Alimony

Alimony (also called spousal support or spousal maintenance) is the

payment of money by one spouse to the other after separation or a

divorce. Its purpose is to help the lower-earning spouse maintain the

same standard of living after a divorce

The IRS allows the paying spouse to deduct the alimony payments for tax reporting purposes provided they follow certain rules In turn, the recipient must report the alimony payments as income In most cases, this results in an overall tax savings — they are shifting income from a higher to a lower tax bracket by transferring alimony from the higher-earning spouse to the lower-earning one The high earner (Payor) saves money that would otherwise be paid to the IRS. The recipient’s (Payee) tax bracket may not change as a result of the alimony payments. In theory, the payor may be more generous because of the tax savings Most people want to make alimony tax deductible because it may save tax overall and the payor saves tax on the payments. However you do have a choice - for some couples the tax consequences are more favorable if they make payments nondeductible and nontaxable because of the tax consequences. This is an emotionally charged situation and it is not unknown that a couple who used to love each other now want nothing to do with each other - not even through their tax accountants Caveat - Tax Traps:  Not all alimony payments qualify as deductions - The IRS imposes 7 requirements on taxpayers seeking to deduct alimony payments: 1. Make payments in cash or by check You must pay alimony by cash or check for the benefit of a spouse or former spouse. The value of in-kind alimony—for example, giving your spouse your car—isn’t deductible 2. Follow the documents and designate payments as tax- deductible Make payments in accordance with a divorce document, such as a marital settlement agreement, separation agreement, court order, or divorce judgment. Payments made under to a temporary support order also qualify. (IRC Section 71). Make sure your documents state the amount to be paid and describe it as alimony, spousal support, or spousal maintenance. The documents should also clearly label the payments as deductible by the payor spouse and taxable to the recipient spouse 3. Don’t confuse payments with child support - or a part of a property settlement  Child support payments, unlike alimony, are never tax deductible. So be sure that alimony payments are not tied in any way to support of your children. EG: if you agree that alimony will end when your child becomes an adult, you run the risk that the IRS will reclassify past alimony as nondeductible child support. Your past alimony deductions would be disallowed, and you would owe back taxes. Similarly, if a payment is seen as part of your division of marital property, it’s not tax deductible 4. Specify that payments end at the recipient’s death  The marital settlement agreement or judgment must provide that alimony payments terminate when the recipient dies. (The document can also provide that the alimony obligation ends when the payor dies). Most payors also have the right to terminate alimony if the recipient remarries 5. Live apart  If you are still living with your spouse or former spouse, alimony payments are not tax deductible. Payments must be made after a physical separation 6. Don’t file a joint tax return (MFJ)  If you and your spouse file a joint income tax return (MFJ), you can’t deduct alimony payments 7. Don’t pay extra up front Make sure to follow IRS rules against front-loading—the advance payment of alimony that’s due later. Alimony should not be excessively high or front-loaded in the first three post-separation years Beware the Alimony Front-end loading Trap Front loading refers to paying a large amount of alimony in the first few years of your support obligation, maybe while you feel like you have the money and/or when your children are minors and you want to pay family support. The problem with front loading is if you reduce the payment substantially in the second year, you trigger recapture. If you do not, but then in the third year the payment is as little as $15,000 less than the second, you also trigger recapture. Instead, consider extending the front loaded payments over more than three years or transferring an asset or assuming a debt in lieu of front loading the payments altogether Consequences - a tax audit As if paying alimony  weren’t enough already, imagine receiving an unfriendly letter from the IRS forcing you into an audit and assessing tax for 3 years of returns during which you previously deducted the alimony Because inspection of the divorce agreement has to be done to resolve the issue an IRS audit is usually triggered as the means of doing this. You may want to avoid that by avoiding the Front-end loading trap to begin with.  About 100% of taxpayers would choose not to have an audit - even if it was on their ex-spouse The rule applies when alimony payments decrease or terminate during the first 3 calendars years post-divorce - if  the payments decrease by $15,000 or more from the payments made in the previous year The recapture rule forces the alimony payer (almost always the ex- husband) to report as income the excess alimony payments he previously deducted, which means the ex-wife is entitled to reduce from income the same amount of excess alimony payments she previously received So my message to you is clear – if you think I may be able to resolve a problem you should call me at (949) 813-1349 or email me at cliffbeacham @ cpa . com