Alimony, also called spousal support or spousal maintenance, is the payment of money by one spouse to the other during and after a divorce. Its purpose is to help the lower-earning spouse maintain a standard of living as close to the marital standard as possible.
If you follow certain rules, the IRS allows the paying spouse to deduct the alimony payments for tax reporting purposes. In turn, the recipient must report the alimony payments as income. In many cases, this results in a tax savings for both spouses—they are shifting income from a higher to a lower tax bracket by transferring alimony from the higher income spouse to the lower income spouse. The high earner saves money that would otherwise be paid to the IRS. The recipient’s tax bracket doesn’t usually change as a result of the alimony payments, and the payor is sometimes more generous because of the tax savings, so the recipient benefits too.
Example: If the higher earner has taxable income of $200,000 a year and pays the other spouse alimony of $80,000 a year, the higher earner will be taxed on $120,000, not $200,000. The recipient might pay taxes of $16,000, but the payor would have paid $50,000 on $200,000 and now pays only $24,000 on $120,000. Between the two spouses, they are paying a total of $40,000, or $10,000 less, than the higher earner would have paid before deducting the alimony payments.
Not all alimony payments qualify as deductions. The IRS imposes seven requirements upon taxpayers seeking to deduct alimony payments:
1. Dollars. Make payments in cash or by check to or for the benefit of a spouse or former spouse—in-kind alimony doesn’t qualify as deductible.
2. Documents. Make payments in accordance with a divorce document, such as a marital settlement agreement, separation agreement, court order, or divorce judgment. Payments made pursuant to a temporary order or also qualify under Section 71 of the Internal Revenue Code. Just make sure your written documents reference the money to be paid, and refer to it as alimony.
3. Designation. Include a statement in the divorce document labeling the payments as deductible by the payor and taxable to the recipient. You do have a choice, and spouses sometimes intentionally make payments nondeductible and nontaxable because of negative tax consequences.
4. Distance. The spouses must live apart in order for alimony payments to qualify for this tax treatment. Payments must be made after a physical separation.
5. Death. The marital settlement agreement or judgment must provide that payments terminate on the death of the recipient. Most payors also have the right to terminate alimony on the recipient's remarriage or upon the death of the payor.
6. Dependents. Don’t tie anything related to your alimony payments to your children. For example, if you agree that alimony will end when your child becomes an adult, you run the risk of the IRS reclassifying past alimony as nondeductible child support. Your past alimony deductions would be disallowed, and you would owe back taxes.
7. Declining. 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. Excessive payments are subject to recapture or being taxed to the payor in the third post-separation year.
