THE ALIMONY GAP
- Alimony is deductible to the payer.
- Alimony is income for the recipient.
- The IRS matches alimony deductions and income by SSN.
- Alimony is often confused with child support payments.
- Audits can lead to filing penalties.
Individuals who pay alimony can deduct the amount paid from income on their tax return to reduce the amount of their personal income tax. Conversely, individuals who receive alimony must claim the amount received as income on their tax returns.
Recently, the Treasury Inspector General reported that for approximately half of all returns filed on which an alimony deduction was claimed, there were significant discrepancies in reporting the corresponding amount of taxable alimony received.
Why does this happen? The primary reason is probably because of a misunderstanding of what constitutes alimony. For divorce, support and separation decrees and agreements made after 1984, the definition of alimony includes six attributes that define when payments are in fact alimony. To be alimony, the payments:
- Must be in cash, paid to the spouse, ex-spouse or a third party on behalf of a spouse or ex-spouse;
- Must be required by a decree or instrument incident to divorce, a written separation agreement or a support decree;
- Cannot be designated as child support;
- Only count if the taxpayers are living apart after the decree (spouses who share the same household cannot qualify for alimony deductions—this is true even if the spouses live separately within the dwelling unit);
- Must end on the death of the payee (recipient); and
- Cannot be contingent on the status of a child (that is, any amount that is discontinued when a child reaches 18, moves away, etc., is not alimony). Payments need not be for support of the ex-spouse or based on the marital relationship. They can even be payments for property rights as long as they meet the above requirements.
Payments need not be periodic, but there are dollar limits and “recapture” provisions. Even if payments meet all of the alimony requirements, the couple may designate in their agreement or decree that the payments are not alimony, and that designation will be valid for tax purposes.
One of the main sources of discrepancies lies with the distinctions between child support and alimony. For example, an individual is required to pay $1,500 per month to a former spouse, with the provision that the payment decreases to $1,000 per month when the couple’s child reaches age 18. In this situation (see #6 above), the alimony is only $1,000, and the $500 is nondeductible/nontaxable child support.
Reporting the incorrect amount will undoubtly lead to an IRS inquiry since the one making the alimony payment must include the Social Security Number (SSN) of the recipient, and the IRS computer matches the income and deduction reported on the respective tax returns. A resulting examination could end with the assessment of tax and filing penalties for the individual declaring the incorrect amount. If the alimony payer reports an invalid recipient SSN, or fails to include it altogether, the IRS may assess a penalty, even if the recipient has properly reported the alimony income.
Those receiving alimony may not be aware that alimony is treated as earned income for purposes of making IRA contributions.
If you are concerned that the amount you are declaring or deducting as alimony might be incorrect, or are currently involved in a divorce action, and would like to understand the tax ramifications of alimony, child support and who will receive the tax benefits provided for your children, please call this office.
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