Health Insurance Paid for Former Spouse Was Deductible Alimony

Married persons with a divorce or agreement finalized before 2019 may continue to handle alimony under old rules: payments that meet the definition of alimony are deductible by the payor-spouse and taxable to the payee-spouse. Payments do not have to be made directly to a spouse; they may be made on behalf of a spouse and still receive alimony treatment under the old rules. This can include the payment of medical insurance premiums for a former spouse. But what if those payments are made from a cafeteria plan funded with pre-tax dollars?

The Tax Court considered the case of a husband who paid his wife’s health insurance premiums pursuant to a separation agreement. This was done through a cafeteria plan of the husband’s employer. The IRS said that he should not be allowed to deduct the premiums because they effectively were paid with pre-tax dollars. The IRS argued that this made them nondeductible as alimony, citing Code Sec. 265, which bars a deduction for amounts allocable to tax-exempt income. To allow a deduction would create a windfall for him. The Tax Court allowed the deduction (Leyh, 157 TC No. 7 (2021)). Because the wife had to include the premiums as taxable alimony, the husband could deduct them. The purpose of the old alimony regime is to ensure that things balance out (a deduction and an item of income). Here the husband’s deduction matched the wife’s income; it was not an offset to excluded wages. It doesn’t matter where the payor-spouse gets the funds to pay alimony.

Note: Under the new alimony regime for divorces and agreements after 2018, there is no deduction by the payor-spouse and no income for the payee-spouse.