37.1 Planning Alimony Agreements

You can arrange beforehand the way in which the costs of a divorce are to be borne. You may specifically state in the decree or agreement that the alimony is neither taxable to the payee-spouse (under IRC Section 71) nor deductible by the payer-spouse (under IRC Section 215). Such a statement effectively disqualifies payments that otherwise would be taxable to the payee-spouse and deductible by the payer-spouse. A copy of the agreement that contains the statement must be attached to the tax return of the payee-spouse for each year the statement is applicable.

The first step in planning the after-tax consequences of alimony is for both spouses to recognize that they may have a common financial interest; the second is projecting future tax consequences.

For example, assume that the husband is to make payments to the wife. If tax planning is approached from the viewpoint of each spouse separately, the tax deduction is an advantage for the husband; tax-free income is an advantage for the wife. However, both advantages cannot be achieved, and the couple must face the reality of the tax law, which allows the husband to deduct payments only if they are taxed as alimony to the wife. The husband and wife must compromise by setting amounts and tax consequences that balance their interests.

One approach is to view both spouses as a single economic tax unit. If this is done and the husband will be in a higher tax bracket during the payout period than the wife, ...

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