When it comes to divorce, alimony and taxes, it is not uncommon to have a lot of questions. While most are answered with the ubiquitous “it depends,” the question of whether paying health insurance premiums can qualify as alimony has been resolved.
In a recent court decision, the court ruled that an individual can deduct the amount of premiums paid to provide health insurance coverage for an ex-spouse as alimony. In this case, the taxpayer had agreed to pay his then spouse’s health insurance premiums, incident to a separation agreement pending divorce, through a cafeteria plan provided by his employer. Subsequently, he had excluded the amount equal to the health insurance premiums from his gross income and also claimed an alimony deduction for the portion of the premiums covering his then spouse.
Double Deduction
There was no dispute that he was entitled to exclude the health insurance compensation from his gross income. However, the IRS had challenged his attempt to also deduct the alimony payments, arguing that permitting the alimony deduction would create a windfall to the taxpayer by granting him the practical equivalent of multiple deductions for the same economic outlay. The tax court disagreed and held that disallowing the alimony deduction would leave the taxpayer with a greater tax burden that would counter the intended purpose of the general alimony regime. Therefore, the taxpayer qualified for both the exclusion and the alimony deduction, and no double tax benefit outcome could arise when considering the alimony regime as a whole. By asking to disallow the alimony deduction where the law plainly permits the taxpayer this right, the IRS attempted to disrupt the uniformity of the general alimony regime under the guise of the double deduction rules when no such threat was present.
Deduction for Wholly Tax-Exempt Income
In addition, the IRS contended that Code Sec. 265(a) disallowed the taxpayer’s alimony deduction because it provides that an amount may not be deducted if it is allocable to wholly tax-exempt income (other than interest). The tax court, however, had never applied Code Sec. 265(a)(1) to disallow an alimony deduction, or, in any instance where the supposed exempt item of income at issue was actually included in gross income by a different taxpayer. Moreover, the alimony payments were not considered allocable to wholly tax-exempt income for Code Sec. 265 purposes as the taxpayer was required to include it in her income.
If you have questions about your post-divorce tax situation, reach out to us and we will do all we can to help.