Alimony payments generally are tax deductible to you as the payor and taxable to your ex, the recipient. Child support payments are not tax deductible. Two issues arise concerning the amount and timing of alimony or separate maintenance payments when a marriage dissolves: the amount and the timing of payments. With some careful and attentive planning of alimony, child support, and property payments, divorcing couples may be able to minimize the tax impacts of the divorce and maximize the cash available towards future living expenses.
The following requirements need to be met for deductible alimony treatment:
- All payments must be made in cash or its equivalent. This includes checks, money orders, or payments to a third party on behalf of your ex. Payments must be defined in the agreement or requested in writing by your ex.
- Your agreement should have no conditions that state that you and your ex are opting out of alimony treatment for income tax purposes.
- You and your ex must not reside in the same household after the settlement.
- Alimony must terminate on the death of your ex.
A great deal of time is spent to negotiate the various settlement amounts, but very little consideration is given to the timing of payments and this may also have tax consequences. The Tax Reform Acts of 1984 and 1986 enacted rules designed to prevent excess front-loading of property settlements into alimony payments. The first of the rules applies only to the first three tax years following the divorce. This is what is commonly called the three year look back rule. The computation is fairly complex, but an easy rule of thumb is not to have alimony reduce by more than $15,000 per year for the first three tax years. If you fail that test and do not meet certain allowable exceptions, a portion of your alimony payments will be viewed as non-deductible.
Care must be taken to avoid tying any alimony reduction conditions to situations relating to a child attaining a specified age or income level, dying, marrying, leaving school, leaving your ex’s household, or gaining employment. Other stipulations to avoid are situations where there is only one unemancipated child and the agreement provides for a reduction to occur within six months of the child attaining the age of 18, 21, or the local age of majority. The rules are even more complex if you have two or more reductions involving two or more unemancipated children. Carelessness in the drafting of these provisions can result in alimony deductions being disallowed from the inception of the agreement through to the time of the reduction.
While there are some obstacles to overcome, proper planning and the guidance of professionals can help you attain substantial tax benefits with the cooperation of your ex when structuring the settlement.
Material discussed in this article is meant to provide general information and should not be acted on without professional advice tailored to your individual or business’s needs. The information in this article is for general guidance only and is not a substitute for professional advice. IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.
Henry Guberman is the partner in charge of the matrimonial accounting department of ParenteBeard LLC. He is a diplomate with the American Board of Forensic Accountants, a Certified Fraud Examiner, and Accredited in Business Valuation. He has been a CPA for more than 23 years and has extensive experience in providing expert consulting and testimony services to assist counsel and their clients in marital disputes.