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The Seven Rules of Alimony Deduction

Sometimes the IRS allows a deduction for alimony payments. It is granted in part because the recipient is taxed on alimony. The two parties end up paying less in taxes overall because the alimony is deductible. The parties are actually shifting income from a higher to a lower tax bracket, by transferring alimony from the higher income spouse to the lower-income spouse. The high earner saves money that would otherwise be paid to the IRS, and the recipient usually benefits because the payor is more generous due to the tax savings.

Example: The high wage earner makes $200,000 a year and pays the former spouse $80,000 a year. As a result, the higher earner is actually taxed on only $120,000, not $200,000. The recipient might pay taxes of $16,000, but the payor would have paid $50,000 on $200,000 and now pays only $24,000 on $120,000. Between the two of them, they are paying a total of $40,000, which is $10,000 less than the higher earner would have paid before deducting the alimony payments.

However, not all alimony payments qualify as deductions. The IRS has seven requirements for taxpayers seeking a deduction:

  1. Dollars: Payments must be made in cash or by check to or for the benefit of the former spouse.
  2. Documents: Payments must be made in accordance with a divorce document, such as a marital settlement agreement, separation agreement, court order or divorce judgment. (Payments made pursuant to a temporary order or order pendente lite also qualify under Section 71 of the Internal Revenue Code.)
  3. Designation: Statements in the divorce document must specify the payment as deductible by the payor and taxable to the recipient.
  4. Distance: Payments must be made after the parties are physically separated, not while they are still living together.
  5. Death: Payments must terminate on the death of the recipient and that condition must be included in the divorce judgment. (Such phraseology in the judgment often also includes the right to terminate alimony upon the recipient's remarriage.)
  6. Dependents: There must be a clear distinction between alimony and child-related events. If you specify that alimony is terminated upon the emancipation of a child, you run the risk of the IRS reclassifying past alimony as non-deductible child support. Past alimony deductions would then be disallowed, and you would end up owing back taxes.
  7. Front-Loading: IRS rules against front-loading must be followed. Alimony should not be excessively high or front-loaded in the first three post-separation years. Excessive payments are subject to recapture or being taxed to the payor in the third post-separation year.