According to IRS Code Section 1041, in order for alimony/spousal support to be tax deductible for the payor, the parties may not be members of the same household. Consider the following case study.
Brad and Heather are getting divorced after 18 years of marriage. They have 3 small children and they owe far more on their mortgage than their house is worth. However, they agree to sell the house and pay off any amount owed out of joint funds. Brad’s income is substantially higher than Heather’s therefore, the settlement they’re contemplating includes a provision for temporary spousal support. They agree to live in the marital home together until the house sells. They sign on the dotted line and are officially divorced.
Fast forward three years. The house still hasn’t sold and Brad and Heather have been maintaining a pleasant co-existence in it. However, Brad has been paying Heather what he assumed was tax deductible spousal support and Heather has been paying income tax on the payments as well! This is clear violation of IRS Code Section 1041. Even though the parties have not been filing a joint return, they are still members of the same household.
This is becomming a common scenario in Michigan as the housing market remains challenging and couples are attempting to find creative solutions when they can’t sell the marital home. What is the answer to this growing problem? As always, we recommend that clients sit down with a qualified tax preparer to discuss the tax deductibility of spousal support. If parties are currently in the same situation as Brad and Heather, they should contact their attorney immediately to discuss revising their divorce decree and any other possible options.