As a part of going through a divorce, ex-couples need to work out an agreement to divide the marital assets fairly. Since a major element of marriage is the financial partnership, a divorce should split all assets in half. One step in this process is deciding if alimony payments should be made. An individual who has agreed to make or receive alimony payments should know ahead of time how those payments will affect their US tax return, and should also note that there are special rules in place for a US citizen who is paying alimony to a nonresident alien.
How to report alimony payments to Residents and Nonresidents
What is Alimony?
Alimony is a series of regular payments made from one ex-spouse to their former partner. This type of payment is typically a part of a divorce where one spouse earned a significant amount more than the other. Since one spouse was financially dependent on the other to maintain their lifestyle, alimony payments serve to keep the balance so that neither party has to make adjustments to their quality of life.
Making alimony payments to a nonresident can become complicated. The tax rules are similar to purely domestic situations and encourage taxpayers to be compliant, but with withholding, paperwork and risks of being charged penalties for being compliant.
The Internal Revenue Service (IRS) has set up these guidelines to help identify when alimony payments are being made:
- The payment has been made in cash
- The payment is being received by or on behalf of an ex-spouse under a divorce or legally binding separation agreement
- The ex-spouses are living in different residences while the payments are being made
- Any payments being made to third party on behalf of the intended recipient are well documented with timely executed paperwork
- The obligation to continue making these payments ends when the recipient dies
- The ex-spouses do not file a joint tax return
- The divorce or separation documents do not designate non-alimony treatment
How Alimony Payments are determined?
Throughout the divorce process, both partners need to work out an agreement that states how any joint property and assets are divided along with income. The terms will depend on how the divorce is settled. Some ex-spouses may work things out through a mediator, while others need to go to a divorce court and have a judge make a final ruling on the terms of the divorce.
In either case, the divorce agreement is a legally binding document, whose stipulations must be followed. This includes any terms set there-in for alimony payments. As soon as a schedule has been set for making alimony payments, the payer is obligated to make those payments or they will be in violation of the law.
Do Alimony Payments Expire?
How long alimony payments last depend on how they have been laid out in the divorce agreement. They may be set to end on a specific date agreed to by both parties. In some cases they are scheduled to end in the event that the receiving ex-spouse remarries. Other stipulations could be that they end at the time of retirement or if the paying spouse were to lose their job. A judge also retains the right to review and amend the conditions of alimony payments if for example the receiving ex-spouse did not make a concerted effort to find employment.
How Does Alimony Affect Your Taxes?
For the receiving ex-spouse, any alimony payments count as income. Individuals receiving alimony payments must report them to the IRS and pay income taxes on that money in the same way they would with a salary received from employment. The ex-spouse who is making regular alimony payments may deduct them from their income taxes. Since legally those monies are being passed to another individual, the IRS has deemed that it should not be counted as income for the payer.
How to Report Alimony Payments on US tax return?
Reporting alimony received is fairly straightforward. The total amount received should be reported as taxable income on line 11 of a 1040 Form. It will then be calculated into the total taxable income.
For individuals who are paying alimony, the total paid is a taxable deduction. This is considered an above-the-line deduction that gets noted in full on line 31a of a 1040 Form before calculating the total taxable income for the year. The social security number of the recipient will need to be included on the form along with the amount of alimony being paid.
Why is it so Important to Report Alimony?
US taxpayers are legally obligated to report any alimony payments to the IRS, just as they do with any income received from employment. If they do not, they are in violation by not reporting income on their tax return. This could lead to having to pay any unpaid taxes and extra penalties and fees if the IRS where to find out.
The paying ex-spouse will almost always report as they are entitled to use that money paid as a tax deduction. The IRS is beginning to crack down on those receiving ex-spouses who are not reporting. The Treasury Inspector General for Tax Administration has released a report citing discrepancies in the amount of money that alimony paying individuals are reporting in comparison to the amounts being reported by receiving ex-spouses. Since the IRS now knows that this is an issue, they are making an effort to correct the problem by singling out those non-compliant taxpayers.
What is Child Support? How is the Child Support different from Alimony?
One reason why a taxpayer may not understand the importance of reporting their alimony payment for taxes is because it gets confused with child support payments. Child support payments are an issue when a divorcing couple has the expense of raising minor children to consider while drafting the terms of a divorce. These monthly payments are meant to be used to financially help in raising the child or children if one parent is in physical custody of them for more time during the month than the other.
As with alimony, the terms for child support payments will be set in the divorce agreement and are legally binding. These types of payments will generally be ceased once the child turns 18 years of age. The major difference between alimony and child support payments is the way in which they are handled for taxing purposes.
How are the Tax Rules for reporting Child Support?
With child support payments, the rules for reporting differ greatly. The receiving parent does not report child support payments as income and therefore does not pay taxes on that money. The parent responsible for making child support payments is unable to deduct those from their income taxes. This is where the confusion lies, as many people assume that alimony payments have these same regulations.
A divorce agreement will state clearly which parts of the monthly payments are allocated for child support and which are for alimony. Those payments which can be directly related to children, such as with terms stating they end when the minor turns 18, will likely be classified as child support by the IRS.
It may be difficult immediately following a divorce to figure out these differences in the laws. Individuals who plan right using this information should be able to sort it out without problem.
How Are Alimony Payments to a Non-Resident Spouse Reported?
Alimony payments being made to an ex-spouse who is a non-resident are still deductible. It is applying that deduction which becomes more complicated. The amount of paperwork required will be dependent on the Tax Treaty, if any, that exists between the United States and the country where the ex-spouse receiving alimony resides.
In the event that the Treaty provides an exemption to the recipient of the alimony received by a US citizen spouse then the alimony payment may still be deducted by the payer despite the ex-spouse not having a US tax ID number. This type of agreement exists in the Tax Treaty that has been set in place by the US and Switzerland.
For those payers whose ex-spouse lives in a nation where no such Treaty is in place, it is their responsibility to withhold 30% in taxes from each payment and pay that money to the IRS on their non-resident ex-spouses behalf. The alternative would be for the non-resident spouse to obtain a US tax ID number, file form 1040NR (US non-resident tax return), report the receipt of the alimony and pay the appropriate taxes themselves.
The first option is not a cost effective one for the payer, as his or her tax reduction may be less than the 30% taxes paid out for the ex-spouse. Unfortunately, the second option is often not feasible in real life circumstances.
How Does a US Person Report Foreign Alimony Payments?
Alimony which is paid by a non-resident spouse to a US citizen is considered taxable income for the recipient. For those individuals living in the US, the income would be reported on 1040 Form and fully taxable.
For those US spouses who are living abroad and receiving alimony from a non-resident, most tax treaties will provide special exemptions for those payments. Tax should only be applied by the country where the citizen resides and not be included as taxable income for any other taxing agency. A tax advisor should be consulted in this case as Treaty exemption rules will vary by different countries.