The Tax Rules of Alimony

To make the divorce process even more painful, the tax man often gets involved.

There are tax implications involved around the division of property, child custody decisions (who gets the dependent?) and financial support, which includes alimony payments.

Alimony is deductible to the person paying it out resulting in a lower tax liability. By the same token, the recipient must include alimony received in income and pay tax on that amount. It’s important to make sure the figures align when each party files its tax returns in order to help prevent an audit. If one spouse files a return showing payment of $30,000 in alimony and the former spouse shows receipt of only $25,000 in alimony, the IRS is sure to come knocking to ensure the correct amounts have been reported by both parties.

It turns out, discrepancies in alimony payments on returns is a common problem. According to a report from the Treasury Inspector General for Tax Administration (TIGTA) publicly released on May 14, there is a $2.3 billion gap between the amount of alimony deductions claimed by taxpayers in 2010 and corresponding income reported.

“In Tax Year 2010, 567,887 taxpayers claimed alimony deductions totaling more than $10 billion.  TIGTA’s analysis of returns with an alimony deduction claim identified 266,190 (47 percent) tax returns in which it appears that individuals claimed alimony deductions for which income was not reported on a corresponding recipient’s tax return or the amount of alimony income reported did not agree with the amount of the deduction taken.  This alimony gap totaled more than $2.3 billion,” the report stated.

That’s a big gap for one year. Solving alimony payment inconsistencies involves a lot of work for the IRS since it involves contacting two parties for document verification. And according to the TIGTA, the IRS does not currently have systems in place to handle this issue.

Oftentimes, the variance between what is reported and what is received is due to end of year spillover. Perhaps the payer writes a check on Dec. 29 that doesn’t reach the recipient until the next year. The payer may include that payment as a deduction for the year the check was written, but the recipient reports the amount in the year received.

To resolve this issue, the IRS goes with the rule of “constructive receipt,” and will allocate the payment to the subsequent year, in favor of the recipient. However, in some cases, they may take sides with the payer who may claim the check was hand delivered on Dec. 29. Each case is analyzed on its own merits.

To avoid any tax issues, it is important to find consistency with payments, which can be a problem with former spouses that have a contentious relationship. I suggest that the last alimony payment of the year include a statement listing each payment made during the year with the total the payer intends to report. This should be compared with the recipient’s records to ensure consistency in reporting.

It’s also important to include the Social Security number or taxpayer identification number of the recipient on the tax return. Failure to do so could result in penalties. However, according to TIGTA, “IRS processes also do not ensure that individuals provide a valid recipient Taxpayer Identification Number (TIN) when claiming an alimony deduction as required.  TIGTA’s analysis of the 567,887 Tax Year 2010 returns that claimed an alimony deduction identified an estimated 6,500 tax returns claiming an alimony deduction for which the IRS did not identify that the recipient TIN was missing or invalid.  In addition, because of errors in IRS processing instructions, the IRS did not assess penalties totaling $324,900 on individuals who did not provide a valid recipient TIN as required.”