When spouses discuss and negotiate alimony, they usually have a lot of questions. The person that is potentially on the hook for paying alimony might ask why and if they have to pay alimony at all, and the person hoping to receive alimony might ask how much he or she is entitled to receive, for how long, and whether that amount is subject to modification. These are all very important questions, but one question that often gets lost in the process – and yet is an issue that can have a huge impact on how much alimony you actually end up paying or receiving at the end of the year – is whether there are taxes and/or tax deductions associated with alimony. The answer is often yes, and there are several important issues to keep in mind with regard to how alimony will be treated on your state and federal tax returns.
Alimony is Considered Ordinary Income to the Receiver
The general rule is that, if you receive alimony through a court order, then that alimony will be considered ordinary income and you will be expected to pay federal income taxes on all alimony you receive at the end of the year. Your alimony will simply be added to the amount of taxable income that you earned in a year, and assuming you do not have other deductions or were otherwise owed a large tax refund that collectively was more than the amount of alimony you received, this will likely mean that you will have to end up paying money to the federal government at the end of the year.
Furthermore, because alimony will be added to your income on top of any income you have already received, this means that the alimony payments will be taxed at the highest rates applicable to you. Thus, when thinking about your needs post-divorce, it is important to keep in mind how much of the alimony you are seeking will have to be paid in taxes.
Alimony is an Above-the-Line Deduction to the Payer
On the other hand, alimony can be a federal tax deduction for the person making the alimony payments, and this will come off the top of the payer’s income as an above-the-line deduction. Thus, payers of alimony, especially those earning high incomes, can get a good chunk of their payments back in their tax return at the end of the year. For example, if the top tax rate that applies to you is 35% and you pay $30,000 a year in alimony, you could potentially lower your tax burden by up to $10,500.
State Taxes May Apply As Well
Many states also consider alimony as taxable income and a qualifying tax deduction on state tax returns, but this is not the case in Pennsylvania. Thus, residents of Pennsylvania do not have to pay state taxes on alimony received nor can they take a deduction for alimony paid.
Not All Alimony Qualifies For This Tax Treatment
Because the tax liabilities and benefits of alimony can be so significant, it is incredibly important for spouses on both sides to understand whether their alimony payments will qualify. Again, only court-ordered payments will qualify, so paying spouses should understand they will get no benefit for voluntarily-made payments prior to an order. Furthermore, attorneys may negotiate a settlement which will require the payer to agree not to take a deduction so that they payee does not have to declare it as income. Failure to appreciate such a term can have huge impacts for both sides in a divorce.
Work with a Family Law Attorney in Your Pennsylvania Divorce
At The Martin Law Firm, P.C., in Montgomery County, we are committed to serving your family law needs in a compassionate manner. Call us today for a no-hassle consultation regarding any questions you have about the divorce process in Pennsylvania.