For individuals paying or receiving alimony, there are important tax implications that should be properly considered. If your divorce is going to include alimony issues, you ought to make it a priority to learn about the tax implications because they can have adverse effects on your ability to come to an agreement. Alimony can be defined as the money a spouse pays to the other for support after separation. Alimony only begins when there is a family law court case that’s opened and can vary from one case to the next. A spouse or partner can request an alimony order during a divorce, legal separation, domestic violence restraining orders, and annulments. This payment is referred to as spousal support when a marriage ends in divorce or legal separation and partner support when a when a registered domestic partnership ends in divorce or legal separation.
Regardless of the term used to describe alimony, all streams of support disbursements raise alimony tax implications and do not exempt you from Federal tax law. The main purpose of alimony payment is to ensure that the lower-earning spouse or partner leaves the marriage or the partnership in the same standard of living as they had established in the union. There are certain regulations that spouses must follow in order for the IRS to allow the spouse paying the alimony to deduct it when reporting on tax. The recipient, in this case, is required to report the alimony disbursements as income.
In most cases, such an arrangement enables the spouses to save a considerable amount of money, the rationale being that when you transfer money from a spouse with higher earning to one with a lower earning, you are moving revenue from a higher to a lower tax bracket. This means that the higher-earning spouse is able to save money that that would otherwise go to the IRS. As such, alimony payments and taxation issues do not change the recipient’s tax brackets, and the tax savings only make the alimony more substantial. However, you have the option of making alimony non-taxable and non-deductible provided the both of you come to an agreement. In this case, you will be required to provide a detailed explanation in your settlement agreement. You might do this if the recipient spouse does not want to report the income, and the paying spouse does not need the tax deduction.
Ensuring That Disbursements Are Tax-Deductible
Conversely, not all alimony meets the criteria for deductions. For those taxpayers who wish to have their alimony payments deducted for tax purposes, there are several requirements that the IRS imposes for you to qualify:
- The payments ought to be made in cash or by check. This means that you must make the payments to your spouse, former spouse, partner, or former partner through a transfer of funds, either in cash, by check, or electronically in the form of bank-to-bank transfer. For instance, if you gave your spouse a car value of in-kind alimony, you will not be allowed to claim this deduction.
- Present the paperwork and designate payments as tax-deductible. The payments must conform to the details in the divorce document, which may be divorce judgment, court order, separation agreement, or marital settlement agreement. A provisional support order awarded during the divorce process as you await the final judgment is also eligible. You should ensure that your documents clearly specify the amount that ought to be paid and define it as spousal maintenance, spousal support, or alimony. The payments should be labeled clearly on the documents as taxable to the spouse who receives and deductible by the paying spouse.
- Do not describe alimony as a share of an assets payment or child support. Unlike alimony, child support and property distribution disbursements are not tax deductible. Also, alimony payments should never be linked to child support in any way. For instance, if there is an agreement that after your child becomes an adult alimony will cease, you risk having past alimony reclassified as nondeductible child support by the IRS. Your previous alimony deductions in this case will be rejected and your taxes will be backdated. Correspondingly, if a disbursement is viewed as a share of your marital property division, it will not qualify for deductions.
- Make it clear that upon the recipient’s death, alimony payments will stop. The judgment given by the court or the marital agreement settlement should state that spousal support payments will be terminated upon the death of the receiving spouse. The document could also specify that alimony obligations will cease to exist when the payor dies. As an alimony payor, you ought to reserve the right to end alimony payments if the other spouse remarries or gets into a registered domestic partnership.
- You must not live together. For those who continue to live with their spouses even after the alimony arrangements have been arrived at, their alimony disbursements do not qualify for tax deductions. For the payments to be tax deductible, there must be a physical separation.
- You and your spouse or former spouse should not file tax returns jointly. If you do so, alimony payments cannot be deducted for tax purposes.
- Never pay alimony in advance. Ensure that you adhere to IRS rules that discourage front-loading alimony. Also, alimony should not be exceptionally high in the initial three years after separation. Excessive payments could be recaptured or be taxed to the paying spouse in the third year after separation.
If these requirements are met, the payor may use the standard IRS-provided forms to claim a deduction. The most common is the IRS Form 1040. At this point, you will be required to provide your former partner or spouse with information on the amount of alimony paid during the previous year as well as your social security number.
For Those Who Receive Support
It is wise to plan for the effect of taxation on alimony income if you are the receiving spouse. Although your employer can withhold taxes from your paycheck, that cannot happen with your former spouse on the alimony payments. If you have young children to take care of at home and do not have a job, you can lessen your tax burden at the end of the year by paying taxes each quarter to your state and the IRS. If you have another source of income or are employed, your employer could increase withholding from your salary as a way to compensate for probable effects of alimony payments.
You need an expert tax support and experienced family law attorneys such as the San Diego Family Law to navigate this turbulent waters. The tax expert will assist you to evaluate diverse payment situations and their impact on your tax regime. You could also examine your probable tax obligation at the IRS website. A tax expert can assist you to look at various support amounts and evaluate their tax impact, to arrive at an optimal value. The amount should be the one that leaves both the spouses with the highest amount of money after taxation, for the one who enjoy tax deduction as the payer and the recipient. If a third party makes payments on your behalf, those payments ought to be treated just like you received them yourself and must be incorporated as taxable income. For instance, if your previous spouse directly pays the mortgage, the amount should be recorded as an income.
For Spouses Paying Support
Property division and child support, unlike spousal or alimony support, are not tax deductible. The IRS is normally very keen during the initial three years after support commences, to ensure that you did not hide property division and various after divorce commitments such as advocate dues as deductible maintenance. Divorce agreement that provides for higher disbursements in the initial years after a divorce which is later lowered, will always attract the attention of the IRS who assume that the primary payments are as a result of property division and various non-support matters and may recapture backdated taxes. Those who agree to pay initial alimony and later request for a reduction, after the third year will often get a call from IRS demanding recapture.
It would be wise to look at different alimony payment arrangements and their tax implications by calculating what you would be deducted as tax if you received a certain amount of support, and also, what your spouse will be able to save after the deduction. You can check out the IRS website for tax tables. Alternatively, you can consult with a tax professional in order to determine the tax implications that would be brought about by different amounts of alimony. The settlement agreement should also specify that any payment made to a third-party as opposed to your spouse, will be deemed spousal support and that the payments should be viewed as those paid to your spouse for tax purposes.
Exceptional Deliberation for Mortgage Payments
Tax implications are quite different if one spouse or partner is paying the marital home’s mortgage. For example, when you pay the mortgage on account of the spouse who still resides in that home, this will be viewed as alimony. Nonetheless, there are certain factors that will inform you whether under those conditions you are eligible for tax deduction:
- If you are paying mortgage for a marital home that is in your name, and you are the exclusive owner of the property, and the other partner stays in the house, you cannot claim that this as spousal support deduction. However, you can claim the interest share of the recompense as a deduction.
- If the title remains in both the names of the receiving and paying spouse, the payor could subtract half the payments and subtract interest on the other 50% of the disbursements. For instance, if you are paying mortgage totaling US$500, you could claim deduction for US$250 of the mortgage and the interest accrued by the other US$250
- If the receiving spouse exclusively owns the residence and resides in it, but the paying partner is making the mortgage disbursements, the entire mortgage now becomes alimony and is deductible on the side of the paying partner.
Exclusion by Designation
Even in circumstances where alimony payments would be deductible and taxable, you and your spouse could avoid the tax implications. If the separation agreement or court order serving as the legal instrument specifically says that the disbursements are neither deductible nor taxable, then they will remain that way. The exemption permits the parties to opt out of the conventional tax deliberations that come with alimony payments. If the agreement states clearly that the disbursements should not be incorporated in the gross income for the purposes of taxation and ought not to be deducted, the payments will not be viewed as alimony and the tax consequences that would come into play are not there anymore.
For instance, the most popular situation of designate alimony payments is when the parties decide to have the alimony paid in a lump sum. In this case, the receiving spouse would welcome such a payment because they get the money tax-free. But there are numerous other motives why spouses and courts might be persuaded to choose an alimony that is non-deductible and non-taxable. In cases where the alimony is temporary, it does not serve any purpose to trouble yourself with all the tax implications when you could just pay up in a lump sum.
In cases where the paying partner has no way of benefiting from a deduction, making the alimony non-taxable and non-deductible would make a lot of sense. For example, if most of the income from the paying partner was not eligible for income tax considerations, this benefit would be of no significance and the recipient would still have to pay tax.
IRS has different publications designed to help spouses going through a separation or divorce to negotiate support. You will find a chapter that discusses alimony and taxation, or you can read the IRS Publication 505.
Contact San Diego Family Law Attorney
There are many financial considerations and tax implications that you must be aware of if you are contemplating a separation or divorce. It is important to understand all these issues and you can do so with the assistance of an experienced alimony attorney. At San Diego Family Law Attorney, we understand that You may not be in right frame of mind to get into the mind-boggling alimony negotiation and their tax implications. Let us assist you through this process as quickly as possible and negotiate for the best possible deal. Please do not hesitate to contact us today at 619-610-7425.