Tax Consequences of Maintenance
As a general rule, maintenance payments are treated as taxable income to the party receiving maintenance. Conversely, maintenance payments are treated as tax-deductible to the party paying maintenance. That means that the person receiving maintenance must claim the maintenance (which the Internal Revenue Service refers to as “alimony”) as income on his or her tax returns, and must pay federal and state income taxes on those funds. The person paying maintenance is allowed to deduct maintenance payments from total income on his or her federal and state tax returns.
In light of these general rules, an effective attorney will provide the client with practical advice as to how to go about anticipating these tax consequences prior to filing his or her income tax returns. While the spouse paying maintenance may eagerly anticipate a large tax refund, the spouse receiving maintenance is often totally unprepared for the large tax bill that will come due when filing his or her returns. The attorneys at Kollias & Giese, P.C. make it a point to inform their clients not only of their rights and obligations with respect to maintenance, but also provide practical, forward-thinking advice as to how to anticipate and address the consequences.
With regard to the tax consequences of maintenance payments, there are strict requirements set forth in Section 71 of the Internal Revenue Code which must be met in order for the general rule to apply. These requirements can be summarized as follows:
- The maintenance must be paid pursuant to a legal obligation, such as a Judgment of Dissolution of Marriage or valid temporary support order. Payments which are made voluntarily, or payments made pursuant to an oral agreement, do not meet this requirement.
- The maintenance payments must be paid by way of cash or a cash equivalent, such as a money order or a check. Payments made to third parties (such as paying the spouse’s rent in lieu of maintenance) can sometimes meet this requirement, depending on the way the order is written.
- The parties must live in separate households.
- The maintenance must terminate upon death of either party.
- The parties cannot file joint income tax returns.
- No portion of the maintenance obligation can be specifically designated as child support.
Sometimes, the parties may wish to agree to non-modifiable and non-terminable maintenance payments in their Judgment of Dissolution of Marriage. This form of support is also known as maintenance in gross. The IRS has determined that maintenance in gross does not meet the above-requirements. Instead, it has found that maintenance in gross is in essence a property settlement because it survives death. Therefore, the payments cannot be deducted by the payor. Because the tax issues surrounding maintenance and property settlements are complicated and the laws are ever-changing, you should be sure to seek out the advice of experienced counsel. The attorneys at Kollias & Giese, P.C. have extensive knowledge in this area and would be more than happy to speak to you regarding the individual circumstances of your case.