Structuring Payments as Deductible
By Bruce M. Bird and Marcia Sakai
- Whether a payment made by a taxpayer to a former spouse under
a divorce or separation instrument constitutes deductible alimony
by the payer is often controversial. A payment may be described
in a divorce or separation instrument in a variety of ways. The
payment may be labeled as alimony, periodic alimony, alimony in
gross, child support, division of property, or property settlement.
In addition, the definitions of these terms can vary from state
To be deductible
as alimony by the payer, the payment must satisfy the requirements
of IRC section 71. A recent Tax Court decision involving the payment
of military retirement benefits under the Uniformed Services Former
Spouses’ Protection Act (USFSPA) to the former spouse of
a retired serviceman sheds light on the treatment of alimony payments.
The interplay between the requirements of IRC section 71 and the
USFSPA is analyzed for purposes of structuring a payment under
a divorce or separation instrument as deductible alimony.
under instruments executed after December 31, 1984, the requirements
for deducting payments of alimony or separate maintenance are
relatively straightforward. The payment of alimony or separate
maintenance must be in cash. Under IRC section 71(b)(1)(A), such
payment must be received by (or on behalf of) a spouse under a
divorce or separation instrument. IRC section 71(b)(1)(B) provides
that the divorce or separation instrument does not designate such
payment as a payment that is not includable in gross income and
not allowable as a deduction under IRC section 215. Under IRC
section 71(b)(1)(C), in the case of an individual legally separated
under a decree of divorce or separate maintenance, the payee spouse
or the payer spouse cannot be members of the same household at
the time such payments are made. Section 71(b)(1)(D) provides
that no liability exists to make any such payment for any period
after the death of the payee’s spouse (and there is no liability
to make any payment in cash or in property as a substitute for
such payments after the death of the payee spouse). Furthermore,
under section 71(e), the former spouses must not file a joint
return together. For payments under instruments executed before
January 1, 1985, however, different requirements apply. An individual,
in determining whether a payment constitutes deductible alimony,
will continue to apply the requirements of prior-law IRC section
the scope of this article is limited to payments under instruments
executed after December 31, 1984.
deductible by the payer as an adjustment to income and is includable
in the payee’s income. When a significant difference exists
between the marginal tax rate of the payer and payee, structuring
payments as alimony can result in significant tax savings to the
Assume that the taxpayer/alimony payer has a marginal
tax rate of 35% and that his former spouse/payee has a marginal
tax rate of 10%. If the payments of $24,000 per year under the
divorce or separation instrument constitute deductible alimony,
the payer’s tax savings will be $8,400. (Computed as follows:
$24,000 x 35% = $8,400. This assumes that the payer is in the
35% marginal tax bracket both before and after the adjustment
to income.) The payee’s taxes will increase by $2,400. (Computed
as follows: $24,000 x 10% = $2,400. This
assumes that the payee is in the 10% marginal tax bracket both
before and after the inclusion in income.) If the above payments
constitute child support, however, the payer cannot deduct them.
The payee does not include as income the child support she receives.
was the legislative response to the U.S. Supreme Court’s
decision in McCarty v. McCarty [453 U.S. 210 (1981)].
The taxpayer, a U.S. Army colonel, filed a petition in California
Superior Court for the dissolution of his marriage. At the time,
the taxpayer had served approximately 18 of the 20 years required
for retirement with pay.
Court of California held that military retirement benefits constituted
quasicommunity property subject to division under California law.
(Herein, the terms “military retirement benefits”
and “military retired pay” are used interchangeably
and include both military retirement pay and other benefits.)
Accordingly, the court ordered the taxpayer, upon retirement,
to pay a portion—approximately 45%—of his military
retirement benefits to his former spouse. The California Court
of Appeal affirmed the ruling.
the U.S. Supreme Court, in reversing the lower courts’ rulings,
held that the Supremacy Clause of Article VI of the U.S. Constitution
preempted a state court from dividing military retirement pay
pursuant to state community property laws. After noting the distressed
plight of many former spouses of military members, the Supreme
Court also observed that Congress was free to change the statutory
framework. Soon thereafter, in 1982, the USFSPA was passed. The
USFSPA permits state courts to treat military retirement pay as
marital property. Accordingly, state courts now have the authority,
pursuant to a divorce or separation instrument, to divide military
retirement pay between a retired service member and former spouse.
limits the amount of the service member’s retirement pay
that can be payable to a former spouse to 50% of disposable military
retirement pay. Disposable military retirement pay is defined
as gross monthly retirement pay less qualified deductions. For
a division of retirement pay to be enforceable under the USFSPA,
the service member and former spouse must have been married for
at least 10 years, during which the service member earned 10 years
of creditable service.
does not require that a former spouse be given a portion of a
service member’s disposable retirement pay. Rather, the
USFSPA permits a state court to treat the service member’s
disposable retirement pay as marital property. Whether it is treated
as marital property is determined by state law.
Retirement Benefits: Common Law States
v. Comm’r [129 T.C. No. 12 (2007)] the taxpayer, a
serviceman in the U.S. Navy, was married with two children. In
1993, a Georgia state court entered a final judgment and decree
that terminated the marriage. The divorce decree required the
taxpayer to pay $675 per month for child support, to maintain
medical and dental insurance for each child, and to share equally
with his former spouse any medical and dental costs not covered
by insurance. In addition, the divorce decree required the taxpayer
to pay 25% of his disposable retirement pay to his former spouse
pursuant to the USFSPA.
the taxpayer retired from the U.S. Navy. In August 2000, the taxpayer
began receiving retirement pay; however, he failed to make payments
to his former spouse relating to his retirement pay and to the
amount of his share of his children’s past dental bills
pursuant to the 1993 divorce decree. After being the subject of
a series of contempt proceedings, in 2002 the taxpayer paid a
total of $6,074 to his former spouse. Of this amount, $2,687 was
for his children’s uninsured dental expenses. In 2002, the
taxpayer also deducted as alimony the entire $6,074 paid to his
The Tax Court
first analyzed whether any portion of the $6,074 paid to the taxpayer’s
former spouse constituted child support. According to IRC section
71(c)(1), any payment by which the terms of the divorce decree
fixes a sum payable for the support of children is not alimony.
for by IRC section 71(c)(3), if any payment is less than the amount
specified in the divorce decree, then to the extent the payment
does not exceed the amount required to be paid for child support,
such amount shall be considered support. Of the $6,074 paid by
the taxpayer in 2002, the Tax Court characterized the $2,687 related
to his children’s uninsured medical expenses as child support.
The Tax Court
then examined whether the $3,397 that remained of the $6,074 paid
by the taxpayer constituted alimony. [The $3,397 amount contained
in the Proctor decision appears to be a typographical
error and should instead be $3,387 ($6,074 – $2,687). For
purposes of this article, the $3,397 amount in the decision will
be used.] The IRS contended that the retirement payments did not
meet all of the requirements of IRC section (b)(1)(A)–(D).
While conceding that the payments met the requirements of IRC
sections 71(b)(1)(A) and 71(b)(1)(C), the IRS contended that the
retirement payments did not meet the requirements of sections
71(b)(1)(B) and 71(b)(1)(D).
71(b)(1)(B) requires that the divorce instrument “not designate
such payment as a payment which is not includable in gross income
under the Section and not allowed as a deduction under Section
215.” The IRS contended that the requirement was not met
because the divorce decree referred to the payment as part of
a division of marital property. In Benedict v. Comm’r
[82 TC 573 at 575 (1984)], the Tax Court held that labels attached
to tax payments mandated by a decree of divorce or a marriage
settlement agreement are not controlling. The Tax Court also noted
that the requirements of subsection B will generally be met if
the divorce decree has no “clear explicit and express direction”
stating that the payment is not to be treated as alimony. As a
result, the Tax Court in Proctor held that even though
the divorce decree in question referred to the payments as part
of the division of marital property, the retirement payments satisfied
the requirements of IRC section 71(b)(1)(B).
71(b)(1)(D) provides that there must be no liability for the payer
to make such payments, or for the payer to make substitute payments,
after the death of the payee spouse. The IRS contended that because
the divorce decree did not state whether such payments would terminate
upon the death of the payee, the payments did not satisfy section
71(b)(1)(D). The Tax Court noted, however, that when Congress
amended IRC section 71(b)(1)(D) in 1986, it removed the requirement
that a divorce instrument expressly state that a liability terminates
upon the death of a payee spouse (see 1986 TRA 196, P.L. 99-514,
section 1843(b), 100 Stat. 2853). Under current law, if the liability
ceases by the death of the payee spouse by operation of law, then
IRC section 71(b)(1)(D) is satisfied.
decree in Proctor required the taxpayer, pursuant to the USFSPA,
to pay 25% of his military retirement pay to his former spouse.
Under the USFSPA, payments from the serviceman’s disposable
retirement pay shall terminate under the terms of the applicable
court order, but not later than the date of the death of the service
member or the date of the death of the spouse or former spouse
to whom payments are being made, whichever occurs first (10 USC
1408). Accordingly, the Tax Court held that the retirement payments
will terminate, by operation of law, on the date that either the
taxpayer or the former spouse dies, whichever occurs first.
the Tax Court noted that the USFSPA does not create any right,
title, or any interest that can be sold, set aside, transferred,
or otherwise disposed of—including by inheritance—by
a spouse or former spouse. Because the taxpayer has no liability
to make retirement payments after the death of a former spouse,
the retirement payments met the legal requirements of IRC section
71(b)(1)(D). Accordingly, the Tax Court permitted the taxpayer
to deduct the remaining $3,397 amount as alimony.
Retirement Benefits: Community Property States
gives state courts the authority to treat military retirement
pay as marital property and to divide it, pursuant to a divorce
or separation instrument, between the retired service member and
former spouse. In a common-law state, military retirement pay
is typically treated as the separate property of the spouse who
served in the military.
portion of the U.S. population, however, lives in community-property
states (e.g., Arizona, California, Idaho, Louisiana, Nevada, New
Mexico, Texas, and Washington). Wisconsin and Alaska are also
often considered to be community-property states because Wisconsin
has a marital property act, and Alaska has an optional community-property
involving military retirement benefits received pursuant to divorce
in a community-property state focus upon the ex-spouse of a retired
service member [as in Mess v. Comm’r, 79 TCM 1443
(2000); Denbow v. Comm’r, 56 TCM 1397 (1989); and
Pfister v. Comm’r, 359 F3d 352 (2004)]. Eatinger
v. Comm’r [59 TCM 954 (1990)] involved the taxpayer’s
share of her former husband’s retirement pay. The
Eatingers were married in 1955 and lived in various community
and non–community property states before settling in California.
Lieutenant Colonel Eatinger retired from active duty in 1972.
In 1977, the couple divorced under California law.
wife was married to her former husband for 17 of the 20 years
that he spent in military service. The Superior Court of California,
after determining the taxpayer’s community property share
of her former husband’s military retirement benefits, awarded
her 42.5% (17/20 x 50% = 42.5%) of her ex-husband’s retirement
pay incident to their divorce. The taxpayer contended, however,
that the amounts she received as her share of her husband’s
military retirement pay constituted nontaxable property transfers.
The IRS argued that these amounts represented taxable pension
In its memorandum
decision, the Tax Court held that applicable state law should
be examined to determine property ownership and the nature of
the property law. Under California law, a retirement pension represented
deferred compensation for past employment. Additionally, as part
of the property settlement incident to her divorce, the taxpayer
was awarded a portion of her ex-husband’s military retirement
pension as her sole and separate property. Accordingly, the Tax
Court held in favor of the IRS.
of alimony can be accelerated to a certain extent, but any excess
front-loading of alimony is typically subject to the recapture
provisions of IRC section 71(f). (See Bruce M. Bird and Mark A.
Segal, “Maximizing the Front-Loading of Alimony Payments,”
The CPA Journal, February 2001.) Under current law, the
recapture rules in IRC section 71(f) apply to certain payments
made under divorce or separation decrees, agreements, or instruments
occurring after December 31, 1986. The amount of recapture, if
any, will occur in the third post-separation year. The recapture
amount will be included in the payer’s income, while the
payee will be entitled to deduct it.
recapture rules have several exceptions. For example, if the payer
or payee spouse dies before the close of the third post-separation
year—or if the payee spouse remarries within this period—and
the payment of alimony or separate maintenance stops as a result
of one of these events, then the alimony recapture rules will
not apply. Any payment made under a temporary support order is
not subject to the alimony recapture rules. Moreover, any payment
related to a continuing liability of at least three years to pay
a fixed portion (or portions) of income from a business or from
property is not subject to the alimony recapture rules. (Under
this exception, the fixed portion or portions of income can also
be related to employment or self-employment compensation.)
of military retirement benefits may be subject to the alimony
recapture rules. One situation involves a divorce or separation
agreement in which the division of retirement pay is not enforceable
under USFSPA and the service member stops paying alimony to his
former spouse. For example, a service member and his spouse divorced
after nine years of marriage. In year 1 after the divorce, the
service member made payments of $2,000 per month of his retirement
benefits—legally designated as alimony in the divorce agreement—to
his former spouse. At the beginning of year 2, the service member,
although contractually obligated under the divorce agreement to
pay alimony, stopped paying it. (The Deadbeat Parents Punishment
Act of 1998 increases the penalties for nonpayment of child support.
In some cases, such as moving to another state to avoid paying
child support, nonpayment can be a federal criminal offense. However,
collecting unpaid alimony is typically difficult and time-consuming.)
In an attempt to receive a portion of the service member’s
retirement pay, the former spouse sued under the USFSPA but lost.
(To be enforceable under the USFSPA, the service member and former
spouse must have been married for a period of at least 10 years,
during which the service member earned 10 years of creditable
service). Based upon this information, the service member will
have alimony recapture of $9,000 in year 3. Alimony recapture,
if any, will occur in the third post-separation year if: 1) payments
made in the second post-separation year exceed payments made in
the third post-separation year by more than $15,000; or 2) payments
made in the first post-separation year exceed the average alimony
payments of the second post-separation year and the third post-separation
year by more than $15,000 (see Ephraim P. Smith, Philip J. Harmelink,
and James Hasselback, 2009 CCH Federal Taxation Comprehensive
of computing alimony recapture, if either 1) or 2) above is less
than zero, then $0 should be used. [If both 1) and 2) above are
less than zero, then there is no alimony recapture in year 3.]
In computing 2) above, the average of the payments made in the
second and third years does not include that portion of the payment
made in the second year that is recaptured in the third year.
The calculation of 1) above is $0, and the calculation of 2) above
is: $24,000 -- [($0 -- $0 + 0)/2 + $15,000] = $9,000. Therefore,
the alimony recapture in year 3 is $9,000 ($0 + $9,000).
the payment of military retirement benefits to an ex-spouse as
deductible alimony by the payer involves a number of issues. The
taxpayer should first analyze the applicable law of the state
in which the divorce or separate maintenance instrument will be
executed. Divorce law can vary—often significantly—by
the payer should carefully read the divorce or separation agreement
before signing it. By way of example, a payer who wishes to deduct
the payment of military retirement benefits to an ex-spouse should
make sure that the agreement does not contain a clear directive
or statement that the military retirement benefits are not to
be treated as alimony. A so-called “not alimony” provision
will preclude the payer from deducting the payment.
of retirement benefits under a divorce or separation instrument
executed in a common law state typically can be structured to
satisfy the requirements of both IRC section 71 and the USFSPA.
It is important to determine that all of the applicable requirements
of IRC section 71 are satisfied. The decision in Proctor
indicates that the USFSPA can, in some situations, satisfy IRC
of retirement benefits to an ex-spouse under a divorce or separation
instrument executed in a community-property state will usually
preclude the payer from claiming a deduction for alimony. In a
community-property state, the former spouse of a service member
is often entitled to receive a 50% community-property interest
in the service member’s military retirement benefits. If
so, the receipt of 50% of the military retirement pay by the former
spouse would result in pension income to the payee, while the
payment would not be deductible as alimony by the payer.
It is possible
in a community-property state for a portion of the military retirement
pay to be structured as deductible alimony. For example, if the
former spouse’s community property share of a service member’s
military retirement pay is 50% but the divorce or separation instrument
provides the former spouse with a share greater than 50%, the
excess can be structured to satisfy the requirements for the payer
to deduct alimony under IRC section 71.
M. Bird, JD, CPA, is a professor of accounting at the Richards
College of Business of the University of West Georgia, Carrollton,
Marcia Sakai, PhD, is the dean of the college of
business and economics at the University of Hawaii at Hilo. The
authors gratefully acknowledge the financial assistance of the IRS
Taxpayer Advocate Service in the preparation of this article.