Alimony and Taxes, Here’s the Scoop

Uncontested Divorce Mediation

Posted October 21, 2015

In most Colorado divorce cases involving maintenance (also called “alimony” by the Internal Revenue service):

-the maintenance payer will receive a deduction from his or her gross income equal to the amount of maintenance paid; and
-the maintenance receiver will be required to pay federal and state income taxes on the amount of maintenance received

Most people (even some accountants!) believe that this is the only way to treat alimony under the federal tax code. However, a little known fact is that the Internal Revenue Code does not require that maintenance be taxable to the recipient and a tax deduction to the payer. That is correct, parties may elect the taxable nature of alimony in a divorce.

IRS Publication 504 describes many issues surrounding taxes and divorce, including alimony and it’s treatment by the Internal Revenue Code. In listing eight requirements for alimony to be considered taxable by the IRS, this publication states that “The divorce or separation instrument cannot specifically state that the payments are not alimony.” Page 15 of IRS Publication 504, describes this option further by providing that, if two spouses desire to exclude alimony from the ordinary tax treatment they must include in their separation agreement a provision stating that the payments are not deductible as alimony by the payer and are excludable from the receiver’s income. Important however, is the requirement that the receiving spouse can only exclude the payments from income if he or she attaches to the tax return, a copy of the separation agreement designating the payments as “not alimony” for each year that the designation applies.

So if this “opt out” election is available, why would couples choose this option? Many times in divorce, the couple receives significant tax advantages due to the reduction of taxes for the maintenance payer that is greater than the increase in taxes to the maintenance receiver. However, many times the “marginal tax rate” (the effective rate at which each dollar is taxed at the highest level of an individual’s income) of each person is the same, resulting in no tax advantages for either party by utilizing taxable maintenance. In those cases as well as situations where one person may simply have a preference to pay a “lesser amount” of non-taxable maintenance (even though there is no net negative for the individual receiving maintenance), couples may opt out of the typical tax treatment of maintenance.

These are only a couple of the examples where couples may elect this non-taxable route in dealing with spousal support in a Colorado divorce. Ultimately the question of whether to opt out of the taxable treatment of maintenance is another choice that you will make working with your Split Simple mediator who can guide you and your spouse to the right answer for your particular case.

In addition to considering these issues in mediation, you should always consult with your tax accountant regarding all of the tax issues arising from your divorce.