Alimony is an allowance that is paid by a divorced person to his/her spouse to provide financial support post divorce/legal separation. Such payments can include rent, mortgage, utilities, medical costs incurred, etc. Its purpose is to help the lower-earning spouse maintain the same standard of living after divorce.
It is tax-deductible from your gross income in the year it is paid. Precisely, it is a tax deduction for the person who pays the alimony, and is included as taxable income for the person who avails it. But in case of child support, it is not taxable to the person who is in charge of or having custody of the children.
Let's take an instance to understand how this works. Ron and Helen are a couple who have recently filed for a divorce. Ron has an annual income of USD 175,000 and pays USD 50,000 to Helen, a school teacher by profession who has an annual income of USD 23,000. Ron saves USD 12,500 in taxes.
Helen, obviously, is in a lower tax bracket as compared to Ron, but has to show this as an addition to her taxable income, which will now become USD 73,000. However, she will pay tax at a lower rate than what Ron would have had to pay, therefore, between them they save tax.
- Such a payment must be done under a decree of an agreement citing a divorce or a legal separation.
- The agreement citing alimony benefits, must provide for cash payments (checks or money orders).
- Money paid for child support is not tax-deductible.
- An alimony that is tax-deductible nullifies if there is an untimely death of the receiving spouse.
- The couple should not file returns jointly.
- They should be living separately.
Temporary and Lump Sum Alimony
It is usually paid for a short duration of time, after a petition for divorce is filed. The payment is made by the spouse with a higher income, to the other partner. It depends on various factors like receiving spouse's primary and secondary sources of income, tax deductions on the income of the spouses, medical insurance, and union dues.
It ensures financial stability during the highly emotional phase of divorce. The receiving spouse gets the temporary support, until the court gives its judgment on the dissolution of marriage. But temporary alimony is not tax-deductible if the joint return filed by the couple is still valid.
Lump Sum Alimony
In many cases, instead of a regular alimony, a lump sum amount is accepted by the receiving spouse. There is only one financial transaction between the two partners and that includes all the cash payments and buy-outs.
This alternative is better than the regular payment as the receiving spouse does not have to depend on the other spouse throughout his/her life. Lump sum payment is taxable if the cash transfer happens within a year.
IRS excludes legal fees and costs incurred in obtaining divorce from alimony. It also prohibits deduction for costs incurred for personal advice and counseling.