Tax Deductions For Alimony

When a divorce court orders one spouse to pay alimony to the other spouse it is taxable income to the person receiving the deductions. The person paying it however gets to take a tax deduction on the payment. Alimony is also a deduction from adjusted gross income, which means the husband or wife paying it receives the tax benefit, even if he or she does not itemize their tax deduction.

While this might seem a situation in which whatever one spouse gains the other spouse loses this frequently is not the case. As a bankruptcy attorney I can tell you that in most cases in which the court orders alimony it is because the party receiving the payment needs financial help and the party being ordered to pay it is significantly better off. Thus while the payer will get his deduction the receiver is likely to be in a lower tax bracket and will end up paying less tax than the former spouse saves.

To receive the alimony tax treatment the payment must meet the test set out in the Internal Revenue Code. The payment has to be made in cash or a cash equivalent, it must be the result of a divorce or a separation agreement, and the payments must not continue after the death of the payee. Also it cannot be child support, and there can be some recapture of the tax benefit, if the payment drops too much in the first three years.

Taxation of Installment Sales

When a taxpayer sells property in a contract that calls for payments to be made in more than one year, he or she generally reports the income on the installment basis. This means that he computes the taxable income for each year by multiplying the amount received that year by the percentage of the total sales price that will result in profit.

Example: A retiring bankruptcy attorney sells the painting on his office wall, which he paid $10,000 for to another lawyer for $20,000. The price will be paid over four years at $5,000 a year. Each year the seller will recognize $2,500 of taxable income.

The installment sale method applies only to gains and not to losses. It also requires that the seller recognize certain depreciation recapture and unrealized receivables in the year of sale, and only spread out the balance of the gain to future years.

There are a number of transactions for which the method cannot be used. Dealers in property may not use the installment method except for certain dealers in time shares or residential lots. Nor can relatives or controlled partnerships use it on certain sales of depreciable property. Stock or securities trades on an established security market may not be sold under the installment method, but closely held stocks, partnership interests or small businesses are eligible for the treatment.

Taxation of Income On Long Term Contracts

In our modern world businesses often enter contracts that take several years to complete, and the question arises on when a taxpayer should recognize the income from a long term contract. The general rule is that a taxpayer earning income on a contract for the manufacture, building installation, or construction of property that will not be completed in the tax year in which is starts must report income on each annual tax return using the percentage of completion method.

In the percentage of completion method the business first calculates the cost of the project for the tax year and then determines what percentage this amount is to the total costs that will be incurred on the contract. The second step is to apply this percentage to the total gross receipts that will be received under the contract, and by subtracting the years cost from this calculated percentage of gross receipts one determines the income or loss for the tax year. Exceptions to the requirement to use the percentage of completion method include home construction, other real property construction expected to be completed within two years by a taxpayer with less than $10,000,000 of annual gross receipts, and manufactured items that are not unique and normally take less than twelve months to complete.

Of course to apply the percentage of completion method one has to estimate the total costs and the total receipts one is going to incur during the entire contract term, and as any bankruptcy attorney can tell you contracts do not always finish within budget. The law however includes a look back rule, which requires the taxpayer to recompute at the completion of the project what the profit would have been each year, if they had known the actual total costs and receipts at the time, and pay or receive interest on the difference between the tax paid and what the tax should have been. There are exceptions to the look back rule for certain small contracts and for home and other real estate contracts that are not subject to the percentage of completion method.

Taxation of Partnership Distributions



When a partnership makes a distribution of money or properties to its partners it is generally tax free to both the partnership and the partners. A partnership is a pass thru entity for income taxes. When the entity makes income or loses money each partner reports their share of the gain or deducts their share of the loss on their individual tax returns. The income will thus have already been taxed and the distribution will not trigger additional liability. If a partner later sells the property subsequent to receiving it from the partnership, he or she will recognize taxable gain or loss on the sale.

One exception to this rule occurs when a partnership has unrealized receivables or substantially appreciated inventory. These assets have a built in gain that will generate taxable income and sometimes certain partners will want to receive a higher or lower portion of this property in order to manipulate their individual tax liability.

As an estate planning attorney I sometimes encounter partners who think of this scheme. A partner in a higher tax bracket for example may wish to take a higher percentage of assets that will generate long term capital gains when he ultimately sells them. Unfortunately I have to tell these individuals that the Internal Revenue Code has a provision to discourage this conduct. Unless unrealized receivables or substantially appreciated inventory are distributed to the partners proportionately to their partnership interest the law will treat this distribution as a sale, which can generate taxable income.

Income Tax on Capital Gains

When an individual sells property which is considered a capital asset at a profit after over a year of ownership, he or she will be paying a lower rate of taxes on that profit than on most other types of income. It gets complicated though, since the long term capital gains rate will vary depending on what your regular income tax rate is. Capital assets are also divided into several categories that will affect the rate.

For most assets the long term capital gains rate would be 20% ,if the individual would pay a 39.6 % rate on ordinary income, or 15% if the individual would pay at less than 39.6% on ordinary income but more than 25%. For those in less than a 25% tax bracket, which probably represents a majority of individuals, there is no tax on the long term capital gain. The long term capital gains tax rate however can go up to 25% on property that involves depreciation recapture and 28% on collectibles.

As an estate planning lawyer could also tell you an individual can escape all taxes on capital gains property, if he or she holds it for the rest or their life. Property held at death generally receives a step up in basis to the fair market value at the date of death, and the heir will only incur tax liability, if it further increases in value after that date.

Taxation of Vacation Home

As an estate planning attorney I encounter people from time to time, who have included a vacation home, among their investments. Since most of us have limited vacation time during the year the owners of these residences often rent them out, when they are not using them. The rental income is taxable income, but the treatment of the expenses as tax deductions becomes complicated, when there is both rental and personal use of the property.

Certain expenses such as mortgage interest and property taxes may be deducted on any second home; however, other expenses such as insurance and repairs are only available, if a building is used to produce income. If an owner uses a vacation home for even one day of personal use, he or she is required to allocate these other business expenses between the time the dwelling is used by the owner and the time it is used to produce rental income and no deduction is allowed for the personal use period.

If a vacation home is considered a residence the taxpayer is also limited by a rule that his total deductions cannot exceed his rental income. A vacation home is considered a residence, if the taxpayer puts it to personal use for the greater of 14 days during the year or 10% of the number of days the unit is rented for.

Disability Access Credit

As a bankruptcy lawyer I know that the cost of complying with government regulations can place a heavy burden on small businesses. Congress however has enacted certain tax breaks that sometimes will help to defray the cost of compliance. One such measure is the Disability Access Credit, which allows small businesses a credit for costs of complying with the Americans with Disabilities Act. The credit is 50% of the costs of modifying buildings, equipment, materials or services to make the business more accessible to disabled individuals.

The benefit is designed to apply only to small businesses. The credit is for qualified expenditures of between $250.00 and $10,250.00 which means the maximum credit is $5,000.00. An eligible taxpayer must have gross receipts of $1,000,000.00 or less a year or must employ less than 30 full time employees.