A number of requirements must be met before divorce-related payments between spouses can be deducted by the paying party as alimony. First, let’s cover the basics. Next, we will explain a special rule that allows spouses to flip-flop the normal treatment and when and how this may benefit you. Finally, we will look at the property settlement hurdles.
Payments qualify as alimony only if:
- The payments are in cash.
- They are received by or on behalf of a spouse under a divorce or separation instrument.
- If the spouses are legally separated under a decree of divorce or separate maintenance, they are not members of the same household.
- There is no liability to make payments (or substitute payments) after the recipient’s death.
- The parties do not file a joint return.
- The payments are not child support.
Payments that are not alimony:
- Child support.
- Noncash property settlements.
- Payments that are your spouse’s part of community income.
- Payments to keep up the payer’s property.
- Use of property.
Assuming you structure your payments to meet these basic requirements, you will be able to deduct your payments and your spouse will be taxed.
If you both agree, you may have the flexibility to have future payments not treated as alimony or, in other words, to be tax-free to your spouse and nondeductible by you. This will save taxes for your spouse. You may agree to do this if you do not need the deduction and your spouse agrees to “share” some of the savings with you.
For example, suppose you have tax losses from other sources and you intend to pay $1,000 a month in alimony. If those payments would be taxed at a 40% combined federal and state rate, agreeing to non-alimony treatment could result in a $9,600 tax savings over two years for your spouse that could be shared by allowing you to make lower payments.
Finally, there are rules preventing deductions for disguised property settlements. These so-called frontloading rules provide for the recapture of excess amounts that have been treated as alimony. This means the paying spouse is taxed on previously deducted amounts. A formula is applied to determine whether a proposed payment plan would involve excess payments. See your tax adviser for guidelines concerning the recapture of alimony.
For more general information about divorced or separated individuals, you can print a copy of Publication 504, Divorced or Separated Individuals, from the Internal Revenue Service website at www.irs.gov or you may call our office and discuss your situation with a tax professional. For more information regarding this topic, please contact Henssler Financial at 770-429-9166 or experts@henssler.com.
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