Taxes on Alimony: Who Pays Them?

Your divorce is final and you are now receiving alimony from, or paying alimony to, your ex-spouse. But wait — what about the taxes? What will you owe the next time you file your tax return? The short answer under federal tax law is: if you are receiving “qualifying” alimony payments, you must declare the payments as income and pay taxes on the amount received. If you are making the alimony payments, you are able to deduct the amount you have paid in “qualifying” alimony payments on your tax return. But, the short answer is not the end with alimony. Strategic thinking in structuring your alimony award during divorce negotiations, and even after your divorce is final, is highly important for tax considerations

The Basics of Alimony Payments

Alimony refers to post-divorce payments made from one ex-spouse to the other.[1] The amount of alimony payments, how long alimony will last and other details may be negotiated and agreed upon by the ex-spouses in divorce mediation. Alternatively, the existence, amount and duration of these payments may be determined by the court in divorce litigation. Alimony in Pennsylvania is not automatically awarded. When the court decides the alimony question, it is required to consider and analyze 17 specific, statutory factors under Pennsylvania law. Pennsylvania courts will generally award alimony where the division of marital property between the ex-spouses does not result in economic fairness, such as where a dependent spouse is left financially unable to support him or herself through appropriate employment. Once alimony is awarded and being paid, the ex-spouses must understand how to deal with those payments when filing state and federal tax returns.

What Makes Alimony “Qualifying” for Federal Tax Treatment?

Divorcing spouses have the option of either having alimony payments between them qualify for the taxation and deduction treatment described above, or of opting out and specifying that payments will not be considered alimony for federal tax purposes. Assuming you and your ex-spouse wish to have alimony payments treated as a taxable event, certain requirements in the Internal Revenue Code must be met:

• Payments must be made in cash, check, or money order;
• Payments must be made/received under a divorce or separation document (including a final decree, a temporary court order, or a written separation agreement between the ex-spouses);
• The ex-spouses have not opted out of alimony treatment by indicating in the divorce decree that the payments are not to be considered alimony for federal income tax purposes;
• The ex-spouses have received a final decree of divorce or decree of separate maintenance;
• The ex-spouses are not living in the same household when the payment is made;
• The payor is not obligated to make payments after the payee dies;
• The ex-spouses do not file a joint tax return with each other for the year in question; and,
• Any portion of the payment that the IRS considers to be child support or property settlement may not be treated as alimony for tax purposes.

If you meet these requirements, your alimony payments will be subject to taxation for the receiving spouse and deduction for paying spouse.

In the alternative, you and your ex-spouse may opt out of the tax treatment for alimony. The tax structure decision may be negotiated during divorce proceedings, or you and your ex-spouse may elect to change the tax treatment of your alimony after the divorce is final. If you opt out of tax treatment, you must both acknowledge this agreement in the divorce decree or in a subsequent acceptable writing. When you opt out in this manner, your alimony payments are a tax-neutral event.

Is It Possible to Reduce the Tax Burden on the Spouse Receiving Alimony?

As the person receiving the alimony, your tax burden may be lessened by having the amount of the alimony payment reduced. An ex-spouse may ask the court to consider reducing the amount of the payment in the event of a change in the financial circumstances of either or both of you. In addition, the tax burden may be removed entirely in the event the payee begins cohabitating with a romantic partner, remarries or when either ex-spouse dies. Alimony payments generally terminate under these circumstances.

The Federal Tax Recapture Rule: A Tax-Trap Worthy of Note

Not surprisingly, the IRS has taken steps to make sure ex-spouses follow certain rules in characterizing alimony correctly for tax purposes. The subtle distinction here is between strategic tax planning and blatant efforts to fly under the tax radar. Child support payments and (generally) property settlement payments do not have any tax implications under federal law. The IRS is wise to ex-spouses who attempt to disguise property settlement or child support payments as alimony on their federal tax return, so that they qualify for a tax deduction where there otherwise would be none.

There are reasons that child support does not have tax implications, including the fact that the custodial parent already claims a child as a tax deduction. Had the couple stayed married, they would not be able to deduct the normal expenses associated with the care of their child (clothing, food, etc.) and a divorce does not change that.

For example, if you are the spouse paying alimony and make higher alimony payments in the first three “post-separation” years (“front-loading” alimony), then drop the payment amount down, the IRS may audit you and squelch your efforts using what is known as the “recapture rule.” The recapture rule permits the IRS to tax you, the paying ex-spouse, and allow the spouse receiving the alimony payments to take a tax deduction in the third “post-separation” year.[2] Front-loading alimony payments may raise a red flag for the IRS that the payor may be lumping property settlement payments (which are not deductible) into the alimony he or she is paying in order to increase the amount of the deduction. There are exceptions to the recapture rule provided in the Internal Revenue Code that do allow for front-loaded alimony payments in specific circumstances

One way to avoid any appearance of front-loading is to gradually increase alimony payments over time. This approach may make sense in certain family circumstances. However, another red-flag-raising pitfall may exist here if the increase in alimony amounts appears to be related to a change in your child support obligation (i.e., supported children from the marriage reach the age when they are no longer eligible to receive support), and suddenly you show a significant increase alimony on your tax return. If the two events appear related, the IRS may audit and find that the payor spouse, again to achieve a deduction, has merely lumped former child support payments into alimony payments

State Considerations

Not all states treat alimony the same as the IRS for state income tax purposes. For example, under Pennsylvania law, alimony payments are non-taxable income to the ex-spouse who receives the payments. For state income tax treatment of alimony payments, seek the advice of a tax expert and family law attorney in your state.

It is important both during and after divorce proceedings to think strategically and creatively about how your alimony payments are structured and the best tax treatment to meet your financial situation.