No one wants to think about taxes, especially when going through a divorce. But, knowing the facts about divorce and alimony taxes, before the final settlement, could help you avoid paying significant tax penalties in the future. The Internal Revenue Service (IRS) determines rules about alimony and taxes. Only alimony that is paid or received as part of a legal separation or divorce settlement is covered for tax purposes.
If you are paying alimony, it is most likely a tax deduction. If you are receiving alimony, it is most likely taxable income.
The type of alimony you are paying or receiving will determine the tax consequences for both the payor and the recipient. Additionally, whether the payments are considered alimony or property division will have an impact on how they are treated for tax purposes.
Taxes for the Payor
If the alimony you are paying is determined to be tax-deductible, you will need to consider if you and your former spouse:
- File separate returns
- Pay in cash, by check, or money order
- The payment is received directly by your former spouse or by a third party on behalf of your former spouse (like an attorney or a mortgage company)
- The divorce decree or legal separation is silent as to whether the payment is or is not alimony
- Your payment is not treated as child support or a property settlement
- You and your spouse do not live in the same physical household
- You have no liability to make payments after your former spouse has passed
Depending on your divorce settlement, alimony can include life insurance premiums that you pay on policies owned by your former spouse or for a jointly owned property. Half of the mortgage payments (principal and interest) may be deductible
Taxes for the Recipient
If you are receiving alimony, it most likely is considered taxable income and must be reported when you file a tax return.
Since taxes are not withheld from alimony payments, you will have to plan carefully to avoid owing taxes each year.
Alternatives to Paying/Receiving Alimony
There are alternatives to alimony, and each has its own tax implications.
For example, some people prefer to receive all their alimony as a one-time lump payment. In this case, the payment may be treated as a division of assets and is not taxable for the recipient or deductible for the payor.
Another alternative is setting up a trust. Under this arrangement, the payor transfers income making assets or property into a trust. The income produced from this trust is then used to pay alimony. This arrangement also has different tax implications depending on how it is structured.
Discuss your options in advance with an experienced divorce attorney to determine what’s best for any divorce and alimony taxes you may face. Contact Sauls Law Group to discuss your questions about alimony and the divorce process. Or call us today at (770) 212-9168 for a consultation.