Revenue Code 682: How Alimony Trusts Are Taxed

An alimony trust is a financial vehicle established by one spouse to provide for the other during or after a divorce or separation. This type of trust holds assets, such as stocks or real estate, that generate income, which is then distributed to the beneficiary spouse. Historically, these arrangements were subject to a specific provision of the Internal Revenue Code that dictated how the income was taxed, but significant changes have since altered the financial landscape for these instruments.

The Pre-2019 Rule for Alimony Trusts

For divorce or separation agreements executed on or before December 31, 2018, the taxation of alimony trusts was governed by Internal Revenue Code Section 682. This rule established a tax liability shift where the income generated by the trust and distributed to a recipient spouse was taxable to that recipient. This meant the beneficiary spouse was responsible for reporting the trust distributions as income on their tax return and paying any resulting tax.

This treatment allowed the grantor spouse, the individual who funded the trust, to exclude the trust’s income from their own taxable income. For example, if a trust generated $20,000 in income, the beneficiary spouse would report it, while the grantor would not. The function of Section 682 was to prevent complex grantor trust rules from applying in a divorce context. It “turned off” the default rule that taxes a trust’s creator, ensuring the income was taxed to the ex-spouse who received it.

Repeal and Current Tax Treatment

The Tax Cuts and Jobs Act of 2017 (TCJA) brought a change to the taxation of divorce-related financial arrangements by repealing Section 682. This repeal is effective for any divorce or separation agreement executed after December 31, 2018. It also applies to pre-existing agreements if they are modified after this date and the modification explicitly states that the TCJA changes should apply.

With the elimination of Section 682, the tax treatment of these trusts now defaults to the standard grantor trust rules. Under these provisions, the grantor spouse who creates and funds the trust is treated as the owner for tax purposes and is liable for the tax on all income it generates. This means the grantor spouse must report the trust’s income on their personal tax return, while payments received by the beneficiary spouse are considered tax-free.

Tax Reporting for Affected Trusts

The tax reporting for an alimony trust depends on the execution date of the governing divorce agreement. For instruments finalized on or before December 31, 2018, the trust itself has a reporting obligation. The trustee must file Form 1041, the U.S. Income Tax Return for Estates and Trusts, to report the trust’s income. The trust then issues a Schedule K-1 to the beneficiary spouse, detailing the income they received, which the recipient uses to report the income on their personal Form 1040.

For agreements executed after December 31, 2018, the reporting process reflects the grantor trust rules. The grantor spouse is responsible for reporting all of the trust’s income, deductions, and credits on their own Form 1040. The trust itself may still have a filing requirement, but it is often a simplified informational return. The beneficiary spouse has no reporting duty for the payments received.