Talking about alimony and child support numbers is almost meaningless without looking at the tax effect on both the spouse paying and receiving the money.
One of the biggest concerns when considering a divorce is either how am I going to pay the bills or how much do I have to give my spouse; depending on whether you make the money in the relationship or not.
This is especially true when you have been married a long time. The Courts consider “a long time” to be longer than seventeen (17) years.
The question of spousal maintenance is one that causes most cases to go to trial because doling out future incomes is the hardest topic to deal with, besides custody rights, in family law, most particularly in divorce decree.
You and your spouse have gotten used to using one “pie,” and then when you are divorced that one pie now has to cover two households when previously it only covered one.
When the issue of alimony is being considered, one of the neglected side issues what the tax implication is going to be.
The reason this is such a huge deal is because if you agree on a number you need to understand that is NOT what you will be getting in reality. This is because everyone has to pay “Uncle Sam.”
Alimony and Taxes for the Receiving Spouse
The most important thing you need to understand is that when you are receiving money it is not “free money” but rather spouse income you are receiving throughout the year. Instead of an employer paying you, your former spouse is paying you monthly.
However, unlike an employer, your former spouse is not doing tax deduction from your “alimony income” every month.
What does this mean? This means that at the end of the year, when it comes time to file for your taxes, you have to declare all of the alimony you received as taxable income. Then you have to pay taxes on it.
How much you pay is going to depend on what tax bracket you are in.
Thus, a three thousand dollar ($3,000) a month alimony payment may seem like it will cover all the bills; however, when you factor in the taxes you will have to pay at the end of the year your new monthly payment may only be twenty three hundred dollars ($2300).
What is the solution? When determining the alimony award make sure you take into account what the tax consequences are going to be.
Also, put aside a little each month to save up for the lump sum in taxes you will have to pay at the end of the year.
Alimony and Taxes for the Paying Spouse
While you may not be able to deal with having to pay your spouse a monthly alimony award there is a slight upside to having to pay alimony.
The upside is that alimony payments are entitled to be deducted from your adjusted gross income.
This lowers the taxes that you are required to pay; mainly because the government does not consider the money you had to pay as alimony as a part of your income.
Is the Receiving Spouse Always Responsible for the Taxes?
IF both of the spouses agree, specific language can be included in a separation agreement which requires the paying spouse to pay the taxes on the alimony, and alleviates the receiving spouse from having to pay the taxes his or herself.
If you choose to do this the receiving spouse would simply not report the alimony payments on his or her taxes as income.
This might be done if the paying spouse doesn’t need the deduction, or as a bargaining tool to be able to pay a little bit less in alimony.
Seven Requirements to Count Alimony as Tax Deductible
Alimony payments may not always be considered Tax Deductible. The Internal Revenue Service (IRS) imposes seven requirements for alimony to be considered tax deductible:
- Payments made by cash or check: When you give property instead of an actual payment it is not considered tax deductible. For instance, if you gave your spouse a boat instead of a four thousand dollar ($4,000) payment you wouldn’t be able to deduct it from your taxes.
- Have supporting documents: Make sure you have an agreement or divorce decree specifying the amount to be paid, and having it described as alimony.
- Payments not characterized as child support or property distribution: Make sure you don’t increase your child support payment to include alimony because child support payments ARE NOT tax deductible. Likewise, don’t mix in alimony with an equalizer payment.
- Specify payments end at the receiving spouse’s death.
- Cannot be living together.
- Cannot file a joint tax return.
Cannot pay extra in the beginning: The IRS does not like advance payment of alimony which is due later. The IRS closely scrutinizes tax return payments of divorced couples for the first three years after separation. Excessive payments up front are subject to “recapture” which means the IRS can tax the paying spouse in the third year after separation. In other words if the amount of alimony paid in the first year of separation is significantly greater than the amount paid in the second or third year than the IRS will tax the excessive amount in the third year