In divorce, the parties divide the marital property and enter into child and/or alimony agreements. Property divisions among spouses pursuant to a divorce are not deductible to the transferring spouse and are tax-free to the receiving spouse. Likewise, child support payments are not deductible to the paying spouse and are tax-free to the receiving spouse. The tax treatment of such property transfers and child support are
locked in—the parties cannot change the tax treatment.
The tax law treats alimony payments differently. Alimony is deductible to the paying spouse and is taxable to the receiving spouse. When a party to divorce is required to make payments to the former spouse, from a tax perspective it is advantageous to have the payment treated as alimony. This is due to the tax deduction that will be allowed to the paying spouse. The receiving spouse would prefer child support or property division treatment since these receipts will be tax-free.
If the parties don’t find the tax treatment of alimony advantageous, they can elect out of alimony treatment so that the alimony payments are not deductible by the payor and are not taxable to the recipient.
To receive alimony treatment, the alimony payments must meet tax law requirements. Regardless if the payments qualify as alimony under domestic relations law, they will not be taxed as alimony unless they meet tax law requirements.
All of the following requirements must be met to receive alimony treatment:
Payments must be made under a written divorce or separation agreement. Payments made before such an agreement is executed will not qualify as alimony. Additionally, payments made under oral agreements will not be treated as alimony.
Spouses cannot live together after divorce. After the divorce or legal separation is final, the spouses cannot be members of the same household when the payment is made. However, payments made under a separation agreement (which is operative before the divorce or legal separation is final) will qualify as alimony if the parties continue to live together. Once the divorce or legal separation is final, the payments will no longer qualify as alimony.
The payments must be made in cash or cash equivalents
The payment must be made to or on behalf of a spouse or former spouse. Payments will be made to a spouse under a separation agreement and to a former spouse under a divorce decree.
The parties do not elect out of alimony treatment.
The parties must file separate returns. Once the divorce is final, the parties will not be able to file a joint return. However, under a separation agreement, the parties are still married, are eligible to file a joint return, and will qualify for alimony treatment.
The payments must not be child support. If the payment is labeled child support in the agreement, the payments will not qualify as alimony. Even if the payments are labeled alimony, they may be treated as child support if the payments are reduced or eliminated upon a child related contingency. Examples of child related contingencies include the child reaching the age of majority, getting married, or dying. Since the payments are related to events involving the child, the tax law treats these payments as child support.
The payments must terminate at the receiving spouse’s death. The purpose of alimony is to maintain the receiving spouse’s standard of living. If payments are made to the spouse after his/her death then the payments really aren’t to maintain the standard of living. Payments that are required to be made after death tend to occur because the marital estate could not be easily divided and one spouse must make payments to the other spouse to equalize the division. These payments are property divisions and will not qualify as alimony.
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Buzzkill Disclaimer: This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.