As high as the divorce rate in California is, the tax rules regarding alimony payments become increasingly important. Not following the tax law may result in the IRS assessing significant taxes, penalties and interest. Preventing or solving this tax problem can easily be done with the proper advice from your tax lawyer.
Alimony payments may be included in gross income to the payee spouse and tax deductible by the payor spouse. If under federal tax law the payments do not qualify as alimony, the payments may be excluded from gross income of the payee spouse and may not be tax deductible by the payor spouse.
Recharacterizing alimony payments is very common for the IRS on audit. For the payor spouse, this may result in the IRS disallowing tax deductions for the alimony payments. For payee spouse, this may result in the IRS finding that the spouse failed to report alimony income.
These problems are avoidedable with proper tax planning. Separating and divorcing spouses can recognize significant federal income tax savings when aware of what payments do not qualify as alimony. Generally, payments do not qualify as alimony for purposes of federal tax law if:
• the spouses are members of the same household at the time the payments are made,
• the divorce decree or separation agreement designates the payments as non-alimony,
• the payments are not made pursuant to a divorce decree or separation agreement,
• the spouses are married and file a joint tax return (married couples who file a joint tax return may qualify for innocent spouse relief),
• the payments are child support,
• the payments consist of property rather than money,
• the payments are for the payee spouse’s bills (such as mortgage payments and real estate taxes),
• the payments call for significantly larger payments in the first three years following separation or divorce, and
• there is an obligation to continue the payments after the death of the payee spouse (either in the decree or agreement or in state law).
Divorce decrees or separation agreements should be written in a way that addresses these rules. As with other major financial transactions, taxpayers should consult with their tax attorney if they have any doubt about the taxation of their alimony or other payments.