Generally, alimony payments can be deducted for federal income tax purposes by the spouse who pays the alimony. And the spouse who receives alimony payments must report them as taxable income. This also applies to lump sum payments and can result in significant tax consequences for the spouses. For example, a lump sum payment may be made to equalize the division of marital property.
According to the IRS, noncash property settlements are not considered alimony for tax purposes, whether the settlements are made in a lump sum or installments. Voluntary payments that are not required by a divorce decree or separation instrument are not considered alimony. And, if the divorce or separate maintenance decree or written separation agreement specifically states that a payment is not alimony, it will not be considered alimony for tax purposes and will not be deductible or includible in income.
Other payments that are not considered alimony include child support, payments of a spouse’s share of income from community property, payments to keep up property, and the use of property, for example if a former spouse lives rent-free in a home owned by the other former spouse.
As indicated on the website Flying Solo, the tax consequences of a large lump sum alimony payment can be significant. The spouse who receives the lump sum payment will have a tax liability. And even though the spouse who makes the alimony payment can claim a deduction, he or she may not be able to take advantage of the full amount of the deduction, depending on other taxable income and deductions.
The deduction for alimony paid is an adjustment to gross income on Form 1040. If the lump sum alimony payment is more than the spouse’s taxable income, any tax benefit on the excess amount would be lost. The deduction for alimony is a non-business deduction that cannot be carried forward or carried back to apply against taxable income in another year.
Because of the potentially significant consequences, the payments agreed to in a divorce or legal separation agreement should take into account the tax implications. An evaluation of the tax effects for each spouse could determine that on an overall basis the spouses would pay less tax if the payments are not considered alimony. The IRS code indicates that payments can be specifically designated in the agreement as not constituting alimony.
As pointed out by the Law Office of Lawrence D. Gorin, it is important to include precise wording in the agreement to make it clear how the alimony payments should be treated for tax purposes. This will avoid doubts and not leave the tax consequences up to interpretation by the IRS, which may or may not be to the spouses’ advantage.
Sources:
26 USC § 71 – Alimony and separate maintenance payments, Cornell University Law School
Lump Sum Alimony: Potential Tax Trap, Flying Solo
Publication 504, Divorced or Separated Individuals, IRS
Release No. 200638008, IRS
When is it alimony and when is it not (for income tax purposes)? Law Office of Lawrence D. Gorin
Reference:
- Divorce Over 50: 3 Mistakes to Avoid: finance.yahoo.com/news/pf_article_112425.html
- Splitting Up Nest Eggs: finance.yahoo.com/news/pf_article_108890.html
- Strategizing Your Divorce: Importance of a Financial Planner: voices.yahoo.com/strategizing-divorce-importance-financial-626823.html?cat=41
