By Chrissie A. Powers, CPA/CFF, CFE, CVA
Alimony can be a significant aspect of a divorce. Clients and legal counsel need to understand how alimony can impact the tax return. A temporary written agreement is important when determining the tax implications of alimony. Qualifying alimony payments are deductible by the payer and included in the spouse's or former spouse's income. However, just because a payment is labeled "alimony" in a separation or divorce agreement doesn't make it alimony for tax purposes.1
In order for a payment to qualify as alimony by the IRS, all of the following requirements must be met:
Cash payments to a third party under the divorce or separation instrument are considered alimony if they otherwise qualify. Some common instances where these payments could occur are: rent, mortgage payments, medical and dental costs, utility bills, education and income taxes. The payments are treated as though received by the spouse and then paid to the third party.
Payments that are not deductible as alimony include: noncash property settlements, child support, payments for use of the property, and payments to keep up the payer's property. If the separation instrument doesn't require the alimony payment, then the payment would be a voluntary payment and may be considered a gift by the IRS.
Yet another option, the spouses may characterize otherwise deductible alimony payments as nondeductible by the payer spouse and nontaxable to the payee spouse by including a provision in their divorce or separation instrument. This is often done when the alimony paying spouse doesn't need the deduction. A reduction in payments should be negotiated, since it would greatly increase the payee spouse's after-tax income by excluding the payments from income.
More information can be found in IRS Publication 504. If you have any questions regarding the taxability or deductibility of alimony; please feel free to give me a call to discuss the situation in more detail.