Divorce - Structuring Deductible Alimony
You have informed us that you are contemplating a divorce and expect
that you'll have to make alimony payments to your spouse. Therefore, we
want to explain how the payments must be structured so that you can
deduct them and have them taxed to your spouse.
A number of requirements must be met before divorce-related payments
between spouses can be deducted by the paying party as alimony. Even if
these requirements are met you may have to overcome other hurdles that
are designed to prevent alimony deductions for what are more in the
nature of property settlements. First we cover the basics. Then we
explain a special rule that allows spouses to flip flop the normal
treatment and when and how this may benefit you. Finally, we 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 with each other.
The payments are not child support.
Assuming you structure your payments to meet these basic requirements,
you will be able to deduct your payments and your spouse will be taxed.
But you have the flexibility, if you both agree, 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 don't 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 say a 40 percent combined federal and state rate, agreeing to
nonalimony 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, as we mentioned 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 complicated formula is applied to determine whether a
proposed payment plan would involve excess payments.
We would be happy to explore one or more of the various alimony tax
rules or other divorce-related tax rules in greater detail with you.
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