Skip to content 
If you’re paying alimony as part of a divorce or separation, it’s important to understand the tax rules that govern these payments, especially after recent changes in tax law. Business owners, in particular, need to be cautious to ensure they don’t draw unnecessary attention from IRS auditors when deducting alimony payments on their tax returns. In this post, we’ll break down the critical details and how to protect yourself from potential pitfalls.
Alimony and the IRS: Why It’s a Red Flag
Alimony deductions are historically known to raise red flags for IRS auditors. Before you consider deducting these payments, you must ensure that the terms of your divorce or separation agreement meet strict IRS requirements. Failure to do so can result in costly audits, penalties, and interest on back taxes.
Understanding the language of your divorce or separation agreement is essential, as it dictates whether payments qualify as deductible alimony. If the agreement isn’t crystal clear or is improperly structured, it can lead to trouble during tax season.
Pre-2019 Alimony Rules: What You Need to Know
Before the implementation of the Tax Cuts and Jobs Act (TCJA) in 2018, individuals who paid alimony to an ex-spouse could deduct those payments on their personal tax returns. Conversely, the ex-spouse who received the alimony had to report it as taxable income. These rules were beneficial for payors because the deduction often resulted in significant tax savings, especially for those in higher tax brackets.
To qualify as deductible alimony under pre-2019 rules, the following conditions had to be met:
- The alimony payments must be made in cash.
- Payments must be made to a spouse or former spouse under a formal separation or divorce agreement.
- The agreement cannot explicitly state that the payments are not alimony.
- The spouses cannot live in the same household when the payments are made.
- There must be no obligation to make payments after the death of the recipient.
- Payments cannot be treated as child support or part of a property settlement.
If your agreement met these conditions, you could deduct the alimony payments, and your ex-spouse would report the payments as income. However, if any of these conditions were violated, you would lose the deduction, and penalties could be assessed.
The Tax Cuts and Jobs Act: A Major Shift
The TCJA brought a significant change to alimony taxation. For divorce or separation agreements executed after December 31, 2018, alimony payments are no longer deductible for the payor, and the recipient does not report the payments as income. This change makes it even more important to structure agreements carefully, as there’s no longer a tax benefit for the paying spouse.
Important Note: If you have a pre-2019 divorce agreement that allows for deductible alimony payments, those payments are still subject to pre-TCJA rules unless the agreement is modified. If the agreement is altered and specifically states that the TCJA rules apply, the new tax treatment kicks in.
Common Pitfalls to Avoid
To avoid drawing the attention of the IRS, it’s critical to ensure that all alimony payments are structured correctly and meet the necessary qualifications. Here are some common issues to watch out for:
- Incorrect Designation: If your separation agreement designates alimony as nondeductible, those payments will not qualify for a deduction. Make sure the agreement is clear and explicit about the nature of the payments.
- Living Together: If you and your ex-spouse continue to live together after the divorce, even temporarily, the payments you make during that period won’t count as alimony and will not be deductible.
- Child Support Confusion: Make sure your payments are not being treated as child support. Alimony and child support are treated differently for tax purposes, and any payment categorized as child support is nondeductible.
- Payment Obligation After Death: If your obligation to make payments continues after your ex-spouse’s death, those payments do not qualify as alimony. Ensure that your agreement explicitly terminates alimony payments upon the recipient’s death.
Planning for the Future
For business owners, financial planning is key when navigating the tax implications of divorce and alimony payments. If you’re currently negotiating or modifying a separation agreement, consider how the changes brought by the TCJA affect your financial picture. Consulting with a tax professional is recommended to help structure the agreement in a way that minimizes your tax burden while staying compliant with IRS rules.
Final Thoughts
The repeal of alimony deductions for post-2018 agreements is permanent, and as a business owner, it’s important to keep this in mind when making financial decisions related to divorce. Ensure your agreements are structured properly, and be aware of the potential red flags that could trigger an IRS audit. By staying informed and following the rules, you can avoid costly mistakes and ensure smooth sailing when it comes to your tax filings.
