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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