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Tuesday, November 07, 2017

Alimony--More Important in Family Law than Tax

The House tax reform bill denies any tax treatment to alimony payments, like property division upon divorce and child support.  Currently, alimony is an above-the-line deduction to the payor per §215.  However, alimony was intended to be more revenue-neutral, so the flip side is that alimony is includable as gross income to the recipient per §71.    

These tax rules on alimony have made federal income tax planning an important aspect of matrimonial practice for decades.  In particular, they incentivize the higher-income spouse to agree to pay alimony in a time when state legislators and courts are chipping away at the alimony obligation.

Despite its high impact in family law, the current tax treatment of alimony has only a small fiscal effect.  Indeed, denying the current tax treatment to alimony payments would increase tax revenues by under $1 billion per year.  However, some of this money can be recovered by simply better enforcing §71.   

While alimony payors often take a deduction, payees do not always include alimony in their gross income.  The Treasury Inspector General for Tax Administration (TIGTA) found that 47% of 567,887 tax returns filed in 2010 with an alimony deduction had either no corresponding alimony income reported by recipient spouse, or the amount of alimony income reported did not match the deduction taken.  This meant $1.7 billion in unreported taxes over 5 years.  TIGTA had recommended that the IRS send out warning letters to taxpayers alerting them to potential alimony errors. 

Thus, changing the current tax treatment of alimony while forgetting the family law context results in the unintended consequence of reducing alimony transfers.  If the goal is to guard the public fisc, enforcement of §71 is a better approach than denying tax treatment to alimony.

Posted by Margaret Ryznar on November 7, 2017 at 03:34 PM | Permalink

Comments

Would you really rather the IRS enforce the current law against alimony recipients as opposed to letting them keep it all tax free? I understand that the current state of affairs (the giver gets a tax break and the recipient doesn't report it) is the best from a family law perspective, but assuming the law is enforced, and *someone* pays tax on it, wouldn't you rather the giver pay tax as opposed to the recipient?

Posted by: biff | Nov 7, 2017 11:05:05 PM

I'd give the tax break to the payor to the extent that it incentivizes higher income spouses to agree to alimony in settlements, prenupts, postnups, etc. The lower-income spouses that most need alimony are in a low tax bracket, so the tax liability does not amount to much. But your point is right, and the alimony can also be set at a level to take into account the taxes of the recipient.

Posted by: Margaret Ryznar | Nov 8, 2017 3:31:12 PM

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