Alimony, also referred to in some states as “maintenance”, is a payment to or for a spouse or former spouse under a divorce or separation instrument. Generally, court-ordered alimony is tax deductible to you and taxable to your recipient spouse or former spouse. If you are the person paying alimony, careful consideration of the tax benefits of alimony payments can assist you in calculating the most equitable outcome in a divorce case.
Most of my clients despise the thought of paying alimony. The thought of a continuing monthly obligation to a soon to be ex-spouse is deflating. It is common for a client to want to make a “clean break” at the time of divorce and obtain a waiver of alimony from his/her spouse in exchange for a lump sum cash payment or property offset. Some of my clients request that alimony payments be described as additional child support in the language of the agreement because the thought of paying his/her former spouse “alimony” is just too aggravating. While I understand there may be some emotional benefit to these results, there are no tax benefits.
Only certain kinds of payments under a divorce or separation instrument are considered to be tax deductible as alimony by the IRS and you should keep the definitions and guidelines in mind as you structure the terms of your final settlement. Cash transfers arising out of the division of property and debt in your divorce proceeding are generally going to be considered non-taxable transfers. Therefore, agreeing to a lopsided distribution of the assets and debts in your spouse’s favor so as to avoid paying alimony over a period of time does not provide you with a tax benefit. Making one large cash payment to your spouse in exchange for a waiver alimony will not provide you with a tax benefit related to alimony either. Even if you agree to make a few large cash payments to your former spouse instead of one lump sum amount so that it “looks” more like alimony to the IRS, the payments will not qualify as alimony so long as you are still required by the terms of your agreement or court order to make those payments after the death of your spouse.
In other words, unless there is a provision your payments to your former spouse will terminate your former spouse’s death, the payments will not qualify as alimony but as a non-taxable transfer of property arising out of a divorce. Also keep in mind that alimony does not include child support or any support that is related to your child. If it is your goal to eradicate alimony by agreeing to a higher child support amount until some contingency occurs related to your child (such as his/her graduation from high school), then the payments will be treated as child support payments you will receive no tax benefits from such payments. Your spouse, of course, will want as much as possible now as opposed to later. A large payment now will not be taxed to him/her as alimony. The money will be accumulating interest as time passes. And perhaps most important to him/her, a lump sum alimony payment has no strings attached; your former spouse will be free to marry as soon as your divorce decree becomes final without worrying about losing any stream of income.
If you are bound and determined to negotiate some sort of lump sum payment or offset to avoid alimony, you should at the very least discount the amount of the payment or offset by these variables. You should also keep in mind that there may be some obligations you have assumed either in the context of temporary orders or arising from a divorce decree that do not look like traditional alimony but are tax deductible nevertheless. For example, if a temporary order or your divorce decree requires that you must pay your former spouse’s tuition, medical and/or dental expenses, you may be able to deduct those payments as payments to a third party in lieu of alimony.
Alimony may also include life insurance premiums you have been court-ordered to pay for policies owned by your spouse. If a temporary order or your divorce decree requires that you pay the mortgage on a home owned solely by your spouse you may be able to deduct all of those payments as alimony. (Keep in mind, however, that if the house is owned jointly by you and your spouse, you are probably only eligible to claim half the mortgage payments as alimony.) The language of your court order relative to alimony is very important from a tax perspective. Your prospective payments to your spouse need to meet the requirements of alimony under IRS definitions for you to be able to deduct them. Do not expect your spouse to do you any favors in this regard; any payments tax deductible to you as alimony will necessarily be considered taxable income to him/her. Internal Revenue Service Publication 504, “Divorced or Separated Individuals” provides examples and commentary about the taxability and deductibility of alimony and is an excellent source for information.
While this article attempts to touch upon common tax considerations to make during alimony negotiations, it is by no means exhaustive. Please keep in mind that advice from your divorce attorney can not replace the advice given to you by your tax accountant. While your divorce attorney should help you remain mindful of the tax ramifications of all of your divorce related transactions, you should always seek the individual advice of an accounting professional.
Jill Rauk Daugherty is the Managing Attorney in the Overland Park, Kansas office of Cordell & Cordell, PC.