Alimony: A Tax Planning Opportunity

Federal tax rates are likely to be increased for higher income individuals. Moreover, tax planning issues are already important in Maryland.

Our state’s high income tax rate is added to the local rate levied by all counties with Howard and Baltimore at the highest level permitted by law. Divorce Lawyers need to keep in mind the income tax savings opportunities offered by payments that can be legitimately characterized as alimony. If alimony is paid by a higher income tax payer to a lower income taxpayer, the savings is the amount of the payment multiplied by the difference in the effective marginal rate.

Alimony and child support are areas worth exploring for many higher income individuals involved in separation or divorce.

There are nine tests for alimony:

  1. payment must be in cash or cash equivalent,
  2. the payment must be received by or on behalf of a spouse. The payment may be paid directly or indirectly,
  3. the payment must be made under a “divorce or separation instrument”, which includes a written separation agreement or court decree,
  4. the divorce or separation instrument must not state that the payment is not alimony,
  5. the parties must not be living together, although, there is an exception for parties who are “legally separated” pursuant to the Internal Revenue Code,
  6. the payment must terminate on death of the payee spouse,
  7. the parties may not file a joint tax return,
  8. the payments may not constitute child support and
  9. the payments may not be front end loaded so as to be disguised as a property settlement.

The difference between child support and alimony is somewhat complex. However, especially in an era of back breaking tuition for private schools and colleges, this is an area worth exploring for many higher income individuals involved in separation or divorce. Individuals who are interested in educating themselves further regarding the tax consequences of separation and divorce, should take a look at IRS pub 504 Tax Information for Divorced and Separated Individuals.