According to the Journal of Accountancy, the IRS has increased resources devoted to scrutinizing alimony.
As is well known amongst divorcing individuals and financial professionals, the tax code allows the payor of alimony to deduct it from taxable income, while the recipient must include it in taxable income. So if Kevin pays Kate $30,000 of alimony a year, he can reduce his taxable income by $30,000 while she is supposed to claim $30,000 as income on her tax return, and pay taxes.
Unsurprisingly, divorced couples don't agree about alimony any more than they do about anything else. In March 2014, TIGTA, an IRS watchdog, issued a report identifying a large tax gap between alimony deductions by payers and the corresponding income claimed on ex-spouses' returns.
Titled “SIGNIFICANT DISCREPANCIES EXIST BETWEEN ALIMONY DEDUCTIONS CLAIMED BY PAYERS AND INCOME REPORTED BY RECIPIENTS” (with the ominous all upper case and bold style on the cover), the report found that for the 570,000 returns that they analyzed for the tax year 2010, deductions exceeded income by more than $2.3 billion. More than 47% of returns showed discrepancies between the alimony payments deducted and the income reported.
According to Mike Conti, a CPA in Boston, TIGTA estimated that the IRS revenue loss from alimony errors could add up to $1.7 billion over a five year period. Although that is small compared to the estimated $385 billion tax gap, Mike Conti points out that alimony is now a target that the IRS has identified and quantified.
In fact, the IRS reported adjusting its audit filters to catch more high risk returns. According to the agency it is developing “other strategies” to address the alimony tax gap. In other words, divorcing individuals, at least those paying and receiving alimony, will be at a higher risk for an audit.
Divorces are messy enough as they are that a potential IRS audit may not make it to the top of the list of concerns. However, given that it is now completely predictable, it is better for divorcing individuals to pay the extra attention and avoid the audit or be ready for it.
For people paying alimony as well as for those receiving it, it is important to ensure that:
1) You fully understand what is alimony and what is not. Separation agreements are written in a legal style that is not always clear to non-lawyers. If you are not sure, if you have questions check with your lawyer or a financial specialist such as a CFP® professional, a Certified Divorce Financial Analyst (CDFA) or a CPA.
2) You agree with your ex on what alimony amount you are putting on your respective tax returns. Having a discrepancy between what he files and what she files could put both of you at greater risk for an audit.
3) Your separation agreement correctly specifies alimony. If it does not and you get audited, alimony could get disallowed. If you have not done so already, take the opportunity to verify that your separation agreement correctly specifies alimony.
4) You get proper professional post-divorce support. You will need it anyway for any number of other issues. Analyzing alimony and filing taxes correctly are just two of them.
5) You avoid pushing the envelope on this issue. It is simply not worth the additional aggravation.
Financial Planning Association of Massachusetts member Chris Chen, CFP®, CDFA™ is the principal of Insight Financial Strategists, LLC a Registered Investment Advisor in Waltham, MA specializing in retirement planning and divorce financial planning.
The information contained in this article is not tax or legal advice. If you feel that it may apply to you, consult with a qualified professional.
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