Taxation of Alimony – Part 3

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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.

 

REQUIREMENT # 3 – PAYMENTS MUST BE MADE PURSUANT TO A DIVORCE OR SEPARATION INSTRUMENT

I.R.C. § 71(b)(1) provides that the “term alimony or separate maintenance payment” means any payment in cash if such payment is received by (or on behalf of) a spouse under a divorce or separation instrument.

I.R.C. § 71(b)(2) provides that the term “divorce or separation instrument” means —

(A) a decree of divorce or separate maintenance or a written instrument incident to such a decree,

(B) a written separation agreement, or

(C) a decree (not described in subparagraph (A)) requiring a spouse to make payments for the support or maintenance of the other spouse.

“While the instrument does not have to be part of the divorce decree itself, some written agreement must exist that creates a legally enforceable right to the support payments.” Anderson v. Commissioner, T.C. Memo 1999-53 (1999) (citing Prince v. Commissioner, 66 T.C. 1058, 1066-1067, 1976 WL 3686 (1976).

 

California Divorce Dictionary: Bifurcation

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Bifurcation refers to splitting of a main body into two parts or division into two branches. In a legal context it refers to the division of a trial or legal proceeding into two parts. California Family Code Section 2337 (a) states “In a proceeding for dissolution of marriage, the court, upon noticed motion, may sever and grant an early and separate trial on the issue of the dissolution of the status of the marriage apart from other issues.”

In other words, you can get be legally divorced and take status as a single person without reaching agreement on all issues in your divorce proceedings. This is common in very long litigation that may last years due to complicated financial issues. It is also common when one party wishes to re-marry which they obviously cannot do if still legally married to another.

Caution must be taken as bifurcation has very great ramifications on finances including Retirement plans, Taxes, Social Security benefits, Estate Planning and Life and Health Insurance coverage. Significant financial rules and procedures are laid out in Family Code Section 2337 to protect the status quo. Interim orders and temporary agreements such as joinder of retirement plans and indemnification agreements protecting the other party from taxes and other adverse affects of the change in marital status are often required.

 

California Divorce Dictionary: Section 2640 Claim

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A Family Code Section 2640 claim is a request for reimbursement based upon one spouse’s Separate Property contribution to the acquistion of Community Property. A reimbursement would be due from Community Property to the contributor spouse’s Separate Property to reimburse the contributor for their contribution. A reimbursement claim may be applicable to the extent the spouse can trace his/her contributions. The reimbursement amount is limited to the total amount contributed. Making a 2640 claim will require tracing, forensic accounting and a paper trail. Examples include downpayment on a home purchase or payment for improvements financed from Separate Property funds.

 

Bankrolling Divorce

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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.

 

California Divorce Dictionary: 4320 Factors

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§4320 Factors; The factors set forth in Calfornia family Code Section 4320 for determining the proper amount of permanent Spousal Support.  Earning capacity, marketable skills, child-rearing, education, the foregoing of education, contributions to careers, “marital standard of living”, interests of the minor children, length of marriage, half the length of marriage, presumption of lengthy marriage and the needs of each spouse.