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 from the Internal Revenue Service web site at www.irs.gov
or you may call our office and discuss your situation with a tax professional. For more information contact The Henssler Financial Group Tax & Accounting Division at (770) 428-4025.
