Having to pay alimony (spousal support) in the wake of a divorce is certainly not pleasant, but on the other hand, those who are financially able to pay reasonable, lawful levels of alimony will often still wish their former spouse the ability to readjust and do well in life. And there is another "silver lining" to alimony payments as well: they are tax deductible.
Understanding the relationship between alimony and taxes is critical for those who don't wish to or can't afford to go without the legitimate tax deductions alimony entails. But the tax code and alimony rules are difficult enough to understand separately: when you combine the two, it will take real legal and tax expertise to sort out exactly what to do and what to expect.
If you are the recipient of spousal support, realize that the payments you receive will be taxable; so it's the opposite effect for the receiver versus the payor of alimony benefits.
At San Diego Divorce Attorney, we can assist you in understanding how alimony will affect how you file your tax return and how much you pay in taxes.
Contact us today by calling 858-529-5150, and we can give you a free consultation and help you sort through the issues surrounding taxes, alimony, and their intersection points.
Understanding California Alimony Laws
Before you can understand the connection points between alimony and taxes, you first have to have a good understanding of alimony itself. While not all divorces include alimony (spousal support) orders in their aftermath, many do. And while most alimony is only for a few years or so, sometimes spousal support can continue for 5 or 10 years or even for life.
The amount of alimony to be paid is based on trying to maintain the standard of living that existed during the marriage, at least until the spouse with the lower income transitions back to single life or gets remarried.
Interestingly, only 10% to 15% of California divorces include any alimony judgments whatsoever. But in some cases where alimony is required it can amount to hundreds of thousands of dollars over the course of decades. Thus, it can have a big tax impact to both the receiver and the payor.
Things that can affect alimony requirement and thus, in turn, your tax bill, include: a change in income to you and/or your X-spouse, getting a bonus or overtime pay, the receiver of alimony living with a new partner and getting support from him/her, the supported spouse is getting remarried, the supported X-spouse having gotten a large amount of assets in the original divorce settlement, and the supported spouse not working or seeking to work when fully capable of doing so.
If you are going to retire, you will no longer have to pay alimony. But, that can't legally take hold unless you are age 65 or older. If you were forced into early retirement, however, you could petition the court to allow payments to stop earlier than age 65.
But you cannot avoid alimony by declaring bankruptcy. And if someone seeks to avoid paying alimony by purposefully being unemployed or underemployed, the court can "impute" income to you based on what you "should have been able to make." That would, of course, require that it be proved to the court that the lack of gainful employment was purposeful.
The Tax Status of Alimony Payments
The State of California Franchise Tax Board allows that alimony paid to support an X or legally separated spouse is tax deductible. But, conversely, it is taxable income on the receiver's end.
Note that child support payments do NOT count as alimony and are NOT tax deductible. And since both child and spousal support are generally paid together to the same person as part of the same court order, there may sometimes be some confusion as to how much of the total support counts as alimony. You'll have to check your court documents, talk to the court, or talk to your attorney to help you sort that (it will be different in every case.)
Also note that voluntary payments made before the settlement or court order (or afterward apart from required alimony) does not count as alimony for tax purposes. Nor do property settlements count, nor do retirement benefits that are deemed community property.
You must report your receiving or paying alimony for the tax year in which it occurred. It is to be reported on the IRS form 1040.
Also note that, to deduct alimony on your taxes, the form of payment must have been cash, check, or money order. (But it doesn't matter what form was used as far as having to report receiving alimony.)
In some cases, alimony payments might be made to a third party, typically parents or a relative with whom the X-spouse lives, to cover that third party's cost for providing shelter, utilities, medical expenses, or other assistance. But no matter if the payments are made direct to your X-spouse or to a third party for the purpose of supporting him/her, it's still alimony, so long as it is all stipulated as such in the court order.
Once again, we reemphasize that child support cannot be deducted from your taxes. And note that some post-divorce court orders to pay support refer to "family support." In this case, the whole amount called "family support" is considered as alimony and can be deducted. Unless it is specifically designated as "child support," it's alimony and is deductible.
Finally, we should address the tax status of alimony when it is paid between former domestic partners. Whether called "alimony" or a "separate maintenance payment," it works the same. But as to the status of payments made for support of former domestic partners, federal law is still rather unclear on this matter.
In most ways, domestic partnerships are treated the same as marriages, but alimony in the tax codes is referred to as paid to a "former spouse." California will treat the two the same, so you can be sure about the status on your state tax returns. But the situation with federal taxes and X-domestic partner support is in such limbo that you should contact a good lawyer or tax accountant to discuss the matter just before filing your tax return.
Problems or Questions About Alimony and Taxes
While the basics are pretty clear: alimony is deductible for the payor but taxable for the payee, there are many potential problems and questions that can arise in relation to alimony and your tax bill.
First, you need to know where to file: on IRS form 1040, line 11 for reporting alimony as income but line 31 for reporting it as a deductible expense.
Next, if you are still confused as to what counts as alimony, the rule to go by is: if a court-ordered payment made to an X-spouse for month to month support doesn't say it isn't alimony, then it is.
If you are cohabitating again with your X-spouse or domestic partner, realize that your alimony payments no longer count as tax deductible for the period of cohabitation.
Next, realize that if a person receiving alimony (even from a California resident) is not him/her self a California resident, he/she does not need to pay taxes on it to California. But he/she may well need to pay taxes on it to the state of current residence, besides federal taxes.
Finally, if your supported X-spouse dies, alimony payments will immediately cease. You are not required to pay for a period following his/her death to cover final expenses and the like.
Common Alimony-related Tax Mistakes
Mistakes in relation to alimony when filing one's taxes are extremely common. The most common mistake for the payor is to think that all monies paid to his/her X-spouse count as alimony, thus wrongly including child support payments.
The second most common error of payors is to cut themselves short but not counting "family support" as alimony, which it nearly always is supposed to be counted as.
In the case of receivers of alimony, it is very common that they fail to report the alimony as taxable income, thus wrongly lowering their taxes. There is a persistent but incorrect assumption that one does not have to pay taxes on spousal support payments. So we cannot emphasize too strongly that this is NOT the case, even as the persistent wrongful inclusion of child support in alimony deductions can hardly be overemphasized.
Contacted by the Franchise Tax Board?
When mistakes have been made on your tax returns as to alimony deductions or reporting alimony as taxable income, you may well be contacted by the State of California Franchise Tax Board about the matter.
If this happens, you should seek legal assistance and advice without delay.
If you simply ignore the FTB letter, the board will take the liberty, after a specified deadline is crossed, of revising your tax bill in accordance with the law on the alimony related discrepancy. If you respond in time and have sound legal help, you might have more options.
If there has been a mistake on the FTB's part, you might be able to fight it; but you have to act quickly.
There is a tax penalty for failing to report alimony or reporting excess alimony, equal to 20% of the resultant underpayment on the total tax bill. This fine will apply if the reason for the discrepancy was a matter of negligence to be aware of the rules or a purposeful disregard of the tax rules. And the same would apply if understating your income or other discrepancies caused the lower tax bill.
Exceptions to the Tax Penalty
Even if you didn't properly report your alimony (as payor or receiver) on your tax form, it is possible you won't have to pay the 20% penalty. But you will have to demonstrate you qualify for an exception and thus "relief" from the fine.
Defenses to help you avoid the tax penalty include the following:
- Substantial Authority. If you had been advised from a legitimate authority or had a reasonable reason for treating the incorrectly reported tax item as you did, you could be exempted from the fine.
- Adequate Disclosure. If you fully disclosed your information on the tax form and included a reasonable basis for how you filed in the original filing, then it can be considered a mistake that would not incur a 20% penalty. The point here is you weren't trying to hide anything, you just made a mistake in the calculations.
- Reasonable Cause. If it can be shown that you had a reasonable cause for the tax understatement and that you acted in good faith in how you filed your taxes; then, though it was incorrect, you might be exempted from the fine. But "reasonable cause" is a somewhat fuzzy term and has to be determined on a case by case basis.
If your understatement was "substantial," it will be more likely to be treated more severely and incur the fine. A "substantial" underpayment is one that is 10% or more of the amount you were supposed to pay in taxes that year, or any underpayment of $5,000 or more, regardless of the percentage.
Finally, note that if your returns were filed late, you still have to pay the late filing fee even if you end up qualifying for an exception, and don't have to pay the 20% penalty.
Needless to say, federal and California tax law can be quite complex when it comes to alimony matters, and even in general. Any mistake or misrepresentation can lead to penalties. And if you are facing an issue with the FTB, it is in your best interests to get some sound legal and tax advice from an experienced attorney.
Contact Us Today For Assistance
At San Diego Divorce Attorney, we understand you may have numerous questions and concerns about how alimony and your income taxes might affect each other. We have deep experience in these matters and can give you solid advice on alimony-related tax laws plus on how to take advantage of tax deductions for alimony payments.
To learn more or for a free, no-obligation consultation on this and related family law matters, feel free to contact us today by calling 858-529-5150.