Alimony Taxation – Part 6

Alimony, also known as Spousal Support in California, is GENERALLY deductible to the payor and taxable income to the payee. I highlighted the word generally because the mere use of the term Alimony or Spousal Support in a settlement agreement does not affect the tax consequences of payments. Internal Revenue Code Section 71 contains eight requirements that must be met for a payment to be considered taxable to the recipient and tax deductible to the payor. I will review all eight in the coming weeks.


I.R.C. § 71(b)(1) provides that the “term alimony or separate maintenance payment” means any payment in cash if —

(D) There is no liability to make such payment for any period after the death of the payee spouse and there is no liability to make any payment (in cash or property ) as a substitute for such payments after the death of the payee spouse.


Gray Divorce: The Question of Alimony

I was recently interviewed for an article written by Caryn Brooks for Reuters. The article, titled “Gray Divorce: The Question of Alimony” seeks to understand what if any difference there might be in decision-making regarding Alimony and Spousal Support in Gray Divorces.

Gray Divorce refers loosely to the dissolution of marriages when the parties are over the age of 55. I make no judgments as to whether a certain age makes a divorcee old. I do however believe there are many financial complications and intricacies to the dissolution of marriage at a later stage in life. I will review many of these issues, concerns and questions in detail over coming months in my Gray Divorce series.

The Reuters article quotes a Massachusetts attorney, Garbrielle Clemens, who shared the story of two of her clients “forgoing alimony in order to front-load money in case their ex-spouse can’t come up with the payments down the line”. Click on the link above to learn a little about my opinion regarding the front loading and/or buy-out of Spousal Support in long term marriages ending in Gray Divorce as well as some practical thoughts when considering it as an option.



Life Insurance as Security for Support

It is common for a divorce decree or Marital Settlement Agreement to require a providing spouse maintain a life insurance policy on his/her life during the period spousal and child support payments are being made. This is called Life Insurance as Security for Support. Spousal Support terminates at the death of either party. Life Insurance can protect the supported party in the event the support payor were to pass away un-expectedly.

What type of insurance should be used?

  • The shorter the obligation the more likely some form of term insurance will be advisable. Longer time frames may call for some form of permanent life insurance. When lifetime alimony payments are required, permanent insurance will be preferred.

How can the recipient spouse be assured the life insurance policy is placed and remains in force?

  • The ideal policy would be fully paid but is not likely to be financially viable. The next best option is to require annual premium payments necessitating one check per year rather than 12 and limiting the logistic problems. The recipient spouse should be the owner of the policy meaning they will be notified if a premium payment is missed before the policy lapses


Bankrolling Divorce

The New York Times ran an article December 4 2010 titled “Taking Sides in a Divorce, Chasing Profit” . The piece details the emerging business of bankrolling litigation. In this case, Divorce  litigation.

“With some in the financial world willing to bet on almost anything, it should be no surprise that a few would see the potential to profit from the often contentious and emotional process of ending a marriage.”

I am encouraged by the opportunity this creates. Here is how it works and why I see the idea as a welcome twist.

In California, family law attorneys are required to be paid up front in a retainer form rather than on a contingency basis common in other forms of litigation. When retainers run out they must be refreshed. As divorces drag on and fees mount, one spouse may find themselves with no cash to continue paying the attorney charged with protecting their legal rights. This leaves the party with control over the family assets in a position of power and may lead to the out spouse, the one without control, being pushed into a corner during settlement discussions. Faced with taking the deal offered by their soon to be ex or incurring additional legal fees they can not pay, the out spouse will often choose to take a deal that is less than equitable.

Divorce Bankrolling would loan the out spouse the additional funds necessary to prepare and sustain a case as long as necessary and help level the playing field during litigation. Of course it is not without costs. Clients end up paying back the loan along with a percentage of the “winnings”.

What remains unclear is what exactly does winnings mean. To make a truly fair exchange for value and compel me to recommend the service to clients I would need to know just how the lender will define “winnings”. It seems impossible to calculate two versions of the settlement, one before the loan and one with the loan, then calculate the difference and call it “winnings” but this seems to be the closest thing to a true contingency type arrangement. Divorcing clients are rarely faced with fighting for millions at the risk of getting zero as is done in the world of civil litigation. So how do we determine the true value of this service?

I will keep my ear out to see how the idea progresses. The New York Times reports the business is small but quickly gathering interest. Time will tell if it also gathers supporters and clients.


Ever Wonder Why Frequent Flyer Miles Seem So Valuable?

People often focus on near-term concrete goals in financial decision-making. While trying to maximize these immediate and clear goals they forget or discount the real reason for the actions. This is called Medium Maximization. Having something measurable within reach can redirect our motivation. Immediate and concrete goals by which to measure ourselves give a sense of progress. Plus it just seems an easier decision to make.

When an airline offers a frequent-flyer program it allows members to accumulate miles. The miles begin to obtain value to the program member despite being only a medium you can trade for free travel. The member doesn’t truly care about the miles. He cares about the benefit of accumulating those miles, free travel. The medium, in this case, frequent flyer miles, truly has no value yet still draws the concentration of the program member. “The money we earn from work is also a medium. Thus, the potential implication of research on medium is not medium; it is extra large.” Christopher Hsee, Journal of Consumer Research, June 2003 

The tenet of Medium Maximization says people often fail to fully skip over the medium (frequent flyer miles) in favor of the benefit (free travel). For example, consider the opening scene to the film Wedding Crashers. The scene concentrates on a divorcing couple in the midst of a Divorce Mediation session. They begin arguing over who should be awarded the frequent flyer miles. Frequent flyer miles and other frequent buyer or cash back rewards programs are considered by family law courts to be a community asset in California. The husband says “I earned those miles”, the wife seems to agree but believes he earned them on trips to see his -insert expletive- girlfriend. The miles are the medium to this couples’ financial decision-making process (dispute). By focusing on the medium (frequent flyer miles) rather than the benefit (free travel) of owning the medium, they have both failed to consider the decision at hand from a rational perspective. The real decision at hand is who will be awarded the right to free travel in the future not who gets the frequent flyer miles. The value of this free travel can be estimated fairly easily. Twenty-five thousand (25,000) miles might earn a one way ticket from Los Angeles to New York while the same ticket would actually cost $300. The wife lost sight of the benefit of the miles immediately when she associated the medium with the outcome in her mind, her cheating husband. She has missed the point by concentrating on the medium rather than the benefit.

The wife is very clearly upset by the situation and allows her emotions into the decision making process. I don’t blame her. The point of the illustration is to realize that economic theory tells us people will never concentrate on the medium because it has no value. The emotional turmoil of the dispute in the movie tells us humans often place a value on the medium and may ultimately make emotional decisions because of their tendency for medium maximization. Understanding Behavioral Finance can help mitigate emotion but we can never hope to completely remove it making Behavioral Economics vital to appreciating real life financial decision-making especially in Divorce Financial Planning.