How Divorce Can Affect Your Taxes

Individuals who were recently divorced may receive or pay alimony. If this situation applies to you, here is some advice on how to correctly treat the payments on your tax return.

The first thing that you will need to consider is the definition of alimony. There are actually two different definitions of alimony; one for the payments that are made as a part of a divorce decree or separation agreement made before 1985 and another for agreements that have been made after that time. For the purposes of this article, we will only cover the rules regarding the post-1984 decrees and agreements.

For post-1984 decrees and agreements, alimony has the following requirements:

  • The payments must be made in cash to a spouse, ex-spouse or third-party on behalf of the spouse or ex-spouse, and the payments have to be made after the divorce decree has been finalized. If the payments are made under a separation agreement, then the payments must be made after that agreement has been executed.
  • The payments must be required by a decree or instrument incident to divorce, a written separation agreement, or a support decree.
  • The payments can not be designated as child support payments. Child support payments are not considered as income for the recipient nor a deduction for the payer.
  • Payments that are made while spouses or ex-spouses share the same household are not qualified as alimony. This can be true even if the spouses live separately within a dwelling unit.
  • The payments must stop once the payee has died.
  • The payments cannot be contingent on the status of the child in order to prevent child support from being disguised as alimony that can be deducted.

If the payments that you make to or receive from a spouse or ex-spouse meet the definition of alimony, these payments are considered taxable for the recipient and deductible for the payer. There is a single exception to this rule, however: A divorce decree or separation agreement may designate that alimony payments are neither deductible nor taxable. If this situation applies to you, then the payments may not be reported on either party's return.

Here are some additional concerns that should be noted.

  • The IRS requires that taxpayers who deduct alimony include the payee's Social Security Number (SSN) on his or her tax return. As a result, the recipient must give his or her SSN to the payer.
  • The IRS has determined that a certain portion of taxpayers are incorrectly reporting their alimony by understating the income or overstating the amount paid. Thus, the IRS computer makes a comparison between the amounts listed on the payer's and the recipient's tax returns, and it will initiate a correspondence audit where a discrepancy has been found.
  • The recipient of alimony payments may opt to treat alimony payments as compensation although the payments are the only income for that person. This permits alimony recipients to save for retirement by making contributions to either a Roth or Traditional IRA, the rules for which require that the contributor earns income or compensation. Alimony income can satisfy this requirement.
  • If a divorce decree or other written instrument or agreement requires both child support and alimony, and the person making the payments has paid an amount that is lower than the total that is required, the payments must first be applied to child support. Any amount that is left over is considered to be alimony. 
  • There is no income tax withholding from alimony payments, so that recipient may need to opt to make estimated tax payments.

Other concerns that can create issues have not been addressed here. If you have a complex alimony concern or you wish to discuss alimony in regard to how it affects your situation, please contact us.

For help in understanding your individual tax return and the options available to you, contact Tera D. Kovanes today at (804) 446-6685 to set up an appointment.