Originally published on Forbes.com Aug 13th, 2014
Until recently, I had a hard time understanding why there are so many alimony tax cases. I mean, after all, it is wash, right? One party has a deduction against AGI. He or she, probably still usually he, puts the recipients social number down and the recipient picks up the same amount as income. Then TIGTA issued a report on discrepancies between payers and recipients of alimony. In 2010 there were 567,887 returns deducting a total of $10 billion in alimony. Nearly half of the corresponding returns of the recipients did not match. The net difference was $2.3 billion. Of the 266,190 unmatched returns, the IRS opened examinations on 10,870. This led to further examinations of recipients in just over 2,000 cases.
So alimony is supposed to be a wash in terms of total income reported by taxpayers. It turns out that taxpayers are routinely whipsawing the IRS. That accounts for the large number of alimony cases. Actually, there should be a lot more. The latest I have seen is the case of Joseph Peery which was decided last month by the Tax Court.
Mr. Peery’s divorce agreement called for him to pay 40% of his income as spousal support. The obligation terminated on his death, her death or her remarriage. So far so good. There was also a property settlement. That was a little complicated, but the only part relevant to the case is a cash payment in the amount of $63,500.
The Court went through the statutory analysis as to whether that $63,500 was deductible alimony. There is quite a bit more detail, but the deciding factor was probably that:
The plain language of the separation agreement states that petitioner was obligated to make a $63,500 payment to Ms. Peery as a property settlement.
But it gets more complicated. There was a $63,500 check that was included in the substantiation of a total alimony deduction of $90,265.67. The check was issued eight days after the required property settlement. “Spousal Support” was written in the memo section of the check, but that was crossed out.
Mr. Peery argued that the property settlement had been paid from other sources and that the $63,500 check was his ex-wife’s share of a capital gain. Just one of those crazy coincidences. It happens. Unfortunately, he was unable to substantiate the other $63,500, leaving the IRS unsatisfied and the Tax Court agreeing, The Court also upheld the accuracy penalty.
The check with “spousal support” written on it and crossed out makes me think that this was one of the less than 5% of the alimony mismatches that was actually examined by the IRS. I am beginning to suspect that divorce attorneys, who may be smarter than their agreements make them look, may be deliberately gaming the system. Of course the AICPA Standards of Tax Practice prevent me from giving advice based on the audit lottery. Nonetheless, my inner villain’s take away from this case is that if you are going to have an alimony mismatch, better you should keep it under 50 grand.