When you're negotiating with your spouse or arguing in court about the level, type, and duration of spousal support (also called "alimony" or "spousal maintenance"), tax issues should never be far from your mind. One of the most frequent questions during divorce negotiations is, "do you pay taxes on alimony?" This article explains the basic rules and significant concerns for each spouse—but you may need some assistance in making decisions about support, as discussed below.
What used to be a simple answer is now a little more complicated. Alimony may be tax-deductible, but only in certain circumstances. On December 22, 2017, President Donald Trump approved and signed into law the Tax Cuts and Jobs Act (TCJA), which made sweeping changes to the United States tax code.
One of the most significant changes affects spousal support and how the Internal Revenue Service (IRS) handles the tax implications of support. The TCJA became effective as of January 1, 2019, and divorcing couples must understand the new laws before negotiating a spousal support settlement in their divorce.
If a judge finalized your divorce on or before December 31, 2018, then spousal support must be reported as taxable income by the recipient and can be deducted by the paying spouse, unless you agree otherwise. (This is the opposite of child support, which is neither taxable nor deductible.)
In general, a higher earner will be looking for deductions, and a lower earner will not have to pay much tax on the amount of support received, so the taxable/deductible structure works fine. The significant tax savings can often offset any increase in tax for the recipient for the higher earner, who can make up the difference to the recipient either with an additional payment or in another way. For example, the paying spouse might agree to pay the recipient spouse's tax liability.
You can, however, make spousal support payments nontaxable and nondeductible as long as it goes both ways, and you both agree (you'll state as much in your marital settlement agreement). You might do this if the spouse receiving support is in a higher tax bracket than the paying spouse (this would be unusual, but might happen if the recipient spouse is receiving reimbursement support and has significant assets), or if the paying spouse doesn't need the tax deduction and the recipient spouse doesn't want to report the income.
If you do decide to make spousal support nontaxable and nondeductible, the recipient spouse should simply not report the income on that year's tax return.
If you receive spousal support, you must report the payments as income and pay taxes on the money. Spouses need to plan for the potential tax impact of the income. Unlike an employer, your former spouse won't withhold any taxes from your support check. If you're staying at home to care for young children and have no other source of income, paying estimated tax each quarter (to both the IRS and your state) may be a good way to avoid taking a tax hit at the end of the year. If you have a paying job, then increasing withholding from your paycheck is another way to offset the potential impact of support payments.
You may need to spend some time looking at different payment scenarios and how they play out tax-wise by calculating what your tax liability would be if you received a certain amount of support and what benefit your spouse would receive from the tax deduction. You can check your potential tax liability on the IRS website at www.irs.gov, where tax tables are available. Or you can ask a tax professional to help you look at the tax impact of different amounts of support so that you can figure out the optimal amount—that is, the amount that puts the most money in each person's pocket after taxes.
The IRS offers many publications that may help you as you negotiate support. There's a chapter specifically on alimony, and IRS Publication 505, Tax Withholding and Estimated Taxes, is one, and IRS Publication 504, Divorced or Separated Individuals, is another. Both are available at www.irs.gov or by phone request at 800-829-3676.
The IRS treats payments made to third parties on your behalf as though you received them—you have to include them in your taxable income. So, for example, if your former spouse pays the mortgage directly (and this is provided for in your marital settlement agreement or court order), you must report that amount as income.
You can deduct spousal support payments on your income tax return, but not child support or property distributions. The IRS scrutinizes support paid in the first three years to make sure that you didn't disguise property distribution or other post-divorce obligations, like attorneys' fees, as deductible support. If the divorce agreement calls for higher payments in the first post-divorce years and lower payments later, and the IRS believes the early payments are in lieu of property division or other nonsupport items, it can go back and "recapture" retroactive taxes. If your agreement calls for a reduction of $15,000 or more in spousal support during year two or year three after your divorce, you may find Uncle Sam knocking at your door to discuss recapture.
When you negotiate your spousal support agreement, it's important to make sure that you don't tie the termination of spousal support to anything related to your kids—for example, the time they leave home or when they finish college. If you do, the IRS might consider the payments child support rather than spousal support—and child support payments aren't tax-deductible.
If you're making payments to a third party instead of to your spouse, but you've agreed (in your settlement agreement) that the payments constitute spousal support, for tax purposes, the IRS treats those payments as if you sent them directly to the recipient. In other words, you can deduct them (at least in part) as support payments. Certain payments are not fully deductible, though, including payments related to a jointly owned home. If you and your spouse continue to own the home together and you pay all the expenses, you are allowed to deduct only half of the mortgage payment as spousal support. But you can take half of the mortgage interest deduction as well.
If you (or the judge) finalized your divorce after December 31, 2018, the Tax Cuts and Jobs Act permanently eliminated the deduction benefit and reporting requirements of spousal support. In other words, the IRS is treating spousal support payments the same as child support—no deduction or credit for the paying spouse and no reporting requirement for the recipient.
The new tax changes will likely cause adversity in divorces that may have otherwise settled. Paying spouses may feel as though the IRS is punishing them and rewarding the recipient with a financial windfall. However, if couples consider the ramifications of the tax law changes before negotiating, both spouses can walk away with a fair settlement.
For example, a paying spouse who earns $50,000 fits into the 24% tax bracket of the IRS. If spousal support costs $10,000 per year, under the old tax law, the paying spouse will fall into a lower tax bracket (22%) after deductions. Additionally, the recipient who earns $25,000 per year would report the income and pay taxes in a higher tax bracket than without the support. Without the tax-deduction and reporting requirements, the paying spouse remains in the higher tax bracket, thus paying more tax overall, and the recipient stays in the lower bracket, paying less. Spouses can split the difference between the new tax changes, and a paying spouse can argue that paying less spousal support is fair to both spouses.
There are a lot of tax issues and financial considerations to be aware of during a divorce. Make sure you take the time to understand these issues. Please see the Divorce & Taxes section of our website and/or contact a local family law attorney for advice