Divorce, Alimony, & Taxes: The Details

Understanding the Basics of Divorce, Alimony and Taxes

Know Your Terms

To begin with, alimony has a very specific meaning — it is the sum of money one spouse provides to the other as support after a divorce. No two alimony settlements are exactly the same, as there are many factors the court will consider. In North Carolina, for example, there are no regulations regarding alimony. There are no rules as to how much a spouse should receive or how long the payments must continue. It is all decided during the negotiations, so you need to be careful about what you are agreeing to.

In addition to alimony, the term has several different names you are likely to encounter. Those include maintenance, spousal support, and financial support. Keep in mind that no matter the term found in your separation agreement, you will be required to pay taxes on alimony. Support payments result in taxes regardless of the way they are named.

Alimony Taxes for the Paying Spouse

Before 2019, people who were paying alimony were able to deduct it from their taxes. However, this is no longer the case — if your divorce was concluded after 01/01/2019, you must pay taxes based on your entire income. If it took place before that date, alimony payments should still be tax-deductible for you.

You need to be careful not to amass a huge tax bill when filing at the appropriate time. One way to avoid that is to pay your taxes on a quarterly basis. This way, you will spare yourself any unpleasant surprises.

Also, make sure you do not skip alimony payments. If a court orders you to pay arrearage, it might come with an added interest that will make the bill considerable — and you will not be able to deduct it from your taxes.

Does the Receiving Spouse Pay Alimony Taxes?

Since taxes on alimony are the responsibility of the spouse who pays it, the receiving spouse is not subject to any taxation. Alimony payments are not regarded as taxable income any longer. However, the situation was different before 2018 — you had to pay a 10%–30% tax on any alimony you receive, just as you would do for your salary.

As the receiving side, you need to be aware of how paying alimony and the taxes involved will affect the other side. Keep in mind that alimony payments are not tax-deductible for the paying spouse anymore, so they will end up paying every dollar owed in taxes. If you want your alimony payments to be consistent, make sure you agree upon a sum that your ex-spouse will be able to handle.

For example, if you want $1,500 in alimony per month after the divorce, make sure your soon-to-be ex-spouse knows that they will have to set aside around $375 for taxes (assuming they are taxed at a rate of 25%).



The Recapture Rule

When it comes to discussing alimony payments, you must always keep in mind the so-called “recapture rule.” It comes into effect if the payments experience a “substantial decrease” or simply stop in the first three years after your divorce. So, what does substantial decrease mean and when can it be argued?

You can argue a substantial decrease in two specific cases. In the first one, the total alimony payments received for the third year plus $15,000 must be less than the alimony paid for the previous year. In the second case, the average alimony paid for the second and third year must be less than the total paid during the first year. If one of the two situations occurs, the recapture rule applies.

The recapture rule makes the paying spouse pay back the IRS any tax benefits that were improperly taken during the first two years after the divorce. In addition, any deductions must also be recaptured after the third calendar year post-divorce has passed.

Alimony and Mortgage Payments

If you and your spouse own a residence and only one of you will be paying the mortgage for it, there are some more tax implications to consider. If the paying spouse agrees to pay the mortgage while the receiving spouse still lives in the residence, then the mortgage payment is technically also an alimony payment, no matter whose name is on the deed to the house.

For example, even if you own the house and keep on paying the mortgage, if you move out and decide to let your ex-spouse live there, your payments are essentially alimony.

Alimony Trusts

When discussing alimony, the receiving spouse should make sure payments are regular and will not suddenly stop because of an unexpected issue. There should be a safeguard in case the paying side cannot afford to pay. In order to achieve that,the paying spouse can set up an alimony trust by offering property or an income-producing asset. The purpose of the trust is to cover the alimony payments in case something unexpected occurs. After all, the paying spouse could go bankrupt, become unable to work, or pass away — in such cases, the alimony trust helps the receiving spouse keep on getting the necessary financial support.

As pointed out, an alimony trust can be beneficial for the receiving spouse in several situations.

Such a trust should be up for discussion depending on the occupation, health, and current situation of the supporting spouse. For example, if the paying spouse has an unstable job or exhibits reckless spending behavior, insisting on an alimony trust is the wisest possible decision. Similarly, if the paying spouse is in poor health, establishing an alimony trust would protect the receiving spouse. Similarly, a trust protects the receiving spouse if there are any suspicions that the paying spouse would quit their job in order to avoid paying alimony.

When it comes to taxes on alimony trusts, the IRS has taken special care of such situations. If you transfer property into an alimony trust, you do not have to pay any taxes on it. That includes the usual “gift tax” that would usually apply for such actions. However, it’s important to remember that this exception exists only if you establish the trust as part of a divorce agreement.