Repayment of Alimony

[sinkotax]

A modified court judgement ordered ex-spouse to repay a portion of alimony that she previously received and reported as income. The judgment also ordered an additional interest charge on the repaid alimony, as well as repayment of a portion of the other spouse's attorney fees. The other spouse previously deducted the alimony payments and attorney fees on his tax return. How would you treat the repayments on both their individual returns? I have both clients.

[Snaggletooth]

Welcome to The Sink

Sinko I see this is your first post. We hope you will return to the forum often, and ask/answer questions.

This one about "alimony repayments" is a good one. I can't find a thing in Pub 504, and I don't believe TTB addresses this matter either. So I think we may be plowing new ground here unless you (or someone) has access to possible court cases.

Alimony "repayments" as you have discussed is not to be confused with alimony "recapture". Pub 504 does address actions which may be taken if the reason for the repayment is an error by the court, i.e. a clerical error or error of omission.

I have already pleaded ignorant, however, I would say that reporting income/deduction by virtue of changed conditions (as opposed to a court error) has no provision to report as income/deduction. However, if the changed conditions result in a significant reduction, the payer may be subjected to alimony "recapture." This is plainly discussed in The Tax Book.

Because there is a provision for alimony recapture due to realized reductions in amounts due, I would think the govt would not compound the situation by allowing an additional adjustment (plus or minus) for repayment. I'm afraid I can't address what happens if a repayment is the result of error in previous amounts paid amongst the parties.

Sinkotax, because I have had the verbal continuity to ramble on does not qualify me to be a tax expert. There are several in the forum who are much more knowledgeable than myself, and I hope some of them may offer more definitive answers, and maybe even cites.

[taxea]

alimony deduction is done pre-tax so to original payer it is income Ln21 not subject to SE and interest is Sch B. To receipant it is an adjustment to alimony received with an explanation on the return. Interest is not deductible as it is personal interest. This would be my call.

[Roberts]

Is the court not simply just making a new alimony payment requirement imposed on the couple?
I think you'd need to get and keep a copy of the court order.

[Burke]

alimony deduction is done pre-tax so to original payer it is income Ln21 not subject to SE and interest is Sch B. To receipant it is an adjustment to alimony received with an explanation on the return. Interest is not deductible as it is personal interest. This would be my call.

Let's use John & Mary. It's easier. Mary has to repay John "x" amount of alimony, plus interest. It is agreed the interest is not deductible by Mary, but is taxable to John on Sche B. And John could show it on Line 21. But, for Mary, would the IRS rule for repayment of income received in an earlier year and repaid in the current year not be controlled by the rule for whether it is over $3K or under $3K as a misc itemized deduction subj to or not subj to the 2% exclusion? It's not fair, but that is what it says. It would make more sense if John and Mary each reported the amount received on Line 11, and deducted the amount paid on Line 31a, Form 1040. Then everything matches and nets out correctly.

[Roland Slugg]

The wife can deduct the alimony she repays in the year(s) of repayment. She can not deduct the interest, as it is personal. She also can not deduct her own legal fees or the portion of her ex-husband's legal fees that she is ordered to pay. If the amount of alimony she repays in any one year exceeds $3,000, she can
use the "claim of right" doctrine to recover the tax paid in an earlier year, on the amount repaid in the current year, if that gives her a greater tax benefit. (See Code §1341(a) and Regs §1.1341-1(e))

The husband should report as income the recovered alimony he receives in the year(s) he receives it. He should also report the interest income in the year(s) received. He does not have to report the recovered attorney's fees, as these are an offset to his non-deductible attorney fees paid. Finally, there is no "reverse" claim of right doctrine allowing the husband to offset the alimony he recovers against the amounts he deducted in earlier years.

P.S. You're a brave man (or woman) to keep both parties as clients after their divorce.

[sinkotax]

My initial research also confirms what has been said here in terms of the payor's/recipient's respective treatments of the repaid alimony and interest. However, without doing the deep-dive research as of yet, my thought was the repaid attorney fees would be deductibe by the payor and reported as income by the recipient because they were previously deducted on the ex husband's return. My reasoning is the sole issue in the modified court judgment was the ex-husband wanted a reduction/elimination of the alimony because the ex-wife failed to seek full time employment - and the judge agreed. Hence - legal fees paid in connection with the protection/preservation of taxable income?

[buzzardbreath]

Legal Fees - No

Don't think so Sinkotax. Repayment should be a deductible item because husband deducted legal fees when he paid them?

If husband deducted legal fees when he paid them, that kind of thinking is perhaps what has led to the problem. I don't know how he could have deducted legal fees in association with a divorce.

There might be some deductibility if it can be shown that it was paid in order to directly defend production of income. All manner of possibilities might be raised until you focus on direct production of income. I think Roland Slugg has produced the code/regs that you need.

In a conversation commonly used to portray the invincibility of taxation, it is said that ALL income from whatever source is taxable, and deductions/exemptions/credits do not exist but for legislative grace. I see this as applying to legal fees in connection with a divorce.

[JohnH]

P.S. You're a brave man (or woman) to keep both parties as clients after their divorce.

Wonder if that will still be the case after sinkotax informs the clients of their current tax situation.

[Kram BergGold]

A Different Approach

Is there any way to categorize the repayment as applicable to previous payments in 2014 thereby the husband would just deduct less and the wife would just report less in 2014?

[JohnH]

That's a very elegant solution.
Common sensical and simple.
The net tax savings might more than offset the inequity in the tax treatment of the interest.

Would be interesting to see how it flies with the affected parties (especially the lawyers). The lawyers might object, since handling it this way might give rise to the simple question - "why didn't you think of this?". And there's no good answer to that question...

[buzzardbreath]

Netting Out

Is there any way to categorize the repayment as applicable to previous payments in 2014 thereby the husband would just deduct less and the wife would just report less in 2014?

Not aware that there is a provision to "net out" and thus record a reduced amount of income/deduction, unless by foresight the parties agree to a reduced amount to begin with.

IRS prevents the practice of "netting out" on several occasions, such as a wraparound loan, where the proceeds of one loan pay for another. Interest on the money received is taxable, interest on the money paid is (in general) not.

The facts given in the original post clearly indicate this is a repayment, and a transaction which occurs in a subsequent year. Hard to "net out" under those circumstances.

[Burke]

There might be some deductibility if it can be shown that it was paid in order to directly defend production of income. All manner of possibilities might be raised until you focus on direct production of income.

Generally, if an attorney provides a letter allocating a part of the legal fees which can be directly attributable to alimony, that portion may be deductible.