If you’re recently divorced, you may pay or receive alimony. Here are some tips for how to correctly treat the payments on your tax return.
The first consideration is the definition of alimony. There are actually two definitions of alimony—one for payments made under divorce decrees and separation agreements established before 1985 and another for agreements established since that time. For the purposes of this article, only the rules for post-1984 decrees and agreements will be discussed.
For post-1984 decrees and agreements, alimony has the following requirements: The payments must be in cash paid to a spouse, ex-spouse or third party on behalf of a spouse or ex-spouse, and the payments must be made after the divorce decree is finalized. If made under a separation agreement, the payments must be made after the execution of that agreement. The payments must be required by a decree or instrument incident to divorce, a written separation agreement, or a support decree. The payments cannot be designated as child support. Child support payments are neither income for the recipient nor a deduction for the payer. Payments made while spouses or ex-spouses share the same household don’t qualify as alimony. This is true even if the spouses live separately within a dwelling unit. The payments must end upon the death of the payee. The payments cannot be contingent on the status of a child. This is to prevent child support from being disguised as deductible alimony.
If payments you receive from or make to a spouse or former spouse meet the definition of alimony, those payments are taxable for the recipient and deductible for the payer. There is one exception to this rule, however: A divorce decree or separation agreement can designate that alimony payments are neither deductible nor taxable. If this is the case, the payments are not reportable on either party’s tax return.
Here are some additional issues that should be considered.
The IRS requires that a taxpayer deducting alimony include the payee’s Social Security Number (SSN) on his or her tax return. Thus, the recipient must provide his or her SSN to the payer.
The IRS has noted that a significant number of taxpayers incorrectly report their alimony by either understating the income or overstating the amount paid. As a result, the IRS computer compares the amounts listed on the payer’s and recipient’s tax returns, and it will initiate a correspondence audit where there is a discrepancy.
The recipient of alimony payments may treat alimony payments as compensation even if those payments are that person’s only income. This allows alimony recipients to save for their retirement by making either Traditional or Roth IRA contributions, the rules for which require the contributor to have earned income or compensation. Alimony income satisfies this requirement.
If a divorce decree or other written instrument or agreement calls for both alimony and child support, and the person making the payments pays less than the total required, the payments apply first to child support. Any remaining amount is then considered alimony.
There is no income tax withholding from alimony payments, so the recipient may need to consider making estimated tax payments.
Other complications can occur that are not addressed here. If you have such complications or wish to discuss alimony as it applies to your circumstances, please give Dagley & Co. a call.
Image via. public domain
If you’re struggling with your money, then no doubt you may be excited about your upcoming potential tax refund.
However, that excitement may be premature if you have outstanding federal or state debts. The Treasury Department’s Bureau of the Fiscal Service (BFS) issues federal tax refunds, and Congress authorizes BFS to reduce your refund through its Treasury Offset Program (TOP) to pay:
- Past-due child and parent support;
- Federal agency non-tax debts;
- State income tax obligations; or
- Certain unemployment compensation debts owed to a state.
If you owe a debt that’s past due, it can reduce your federal tax refund and all or part of your refund may go to pay your outstanding federal or state debt if it has been submitted for tax refund offset by an agency of the federal or state government.
If you have an outstanding debt and want to be proactive, you can contact the agency with which you have a debt to determine if your debt was submitted for a tax refund offset. You may call BFS’s TOP call center at 800-304-3107 or TDD 866-297-0517, Monday through Friday, 8:30 a.m. to 6 p.m. EST.
If your debt was submitted for offset, BFS will reduce your refund as needed to pay off the debt and send it to the agency you owe. Any portion of your remaining refund after offset is issued in a check or is direct deposited as originally requested on the return.
If you choose to wait and see what happens when you file your return, BFS will send you a notice if an offset occurs. If you wish to dispute the amount taken from your refund, you will have to contact the agency that submitted the offset claim. It will be shown on the notice you will receive from the BFS.
If you filed a joint tax return, and only one spouse is responsible for the debt, the other spouse may be entitled to part of or all the refund. To request the refund of the spouse that is not responsible for the offset, you can file Form 8379, Injured Spouse Allocation. The benefits provided under the injured spouse allocation will generally not apply if you reside in a community property state.
Please contact Dagley & Co. if have you have questions about refund offsets. You’ll find our information at the bottom of this page.
Image via public domain
You would think federal taxes and law courts would keep up with each other, but they actually do not. In fact, family law courts make rulings that are contradictory to federal tax law all the time, causing confusion and inequity in divorce actions since family court rulings cannot trump federal tax law.
A common issue for divorced parents is who gets to claim the children for tax purposes. Federal tax law provides that the parent with physical custody claims the child unless that parent releases the exemption to the other parent. Frequently, family courts award physical custody to one parent and the tax exemption to the other. To make matters worse, the courts assume that the exemption deduction will provide a financial benefit to the non-custodial parent. Then the court adjusts child support accordingly, leaving the non-custodial parent with two unpleasant surprises when filing his or her tax return: the child support is not deductible and the child cannot be claimed as a dependent without a release from the custodial parent.
Who is to blame? At first glance, one would tend to blame the court. However, it is not the job of the court, but the duty of the attorney to bring the judge’s attention to federal tax law so that he or she is aware of what applies in order to make a correct judgment. Few family law judges know tax law.
Avoid mistakes – Consult with your tax advisor. Go over the proposed settlement and determine what the tax implications will be before the divorce is finalized. Here are some of the tax issues that need to be considered as part of a divorce:
Property settlements – When property is divided in a divorce, the spouse who keeps the property assumes the community basis. This, in effect, means that spouse assumes any tax liability when the property is sold.
Example: A couple has a home worth $450,000 and a mortgage of $50,000, which provides a net equity of $400,000. They also have a bank savings account worth $400,000. They divorce, and agree that the wife will keep the home and the husband will keep the bank account. On the surface, this sounds equitable, but, after taxes are considered, it may not be. Let’s assume the couple purchased the home for $100,000 several years ago. The wife assumes the community basis of $100,000. If the wife sells it for $450,000, she will net only $373,000 from the sale after paying the selling costs of approximately $27,000 and paying off the $50,000 loan. In addition, she has a taxable profit from the sale that is computed as follows:
Sales Price: $450,000
Community Basis: <100,000>
Sales Costs: < 27,000>
Home Sale Exclusion <250,000>
Taxable Gain $ 73,000
Federal Tax @ 15% 10,950 (there may also be a state tax, and Federal tax could be as high as 20%)
So, in our example, the wife nets $362,050 ($373,000 less taxes of $10,950), while her spouse nets a full $400,000 from the savings account. Not exactly even after taking into account the tax liability.
Issues involving Children – There are substantial tax issues related to the children. Here are some of them:
- Dependency – Federal tax law gives the dependency to the custodial parent unless the custodial parent releases, in writing, the dependency to the non-custodial parent. There is a tax deduction of $4,000 (2015) for each dependency exemption.
- Child Credit – The 2015 child tax credit, $1,000 for each child under age 17, goes to the parent who claims the child as a dependent.
- Joint Custody – Some courts award joint custody to the parents. In this situation, the IRS does not split the benefits of claiming the child as a dependent. Instead, the parent with physical custody the greater part of the year receives all of the benefits.
- Education Credits – The education tax credits for college tuition expenses go to the one who claims the exemption for the child, regardless of who paid the tuition.
- Child Care Credit – The parent who claims the child’s exemption is the only one who can claim a tax credit for child care expenses This can cause issues where both parents work and share custody.
- Child Support– is not deductible by the parent who pays the support and is not taxable to the one who receives it.
Alimony – is deductible by the spouse who pays it and includable in income by the spouse who receives it. To be treated as alimony, payments must be in cash, required by the divorce instrument, and end upon the death of the payee. In addition, alimony payments cannot be contingent on the status of a child and are valid only while the taxpayers live apart.
Conflict of Interest – Rules of Practice do not allow a tax practitioner to represent clients where there is a conflict of interest. This is an issue for divorcing couples since the divorce creates a conflict of interest and a practitioner may not be able to provide services to both clients and, in some cases, may not be allowed to provide services to either.
As you can see, there are a number of complications related to divorce and the status of the children of divorced parents. If you have questions, please get in touch with us at Dagley & Co.
Image via public domain