Can Equitable Distribution Payments be Deducted on Federal Taxes?

Equitable distribution in divorce proceedings sometimes includes provisions that one spouse shall keep property in exchange for a lump sum payment to the other spouse. The payor spouse may want to deduct these payments from their taxes, especially when they total large amounts. While alimony payments are generally tax-deductible, not all payments made from one ex-spouse to another are considered alimony for tax purposes.

Martino v. Commissioner

Husband claimed the divorce-related payments he made to his Wife on his federal tax returns for 2017 and 2018 were deductible alimony. After the IRS denied his deductions, he filed a petition with the US Tax Court, which ruled in favor of the IRS. Husband appealed.

Before Husband’s divorce from Wife was finalized, the spouses reached an agreement concerning marital property, which was meant to be an equitable division of the property that was non-taxable to either party. This agreement stipulated that Husband would have sole possession of the former marital residence and would pay Wife $2.2 million in exchange. A separate provision required Husband to pay Wife $3,000 per month as taxable periodic alimony.

Shortly after the divorce decree was entered, Husband and Wife signed a consent order that modified Husband’s obligations. Specifically, Husband was to pay Wife $3.5 million for the marital home, which would be made in three tax-free installments. When Husband failed to make the second installment on time, Wife moved filed to hold him in contempt, and a second consent order was entered. This order required Husband to make the second payment with interest, among other provisions.

Husband Goes Bankrupt

Husband eventually filed for bankruptcy, and the marital residence was sold. The proceeds of the sale went to creditors and not Wife. Husband’s bankruptcy did not include his obligation to pay Wife, which the bankruptcy court ruled was non-dischargeable.

A revised payment schedule was imposed that required Husband to make one immediate payment and then monthly payments. Income-deduction orders were entered to withhold sums totaling $25,000 per month from Husband’s disability insurance distributions and pay that amount directly to Wife.

While additional difficulties arose in Husband’s payments, he had discharged the past-due amounts he owed Wife for alimony and child support by the end of 2016. In 2017 and 2018, he continued to make monthly payments, which totaled $300,000 each year. When Husband filed his taxes for those years, he claimed a $300,000 deduction for alimony, but the IRS denied his alimony deduction.

Husband’s Appeal

In Husband’s appeal, the Appeals Court stated that while alimony payments are deductible, property transfers by equitable division are not. The divorce decree that ordered the payments contained numerous clear and explicit directions that Husband’s payments would not count as deductible alimony. The settlement agreement stated that the payments were non-taxable to either party.

Since all later orders only reaffirmed Husband’s obligation to pay Wife as stated in the divorce decree and settlement agreement, the nonalimony designation was unchanged, which meant Husband’s payments did not meet the statutory criteria for deductible alimony. The Tax Court’s judgment was affirmed.