June / July 2014 : Designation of Payments as Nontaxable/ Nondeductible

Michigan Family Law Journal : TAX TRENDS AND DEVELOPMENTS Feature

by Joseph W. Cunningham, JD, CPA



As indicated by a recent case on which the author was consulted, many attorneys are unaware of IRC Section 71(b)(1) (B) which enables divorcing parties to expressly designate payments from one to the other as nontaxable/nondeductible. In that case, the parties had agreed that one would pay the other after-tax installment payments for a period of years to balance their divorce settlement. Their tax brackets were approximately the same so there was no advantage to converting the after-tax payments to taxable/deductible Section 71 payments.

The question to me was, essentially – Can we structure payments as nontaxable/nondeductible and be assured they will be so treated for tax purposes?

The answer is “yes,” pursuant to IRC 71(b)(1)(B). Just as it is important to include a “tax intent” provision when payments are intended to be taxable/deductible, the same is advisable when they are intended to be nontaxable/nondeductible. Tax intent provisions prevent misunderstandings down the road. Sometimes a tax preparer may suggest payments are deductible by the payer when such was not intended. A tax intent provision avoids this possibility.

The following is sample generic language for a nontaxable/nondeductible tax intent provision:

“Defendant’s payments of [property/spousal support] to Plaintiff provided in paragraph [ ] are hereby designated by the parties, pursuant to IRC Section 71(b)(1)(B), as not includable in Plaintiff’s income under IRC Section 71 and, correspondingly, not deductible by Defendant under IRC Section 215. Plaintiff and Defendant agree that neither will file an income tax return on which subject payments are reported inconsistently with their expressly designated nontaxable/nondeductible status.”

Other Uses

Lump-Sum Payable on Death of Payer – ……

Continued in PDF file below… “Designation of Payments as Nontaxable/ Nondeductible”
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Complete Michigan Family Law Journal available at: Michigan Bar website – Family Law Section (subscription required)