Cliff Beacham CPA | email cliffbeacham@cpa.com |
California | Tel: (949) 813-1349
Alimony
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
Call Cliff at (949) 813-1349
A Tax Attorney is a person who is good with figures
but does not have the personality to be an
Accountant