Are Substitute Payments Alimony?

Alimony payments are deductible for adjusted gross income for the payor spouse; however the payee spouse must include the alimony in gross income. IRC section 71(b) provides specific criteria that must be satisfied if payments from one ex-spouse to another are to qualify as alimony. The payments must be under a divorce or separate agreement, in cash, to an ex-spouse who does not live in the same household as the payor spouse and not designated as either child support or a property settlement. Finally there can be no liability to make either the payments, or substitute payments, after the death of the payee spouse.

John Okerson was granted a divorce in 1994. In 1995 a state court entered a final divorce decree requiring him to make 113 monthly alimony payments to his ex-wife totaling $117,000 from September 1994 through January 2004. The decree, agreed to by both parties, stated the payments were to be considered alimony. The decree also said that if the taxpayer’s ex-wife died before the entire $117,000 was paid, the payments should continue until either of their two children completed their first four years of college or until the entire $117,000 was paid, whichever occurred first. No payments would be required if the children did not attend college, and the payments would be cut in half if only one child attended.

Okerson deducted $21,600 on his 2000 federal income tax return for the payments made to his ex-wife. In 2003 the IRS sent him a notice of deficiency disallowing the deduction. He petitioned the Tax Court for relief in 2003. He then obtained a court order from the state court that had granted the original divorce decree: It said the court had “clearly stated more than one time” that it intended the alimony to be tax deductible to Okerson and taxable to his wife. He presented the court order to the Tax Court.

Result. For the IRS. Okerson had argued the payments should be deductible as alimony since the parties in the original decree and the state court clearly intended to treat them as such. The Tax Court disagreed, saying Congress had eliminated any consideration of intent by the parties or any court when it enacted IRC section 71 and that, therefore, such intent did not determine the tax treatment of those payments. The requirements of the statute had to be followed.

Okerson further argued the contingent payments for the children’s college education should not be considered substitute payments since he never actually made any of them. The Tax Court disagreed, saying the standard to be applied to substitute payments was not whether they actually were paid but whether they could have been paid if the payee spouse died. The court then referred to temporary regulations section 1.71-1T(b), Q&A-14, to determine whether any of the $21,600 might qualify as alimony. The temporary regulations do allow a portion of the predeath payments to qualify as alimony when the postdeath payments are less than scheduled predeath payments. For example, if the predeath payments were $30,000 and the substitute payments were $10,000, then $20,000 would be considered alimony. The court determined that no portion of the $21,600 payments was deductible as alimony since the amount of the contingent postdeath payments would have been the same as the payments made to the ex-wife under the divorce decree.

John R. and Patricia G. Okerson v. Commissioner, 123 TC no. 14.

Prepared by Charles J. Reichert, CPA, professor of accounting, University of Wisconsin, Superior.