This article is the second installment of Littleton Divorce Attorney Bonnie Shield’s series on tax issues in divorce. In this segment, Bonnie explains how spousal maintenance (alimony) is treated on your taxes and how savvy lawyering can help you receive the best tax treatment on your divorce.
How Alimony is Taxed
If you awarded spousal maintenance during your divorce, you will be required to report to the IRS the alimony payments you receive and will be required to pay income taxes on those payments. If you are ordered to pay spousal maintenance to your former spouse during a divorce, you may be able to take deduct from your income the entire amount of alimony paid to your former spouse each year.
For those on the receiving end of alimony payments who are thinking about simply not reporting, that course of action is ill advised. The spouse who is ordered to pay alimony will have to report the receiving spouse’s social security number in order to receive their deduction. This makes it extremely easy for the IRS to catch people who fail to report alimony payments on their income tax return.
Preparing for the tax Consequences of Alimony
Unlike your normal wage/salary income paid by your employer, alimony checks won’t typically have your taxes already withheld from them. This means that at the end of the year you will likely end up owing money on your taxes. For those who don’t expect this surprise come April 15, it can be difficult to shoulder the financial burden. However, there is an easy way to avoid receiving a large unexpected tax deficiency if you’re receiving alimony. Depending on how much you’re receiving in alimony it may be advisable to make quarterly estimated tax payments to the IRS.
Estimated tax payments are made by individuals whose tax withholdings from their wages/salary are insufficient to cover their tax liability. Estimated tax payments are made each quarter and an accountant can help you prepare the proper paperwork. Depending upon your circumstances, you may in fact be required to make estimated tax payments.
Tax Traps for those Paying Alimony
If you’ve been ordered to pay alimony, make sure you’re not front-loading the alimony process. Alimony that dramatically decreases year over year can result in negative tax ramifications. These calculations are fairly complex, so make sure to speak with an accountant or competent tax attorney about the tax ramifications of your alimony payments.
The tax issues associated with alimony payments can be avoided by instead paying a lump sum of cash or other assets as a part of your marital property division. As noted in the previous article on this topic, certain types of property transfers following a divorce are not taxable transactions, and therefore, could be more desirable to both parties depending upon the facts of your case.