In previous blog posts, we discussed the difficulties in dividing a military pension in a divorce. It can be done, but it needs to done carefully and with full knowledge of the process. In fact, no aspect of divorce law is more understood by family law practitioners then military pensions. So, what are the tax consequences of dividing a pension in a divorce? Here is how it works:
In general, the retiree can deduct the full amount of the military pension payments to his spouse from his income taxes. Conversely, the spouse must claim the full amount of the pension payments on her taxes. If the pension payments are made directly by the retiree (or DFAS) to the spouse, are divided by a written instrument (such as a court order or settlement agreement) and end no later than the death of the retiree, then the payments are considered alimony.
Alimony is taxable to the recipient and tax deductible to the payor, even if the parties think payment is part of a property distribution between the parties. The division of the pension payments can happen one of two ways.
Direct payments through the Defense Finance and Accounting Service (DFAS): This is generally the best option for both parties. The spouse can feel safe that the payments will be deducted from the retirees military pension by DFAS, regardless of the retirees location, financial situation or desires. The DFAS payments benefit the retiree by automatically deducting the correct amount from his pay and this deduction is automatically deducted from his taxable income on his form 1099-R.
Payments from party to party. Sometimes payments cannot be garnished by DFAS. For example, if there is not a 10-year overlap between between the marriage and military service, then there cannot be a DFAS garnishment. In that case, the payments may be interrupted if the retiree falls off the grid or moves overseas etc. But the payments will still be alimony per the above.
Filing tax returns: Without DFAS assistance, the military retiree will need to exclude the income on his tax return. He can do this on a Form 1040 by entering a negative number on Line 21 as "other income" or a negative number on Line 16a (Pensions and annuities) or a positive number on Line 31. The retiree should also attach an explanatory note and appropriate documents to show his situation.
The spouse can reflect the gross amount received as income under Line 16a (Pensions and annuities).
Therefore, where DFAS is not involved, it is good practice to insert a clause in the settlement agreement such as: Periodic payments made by Retiree directly to Spouse will be included in Spouse's income under Sections 61 and 71 of the Internal Revenue Code, and these payments will likewise be excluded from the Retiree's gross income.
Please note that Pennsylvania has special exemption rules for military retirement pay and so state taxes are not handled the same as Federal Taxes.
Finally, few attorneys know that a former spouse may possibly deduct legal fees incurred for work done obtaining a portion of a military pension. After all, the legal fees were expended towards the "production of taxable income". Consult your accountant of family law attorney.
As always, consult your individual family law attorney to determine the facts of your specific case. When you do, you can bring the following general knowledge to the meeting. These general principles may, or may not, apply to your particular case.