When it comes to alimony and taxes, the IRS shows no mercy. You need to know what they are looking for to avoid costly mistakes with your annual filing.
A 2014 report from the Treasury Inspector General for Taxpayer Administration (TIGTA) identified a $2.3 billion gap between the amount of alimony deductions claimed by taxpayers on returns and the corresponding income reported.
The IRS has made closing the alimony tax gap a priority in recent years. Many taxpayers have been audited or have gone to court over alimony deductions that were disallowed by the IRS.
What Is (and Isn’t) Alimony
It sounds straightforward, doesn’t it? But much of the alimony tax gap is due to confusion over what exactly the IRS considers alimony.
Alimony payments are deductible by the payor and taxable income for the recipient, but the definition of alimony for federal tax purposes is governed by the Internal Revenue Code, not by divorce decrees or court orders.
In order to be considered alimony for federal tax purposes, there are several requirements that must be met:
- You cannot file a joint return with your former spouse and cannot be members of the same household when you make the payment or payments
- Payments must be in cash (including checks and money orders)
- The payment is received by (or on behalf of) your spouse or former spouse
- Your divorce decree or separate maintenance agreement does not say the payment is not alimony
- You have no obligation to make payments (in cash or property) after the death of your former spouse
- Your payment is not treated as child support or as a property settlement
Payments for child support, property settlements, payments of community property income, and voluntary payments that are not required by the divorce agreement are never considered alimony and not deductible.
There are a few areas pertaining to alimony and taxes where taxpayers tend to get tripped up.
Unallocated Alimony/Child Support Payments
In a 2015 Tax Court Case, a doctor lost his alimony deduction because the divorce agreement did not allocate the amount the doctor was required to pay to his ex-wife between child support and alimony.
The divorce agreement provided that Dr. Donald Girard would “continue to tender unallocated alimony/child support in the monthly sum of $5,232 for a continued eight-year period with the provision as long as the former Mrs. Girard should not remarry or cohabitate.” The agreement was silent as to whether the payments would continue if either party died before the eight years elapsed.
Dr. Girard deducted the payments on his own return, but his ex-wife did not report the payments as income. When the IRS sent her a notice of deficiency, she fought their assessment and the Tax Court found in her favor since the agreement did not allocate what portion of the payments went to child support and what went to alimony. And they did not specify that the payments would cease at death.
Property Transfer Ruling on Alimony and Taxes
In 2015, the Tax Court ruled on a case where one former spouse tried to pay alimony with real estate.
In 2010, Christina Mehriarty and Bradley Williams agreed to a divorce settlement that called for Mehriarty to pay alimony to Williams of $4,000 per month for 60 months. Nearly a year after their divorce was finalized, Mehriarty offered to sign a quitclaim deed to transfer a piece of property to Williams in lieu of the $80,000 left in alimony. Williams agreed.
Mehriarty tried to claim an investment loss of $80,000 on her 2011 income tax return. When that deduction was challenged by the IRS, Mehriarty attempted to argue that the property transfer was a deductible alimony payment.
One of the first requirements for alimony in the tax code is that payments be made in cash or a cash equivalent. The tax court ruled that the property transfer was not alimony.
Paying Less Than The Total Required
If your divorce agreement calls for both alimony and child support and you pay less than the total required, your payments will be applied first to child support.
Any remaining amount will be considered alimony.
Joseph Becker and his wife Jennifer divorced in 2011. Becker was ordered to pay temporary child support of $801 per month and temporary alimony of $815 per month for the 10 months prior to their divorce. He was also ordered to pay child support of $540 per month and alimony of $500 per month, along with paying for his children’s health insurance, after the divorce was granted.
In 2011, Becker owed $8,205 for alimony and $8,307 for child support, for a combined total of $16,612. That year, he made payments totaling $9,688.
When Becker filed his 2011 tax return, he claimed an alimony deduction of $12,036, which the IRS disallowed.
Although Becker tried to argue that he allocated his 2011 payments between child support and alimony, the Internal Revenue Code is clear.
When it comes to alimony and taxes, the IRS rules that payments that total less than the amounts specified in the divorce instrument will be allocated first to child support. Amounts will only be allocated to alimony once child support has been paid in full.
Third Party Payments
There is some good news when it comes to your taxes and alimony.
Payments made to a third party on behalf of your ex for housing costs, medical expenses, taxes, tuition, etc. may qualify as alimony.
Whether housing costs can be considered alimony depends on the ownership of the home.
- If the home is owned by your ex but you pay the mortgage, real estate taxes, insurance premiums and other costs, you can deduct the payments as alimony. Your ex-spouse will have to claim those amounts as income and will be entitled to a tax deduction for the mortgage interest and real estate taxes, even though you actually paid those expenses.
- If you own the home and pay the mortgage, real estate taxes, and other expenses while your ex-spouse lives in the home, you cannot deduct the payments as alimony and your ex-spouse doesn’t have to report the payments as income, even if she lives there rent free.
- If the home is owned jointly as tenants in common, you can deduct half of the mortgage payments, real estate taxes, and property insurance you pay as alimony and your ex-spouse must report that amount as income.
You and your former spouse can deduct half of the real estate taxes and mortgage interest paid as itemized deductions. However, if you own the home jointly as tenants by entirety or joint tenants, none of your payments for taxes or insurance are alimony. You can claim all of the real estate taxes as an itemized deduction.
Exes often get in trouble by verbally agreeing that one spouse will pay expenses on the other’s behalf in lieu of alimony payments. For instance, you might offer to pay a medical bill for your ex and reduce your alimony for the month by the same amount.
While this is legally acceptable, those payments are easily forgotten at year end.
If you want to make that type of arrangement, it’s a good idea to get the agreement in writing so both spouses agree to recognize the payment as alimony for tax purposes at year-end.
The Last Word
With all of the intricacies of alimony and federal tax laws, it’s a good idea to get your tax preparer to weigh in during divorce agreement negotiations.
Your attorney may not be familiar with the tax implications of the specific wording in the divorce agreement. Remember that the way alimony is treated for federal tax purposes is ruled by the Internal Revenue Code, not your divorce agreement.
Getting professional tax advice early will save time and money in the long run.
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- Time for the exceedingly exciting, significantly sexy topic of taxes and divorce tax planning. Brings to mind the classic episode of The Simpsons that begins with our favorite neighbor rushing to file on January 1, to Homer rushing his bundle past the shutting doors at the close of the post…