Alimony causes tax problems for some recipients

The Internal Revenue Service (IRS) recently announced that it would begin to look at the claims that taxpayers make about alimony - either paying or receiving. This adds yet another potential challenge to the already difficult arena of divorce finances.

Here's how it is supposed to work: The receiving spouse is supposed to claim alimony as income, and the paying spouse can deduct it. In contrast, child support and property settlements are neither deductable nor taxable.

When it comes to alimony and taxes, the reality appears to differ significantly from the way it is supposed to work, according to a story in the Wall Street Journal. A watchdog agency known as Treasury Inspector General for Tax Administration (TIGTA) reported that there is a large gap between the amount of alimony claimed as tax deductions and the amount of alimony reported as income. The gap was an amazing $2.3 billion. Of course, the amounts of alimony received and alimony deducted should be more or less the same.

By some estimates, the tax loss because of this widespread error could be as much as $385 billion over five years.

A related issue is that many taxpayers deducting alimony fail to prove a tax ID number for the recipient of the alimony, something that is required by the tax code. However, even though there a huge number of returns without the required tax ID, the IRS will not be automatically rejecting e-filed returns that don't have the required tax ID. It does reject e-filed returns that when both parents claim the child credit for the same child.

It's important that taxpayers understand that alimony is deductable to the payor and income to the payee. Some experts believe that failing to report alimony as income is not necessarily an effort to defraud the government. Because the other two types of payments common in divorce, child support and property settlements, are deductable, it is easy for people to be confused about the rules. Even tax professionals may not be entirely clear.

Alimony is often referred to as maintenance or spousal support. In the latter instance, it sounds like child support, and a recipient could be forgiven for thinking that they are handled the same way by the IRS. Another easy-to- forget type of income that should be reported is gifts from the payor spouse who purchases his or her ex a computer, a smart phone, or other needed item that would be otherwise too expensive to acquire. According to the IRS, such gifts should be reported as income by the recipient.