The Tax Implications Of Spousal Maintenance Buyout

Many divorcing couples in New York look for alternatives to a traditional spousal maintenance agreement. A common option is the buyout: the payor gives the payee an immediate lump sum that represents the current value of all future support payments. While this is often of benefit to both parties, everyone needs to understand the tax implications.

Typical New York State spousal support is tax deductible to the payor, and taxable to the payee. In other words, the recipient has to report the maintenance as income and, to avoid double-taxing the money, the payor doesn’t have to pay income tax on it. On the other hand, alimony buyouts are neither tax deductible nor taxable, and that’s because the IRS doesn’t consider the payment to be true alimony.

The federal government’s view is that a maintenance buyout is part of the divorce property settlement and therefore not taxable. In a property settlement, jointly-owned assets that were bought with previously-taxed money are being divided therefore there is no income and no tax implications. The IRS deems lump sum payments as part of the settlement.

This can be good news for the payee as the money will not be taxed. On the other hand the amount of the lump sum will be lower than the combined value of the maintenance payments laid out in the divorce settlement agreement, in part because of the different tax situation.

The payor might be saying, “Hey, wait a minute! I’m losing a tax deduction.” This is true but consider the big picture. The loss of a deduction is offset by the lower long-term payments as well as less tangible benefits such as not having to write a check to the ex-spouse every month.

Divorce software takes into account taxes, inflation and other factors that affect the current value of future maintenance payments when calculating a lump sum. Attorneys use these applications to calculate an objective amount that is fair to both parties. The lack of bias facilitates negotiation and helps divorcing couples come to an agreement more quickly.

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