Tax implications for Military Retired Pay

by / 0 Comments / 151 View / February 14, 2008

Before I start, let me state that I am not an accountant or tax attorney. Do not make any decisions regarding taxes based upon this posting. Discuss any tax plans with your accountant.

In a recent decision by the U.S. Tax court, Proctor v. IRS, 129 TC No. 12 the division of military retired pay was treated as alimony not a property distribution. This may also have implications for the New York Police or Fire Department VSF.

Under New York law, any benefit to be paid in the future, but earned during the marriage is subject to equitable distribution. Military retired pay is a perfect example. The right to the pay was earned by 20 years of service. The retiree gets paid after she/he retires and as long as he/she lives. Unlike a 401K, there is no account with money to be drawn upon. New York treats this as property, and is subject to property division.

But, apparently, the tax law treats military retired pay differently. In the Proctor decision, the court stated that under Internal Revenue Code section 71(b) payments to an ex-spouse of her share of military retired pay can be considered alimony, and therefore tax deductible to the retiree. The court stated that “in order to qualify as alimony, payments must meet the requirements of section 71(b)(1) (A) through (D)”.

(b) Alimony or separate maintenance payments defined. For purposes of this section–
(1) In general. The term “alimony or separate maintenance payment” means any payment in cash if–
(A) such payment is received by (or on behalf of) a spouse under a divorce or separation instrument,
(B) the divorce or separation instrument does not designate such payment as a payment which is not includible in gross income under this section and not allowable as a deduction under section 215 [26 USCS ยง 215],
(C) in the case of an individual legally separated from his spouse under a decree of divorce or of separate maintenance, the payee spouse and the payor spouse are not members of the same household at the time such payment is made, and
(D) there is no liability to make any such payment for any period after the death of the payee spouse and there is no liability to make any payment (in cash or property) as a substitute for such payments after the death of the payee spouse.

The court found that payment order met the requirements of the statute. This is true even if the divorce decree refers to the payments as part of the division of martial property. The court stated the divorce court’s classifications do not matter. “Labels attached to payments mandated by a decree of divorce or marriage settlement are not controlling.” The court went on to say that “while the designation need not mimic the statutory (B) will generally be met if there is no ‘clear, explicit and express direction” in the divorce decree stating that the payment is not to be treated as alimony.” Since the decree in question does not contain such language the requirements of section 71(b)(1)(B) were met.

The key point is that the divorce decree must either be silent as to the designation of the payments, or state that the payments will be treated as alimony. If you already have a decree, please don’t use this decision as license to take the deductions, talk to your accountant and follow his/her advice.

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