December 2016 : Nontaxable/Nondeductible Designation of Payments

Michigan Family Law Journal : TAX TRENDS AND DEVELOPMENTS Feature

by Joseph W. Cunningham, JD, CPA



A question put to me recently was, essentially – Can payments that may qualify as taxable/deductible be stipulated as nontaxable/nondeductible with assurance 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 prevents this.

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 — The nontaxable/ nondeductible designation can be used to ensure that payments of life insurance proceeds or a lump-sum settlement from the estate of a deceased spousal support payer, which is not deductible as alimony on an estate’s income tax return, will not be taxable to the payee. This prevents the possibility of one party being taxed on a sizable payment for which there is no corresponding deduction by the other’s successor-in-interest.

It is common after the death of an alimony payer to con- vert the balance of the obligation to its lump-sum, present
value, after-tax equivalent (using the payee’s tax rate) and pay it in full with insurance proceeds. The nontaxable designation accommodates this practice.

Lump-Sum Payable for Other Reasons

Continued in PDF file below… “Nontaxable/Nondeductible Designation of Payments”
View / Download December 2016 Article – PDF File

Complete Michigan Family Law Journal available at: Michigan Bar website – Family Law Section (subscription required)