With nearly half of all marriages end in divorce, as a financial planner, it’s inevitable that I will help some clients navigate the murky waters of divorce. While I am not qualified to offer marriage counseling to prevent you from becoming another statistic, I can volunteer some helpful financial insights, in particular for taxpayers who find themselves paying alimony.
Alimony is the support provided by one spouse to another after a separation or divorce. Payments are typically made to help the lower income earning spouse continue to maintain the standard of living they were privy to during the marriage. While the question of whether or not alimony is tax-deductible is not a cut and dry issue, there are a few rules you need to follow in order to be eligible for a deduction. Breaking the rules could render you ineligible, so pay close attention to the IRS requirements.
You first need to know exactly how the IRS defines alimony.
The IRS defines alimony as “a payment to or for a spouse or former spouse under a divorce or separation instrument. It doesn’t include voluntary payments that aren’t made under a divorce or separation instrument.”
It is also important to note that if you are the recipient of alimony payments, you are responsible for reporting that as income on your tax return.
Now, this is what the IRS does NOT consider tax deductible alimony payments. Under the rules of the IRS:
• Child support – both “designated child support” and “deemed child support” built into the payment.
• Payments required to continue after the former spouse’s death
• Noncash property settlements
• Payments to keep up the payer’s property
• Use of the payer’s property
Payments made on behalf of your former spouse to a third party (e.g., mortgage payments, real estate taxes, insurance, housing expenses, etc.) under the terms of the divorce or separation agreement are typically tax-deductible, depending on certain circumstances. Before assuming your alimony payments are tax deductible, verify your payments meet these seven important requirements.
1. Ensure that the alimony payments are in accordance with a written divorce or separation agreement. Label the payments made to or on behalf of your former spouse as alimony or spousal support. If payments are made on behalf of a spouse to a third party, it must be clearly outlined in the written divorce agreement that the payments are made in lieu of alimony paid directly to the former spouse.
2. Make payments check or cash. You cannot gift your former spouse with something, perhaps a car and expect to count it off for tax purposes.
3. Subtract any portion of the alimony payment deemed as child support before taking a deduction. Child support is never tax-deductible. Try keeping your alimony payments separate from your child support payments. If you don’t, and the alimony payment stops once your child (or children) reaches the legal age of your state, leaves home, marries, dies, or becomes employed (attaining a specified income level), it is possible for the IRS to reclassify past payments as child support, therefore leaving you owing back taxes.
4. Be sure you live in separate households. Additionally, file separate tax returns from your former spouse on Form 1040. If you file jointly, you will not be able to deduct the payments.
5. Don’t pay upfront. Follow the IRS rules against advance payment. If you make excessively high payments or “front-loaded” in the first three years of separation, they are subject to recapture or taxes in the third year.
6. Always subtract any additional payment not explicitly designated as alimony in the divorce or separation agreement.
7. Alimony payments must cease upon the death of the former spouse. Most of the time the payor can terminate alimony once the recipient remarries as well.
For more detailed information on alimony, tax requirements visit IRS.gov.
During a difficult time like a divorce, surround yourself with people who will work in your best interest and help you make sound financial decisions. It is a good idea to enlist a team of experts (a CFP®, CPA, and attorney) to assist you in avoiding costly tax code pitfalls. Review your divorce or separation agreement with these professionals to ensure you are receiving all available tax benefits.
For more helpful information read my blog post “Just Divorced: Now What?”