What is Alimony?
Alimony is also often called spousal support. Alimony payments are used to provide the spouse that is making a lower-income with funds to cover expenses that are not provided for through child support or through the division of property. Many factors come into play when determining the amount of alimony (spousal support) that can be awarded. Whereas child support is determined using strict guidelines provided by your state, the judge is often the deciding factor in whether or not alimony (spousal support) will be awarded.
What factors are used in determining the amount of Alimony (Spousal Support)?
Each state will have different guidelines to utilize when considering the awarding of alimony (spousal support). In most cases, the judge will consider each of the spouses work history, their education backgrounds, their work skills, their ability to earn currently, their earnings potential for the future, the length of the marriage, the age of each spouse, the health condition of each spouse, the type of property that is being contested, and sometimes the personal behavior of the parties prior to and during the divorce proceedings.
Alimony (Spousal Support) versus Child Support – Tax Advantages
In general, for tax purposes, payments of alimony are tax deductible and child support payments are not. Conversely, receipt of alimony payments would be taxable income and child support would be considered tax free income. It certain situations, it is advisable to explore using alimony payments to gain the tax advantages available over child support when you and your ex-spouse’s incomes are sizably different.
If your payments qualify as alimony, you will be able to deduct the payments you make as an adjustment to income. You are not required to itemize deductions to take advantage of this tax break. You will need to file a 1040 individual tax return (not a 1040EZ or 1040NR) and you will be required to provide the social security number for whom the alimony payments were made. If you are receiving alimony payments, you will need to report the payments as income and report the social security number of the individual from whom you received the alimony payments from.
Tax impact example – You are required to pay alimony of $10,000 per year. If you are paying tax in the 28% tax bracket, your potential tax savings for the year would amount to $2,800 ($10,000 X .28). If you paid the same amount in child support, your tax deduction would be zero. If you are the one required to make alimony payments, you will realize the importance of meeting the requirements explained below based on the potential tax savings that you can achieve if you structure the payments accordingly.
Over the years, we have seen several cases in which the separation or divorce instruments violate the requirements as they are spelled out, thus leaving the parties with unintended tax consequences. Divorce or separation agreements usually call for multiple payment streams (child support, alimony, cash settlements) to be paid to each of the spouses. Each payment stream must be tested separately when applying the requirements to determine if the payment is alimony (spousal support) or not. If one payment stream between the parties does not qualify as alimony, it will not disqualify the other payment streams from being considered alimony.
If you are interested in additional information related to this topic or additional strategies, please download our eBook: The Financial Divorce – Your Guide to Financial Divorce Knowledge.