or spousal support as it pertains to federal taxes” that should be sufficient for these payments to be treated as not alimony for federal tax purposes. And evidently the IRS agreed with that since the IRS accepted that it was not alimony. Instead, the IRS evidently determined it was taxable for some other reason. What that reason was matters. My best guess without having read the entire divorce decree and knowing the details of the disability award is that the IRS considered the award of the disability as a division of that benefit. If that benefit was a taxable benefit, then each former spouse would be taxble on the share he or she actually receives.

The real dispute here may be whether the ex-husband is paying the correct amount of the benefit, not the tax status. But without reading the decree, the details of the disability award I cannot say if the IRS did, in fact, get it right.

We have been told that IRS has expressed that they regard the payments as income to the recipient, with taxes payable by her. That means they're not treating the money as part of the property settlement. Are there periodic payments between ex-spouses other than alimony that the IRS treats as taxable to the recipient?

A poorly phrased sentence ("Nothing in this decree stipulates Alimony or spousal support as it pertains to federal taxes"), presented in isolation from the rest of the judgment, does not resolve for me questions of whether the payments are properly categorized as spousal support, or if they should be treated as something else. The IRS may have correctly concluded based upon other provisions that the language is not a sufficiently clear and explicit to render the payments to be something other than alimony -- for example, if that provision follows another provision or provisions describing the payments as alimony. It could be that the IRS has misconstrued the judgment. It could be that the language is ambiguous and that there may be grounds to have the judgment amended to be consistent with the intent of the parties (if a settlement) or court (if this is a decision following trial). I don't see a way to analyze the issue without an opportunity to review the judgment.

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Quoting Mr. Knowitall

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We have been told that IRS has expressed that they regard the payments as income to the recipient, with taxes payable by her. That means they're not treating the money as part of the property settlement. Are there periodic payments between ex-spouses other than alimony that the IRS treats as taxable to the recipient?

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Not that I have ever heard of, and I have been a tax professional for pushing 30 years now.

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A poorly phrased sentence ("Nothing in this decree stipulates Alimony or spousal support as it pertains to federal taxes"), presented in isolation from the rest of the judgment, does not resolve for me questions of whether the payments are properly categorized as spousal support, or if they should be treated as something else. The IRS may have correctly concluded based upon other provisions that the language is not a sufficiently clear and explicit to render the payments to be something other than alimony -- for example, if that provision follows another provision or provisions describing the payments as alimony. It could be that the IRS has misconstrued the judgment. It could be that the language is ambiguous and that there may be grounds to have the judgment amended to be consistent with the intent of the parties (if a settlement) or court (if this is a decision following trial). I don't see a way to analyze the issue without an opportunity to review the judgment.

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This situation is actually quite unusual. Normally the IRS will not construe something as alimony/spousal support unless the language of the order is crystal clear that it IS alimony/spousal support. The reason for this is that the payer is normally in a higher tax bracket than the payee, therefore the IRS does not want the higher income payer being able to shuffle a property settlement or child support over to the payee just to save federal taxes. I am serious on this one, the IRS does not normally interpret court orders. Its either crystal clear, or its not alimony.

Had I been the tax professional dealing with the OP, I would have taken it to appeals (internal IRS appeals)...and if that failed, to tax court.

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Quoting llworking

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Not that I have ever heard of, and I have been a tax professional for pushing 30 years now.

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As a non-tax professional, that's my impression as well -- which is at the heart of why I think it's important to review the judgment.

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Quoting Mr. Knowitall

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As a non-tax professional, that's my impression as well -- which is at the heart of why I think it's important to review the judgment.

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I am quoting my decree: "It is ORDERED and DECREED that all payments made to the other party in accordance with the allocation provisions for payment of federal income taxes contained in this Final Decree of Divorce are not deemed income to the party receiving those payments but are part of the property division and necessary for a just and right division of the parties' estate. "

Further down in the decree it says, "It is ORDERED and DECREED that no provision of this decree shall be construed as alimony under the Internal Revenue Code, except as this decree expressly provides for payment of maintenance or alimony under the Internal Revenue Code."

No where else in the decree is alimony, maintenance, spousal support, etc. mentioned.

Under a decree addendum is the division of property for each spouse. SCHEDULE A of Property to be Received by me it lists several items. One of the items is the 1600 NET dollars arising from my ex-husbands disability benefit.

Thank you for taking the time to look at this. I am definitely thinking of hiring a tax attorney.

As llworking said, you can try appealing the determination within the IRS.

Part of your problem may be that IRC governs what is income is this situation, not what some state court says it is ......

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Quoting HRinDEVON

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Part of your problem may be that IRC governs what is income is this situation, not what some state court says it is ......

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No one disagrees with that. However as a tax professional I have a hard time coming up with anything that the IRS could regard as income in this scenario, if its not alimony.

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Quoting llworking

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No one disagrees with that. However as a tax professional I have a hard time coming up with anything that the IRS could regard as income in this scenario, if its not alimony.

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Unfortunately we don’t have all the facts. One possibility, though, is that the IRS determined that the effect of the state court decision was to divide the disability benefit the husband was receiving, allocating a portion of it directly to her, i.e. she in effect was the owner/recipient of a portion of that benefit. In that case, the ex-husband would have been acting as a mere conduit in passing on the payments from the disability plan to the OP. If those payments were taxable disability payments, then they would be taxable to her as the recipient/owner of the payments. It is not a common argument you see made, in part because I think most people, including IRS agents, don’t tend to think of conduit principles in the divorce setting. So, while unusual, there is the possibility that this was indeed taxable for some reason other than being alimony. One would need to look at the IRS determination to see what the basis was for the assessment and need to look at the state court decision to see if the IRS decision, whatever it was, was sound.

Of course, it may be a moot issue for the 2011 year. If the OP settled that year with a closing agreement it would be too late to challenge that now. If that is not a problem and the liability for 2011 has been fully paid, she could file a claim for refund for the amount paid if there is a basis for challenging the IRS determination. That must be done within 2 years of the payment.

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Quoting Taxing Matters

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Unfortunately we don’t have all the facts. One possibility, though, is that the IRS determined that the effect of the state court decision was to divide the disability benefit the husband was receiving, allocating a portion of it directly to her, i.e. she in effect was the owner/recipient of a portion of that benefit. In that case, the ex-husband would have been acting as a mere conduit in passing on the payments from the disability plan to the OP. If those payments were taxable disability payments, then they would be taxable to her as the recipient/owner of the payments. It is not a common argument you see made, in part because I think most people, including IRS agents, don’t tend to think of conduit principles in the divorce setting. So, while unusual, there is the possibility that this was indeed taxable for some reason other than being alimony. One would need to look at the IRS determination to see what the basis was for the assessment and need to look at the state court decision to see if the IRS decision, whatever it was, was sound.

Of course, it may be a moot issue for the 2011 year. If the OP settled that year with a closing agreement it would be too late to challenge that now. If that is not a problem and the liability for 2011 has been fully paid, she could file a claim for refund for the amount paid if there is a basis for challenging the IRS determination. That must be done within 2 years of the payment.

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I think that conduit scenario is a stretch in this case because there is no direct, above the line method for the payer to deduct the income from their tax return. The payer would have a constant, yearly battle with the IRS to justify the reduction in income. I have dealt with enough conduit income scenarios that produced that same sort of result to know that its problematic, at best.