Under section 71, cash payments made under a divorce or separation agreement are considered deductible alimony if they are made to an ex-spouse not living in the same household with the payor and are not designated as child support. In addition, the payor must not be liable to make payments after the death of the payee spouse (a continuing payment liability) or payments in their place (substitute payment liability).
Neil Proctor, an active member of the U.S. Navy, and Liza Holdman were divorced in 1993. The divorce decree required Proctor at retirement to pay Holdman 25% of his naval retirement pay under the USFSPA. When Proctor retired from the Navy in 2000, he did not make any payments to Holdman; however, he was compelled under a 2001 court order to do so. In 2002, Proctor paid Holdman $3,387, which he deducted as alimony on his 2002 federal tax return. The IRS disallowed the deduction, and Proctor petitioned the Tax Court for relief.
The IRS argued the payments did not qualify as alimony because they were a property settlement. The Tax Court disagreed. IRC § 71(b)(1)(B) does permit a divorce agreement to specify that certain payments are not alimony, the court stated. But the Proctor-Holdman agreement contained no such statement; thus, the payments would be deductible alimony if the other requirements of § 71(b)(1) were satisfied. Since the divorce agreement required Proctor to make cash payments to Holdman, who was not a member of the same household, the payments would be alimony if they would terminate upon her death. Under the USFSPA, the retirement payments would stop upon the death of either Proctor or Holdman, whichever occurred first, so Proctor was not liable for any payments after Holdman’s death. Also, under the USFSPA, Holdman had no rights in the retirement pay that she could sell, assign or transfer. Therefore, the court concluded, the payments were alimony.
Neil Jerome Proctor v. Commissioner , 129 TC No. 12
Prepared by Charles J. Reichert , CPA, professor of accounting, University of Wisconsin–Superior.