The principal alimony rules in the IRC are contained in Sec. 71. Under this section, alimony payments are taxable to the payee who received them. Under Sec. 215, the alimony payor receives a tax deduction for the payments.

The taxability and deductibility of the alimony payments depend on the year the divorce or separation instrument was executed. TRA 84 and TRA 86 made substantial changes and unlike many other changes to the Code, these applied only to agreements executed or modified after certain dates. If the divorce or separation instruments were not modified to expressly provide that TRA 84 or TRA 86 would apply, then the instruments are subject to the rules that were applicable at the time they were executed.

PRE-1985 Rules

For instruments (i.e., decress, separation agreements, or support orders) executed before January 1, 1985, alimony payments must meet four requirements:

1. Payments must be made because of the general obligation to support.

2. Payments must be imposed under a divorce or separation decree, or written instrument incident to divorce, written separation agreement, or support order (decree).

3. Payments must be periodic. Installment payments were considered periodic if they were paid over a period of more than 10 years, unless terminated earlier by death or remarriage. Fixed payments are periodic if the obligation to pay is subject to a contingency in time or subject to amount of payments. In addition, payments of a variable amount are always periodic.

4. The payments may not be fixed as child support. In Commissioner v. Lester, 366 U.S. 299 (1961), the Supreme Court held that an indirect designation of child support is not a fixed amount and is treated as alimony.

The first changes to the alimony provisions of Sec. 71 were made in TRA 84. This Act made two revisions to alimony requirements:

1. Elimination of the support requirement for alimony payments; and

2. Elimination of periodic payments (10-year installments).

These changes were made in order to create a uniform federal alimony standard that could be more easily applied to the facts of a particular case.

TRA 84

Under TRA 84, if a payment is a qualified payment (as defined below), it is included in the recipient's gross income. When it is allowed as a deduction to the payor, it is referred to as a deductible qualified payment. The requirements that must be met to be alimony or separate maintenance agreements are as follows:

1. The payments must be in cash, checks, or money orders payable on demand. If the parties want a cash payment for property to be nondeductible/nontaxable, they must designate it as such.

2. The payments must be made to or for the benefit of a spouse or former spouse under a divorce or separation instrument. Payments made directly to the third parties for the benefit of the payee, pursuant to a divorce or separation instrument, or at a written request of the payee is allowed. Cash payments made for rent or mortgage qualify as alimony.

3. The spouses cannot be members of the same household when the payment is made. The parties involved can not file joint returns.

4. The payor has no liability to make payments past the payee's death.

5. Payments that are fixed as child support are not alimony or separate maintenance. To the extent any payments are reduced due to a contingency relating to a child, the payments would be treated as child support and would not be alimony. It should be noted that when a payor pays both child support and alimony, payments are still considered first as child support up to the full amount.

The major distinction between the statute as relating to alimony pursuant to TRA 84 and the prior law is the "Minimum Term Rule." If the payments in any year are greater than $10,000 they are not deductible unless the payments are made for at least six consecutive years, beginning with the first payment. If the amount paid in any prior year is more than the amount paid in any later year, plus $10,000, the excess from the prior year is subject to recomputation in the later year. This excess is income to the alimony payor and a deduction to the alimony payee. It should be noted that the six-year requirement does not apply to payments under a temporary support order.

An exception to the six-year rule exists for payments that fluctuate outside the control of the payor spouse. These payments must be made under an obligation to pay a fixed portion of the income from a business, from property, or from compensation. TRA 84 is effective with respect to divorce or separation instruments executed after December 31, 1984. Divorce or separation instruments executed before 1985 could have been modified to provide that the new rules would apply. In order for TRA 84 to be applicable, the terms of the pre-1985 instrument had to be changed.

TRA 86

TRA 86 further changed the alimony recomputation rules. These changes are effective with respect to instruments executed after December 31, 1986. In lieu of the six-year minimum term rule and the six-year recapture rule, there is a three-year recomputation rule.

Any divorce or separation instruments originated before 1987 can be modified to the new law by amending the old agreement to provide that the changes in TRA 86 will apply to the instrument. The new rules require two separate recomputation calculations. In addition, recomputation can occur only at the end of the third post-separation year. The rules for recapture are as follows:

1. Alimony or separate maintenance payments must be made for at least three consecutive years.

2. Payments made in the second post-separation year will be recaptured if the payments exceed those made in the third post-separation year by $15,000.

3. Payments made in the first post-separation year will be recaptured if they exceed the average payments made in the second post-separation year and the third post-separation year by more than $15,000.

4. The total recomputation amount is income to the alimony payor and a deduction to the alimony payee in the third year.

There are certain circumstances in which the recomputation rules do not take effect. If either spouse dies or the payee spouse remarries before the end of the third year, there is no recomputation. Also, payments made under a temporary support order or similar temporary court decree are not covered by these rules; payments made as a fixed percentage of income from a business or from compensation is not subject to recapture; and, there is no recapture if alimony payments do not exceed $15,000 per year.

Under TRA 86, transitional rules were enacted for 1985 and 1986 alimony payments. If agreements made before 1986 were not modified, then payments made for more than $10,000 must be made for at least six taxable years, but payments are not subject to recapture beyond the third post-separation year. In order for the payments not to be subject to recapture, they may not exceed $10,000 for each of these years.

Before a CPA advises his client about the taxability or deductibility of alimony payments, he should find out when the instrument was executed, and be cognizant of the dates of any modifications, since the tax consequences will vary.

Child Related Tax Benefits Subject

to New Age Limitations

Recent legislative changes enacted by TAMRA and The Family Support Act of 1988 impose a new set of age-based restrictions which limit child related tax benefits. A summary of the most significant changes is shown below.

Dependency Exemption for Students

Effective for tax years beginning after December 31, 1988, students may qualify as dependents only if they have not reached age 24 by year end or if their income is under the exemption amount. While this change can be expected to affect primarily graduate students, there are no provisions to waive this limitation for older students enrolled in an undergraduate or similar type program.

Educational Savings Bonds

For years beginning after 1989, qualified taxpayers will have an opportunity to earn tax-exempt interest on U.S. savings bonds used for the financing of higher education. No age restrictions apply with respect to benefits which are utilized by the taxpayer or his or her spouse. However, benefits for dependents will be subject to the limitations discussed in the previous paragraph. Additionally, these savings bonds will be considered as qualified for the interest exclusion only if they are issued to individuals who have reached age 24 at the time of issuance. Attempts to circumvent this limitation, through gifts or other transfer, will result in a loss of the bond's qualification for exclusion.

Child and Dependent Care Expenses

A new limitation will apply with respect to the age of children considered as qualifying individuals for pruposes of the child care tax credit and the dependent care exclusion. For tax years beginning after December 31, 1988, the qualifying age is lowered from age 15 to age 13.

With regard to the special deemed income rule applicable to the earnings of a spouse who is a student, there are no new age limitations imposed. Whereas, under TAMRA, the exemption is repealed for student dependents who are at least age 24, no corresponding changes have been made with respect to qualification as a student for purposes of the special deemed income rule. In this case, qualification as a student requires only that the individual attend an educational organization as a full-time student during each of five calendar months, not necessarily consecutively, during the taxable year.

Taxpayer Identification Number (TIN)

Requirements

For tax returns due after December 31, 1987, but before January 1, 1990 (without regard to extensions), individuals are required to report the TIN for each qualified dependent who is at least five years of age. For tax returns due after December 31, 1989, the minimum age requirement is lowered to two years. The TIN requirement, discussed above, did not apply with respect to returns which were due prior to January 1, 1988.