Global business affects more than just the economies of the world. As more businesses expand into the global economy, more members of the workforce are being relocated from their home countries. Consequently, more people are marrying people from different countries, and with more marriages come more divorces. Along with the emotional and financial stress, divorces have tax consequences.
This item explains the tax implications for the payers and recipients of alimony from an international perspective.
When a U.S. resident makes an alimony payment to a U.S. resident recipient, the payer is allowed an above-the-line tax deduction (Sec. 215) in the year of the payment, and the recipient is taxed on the alimony income (Sec. 71) in the year of receipt.
What Is Alimony?
Under Sec. 71, for a payment to be classified as alimony, it must be made under a written divorce or separation instrument and meet all of the following requirements:
- The payment must be in cash or cash equivalents;
- The divorce or separation agreement does not designate that the payment is not alimony under the Code;
- For payments made after the divorce or legal separation is final (the couple is no longer married for tax purposes), the payer and payee cannot be members of the same household at the time the payment is made;
- The payment is made to (or on behalf of) a spouse or former spouse;
- The payer's obligation to make payments must be relieved upon the recipient's death;
- The payer and the payee do not file a joint return with each other; and
- The payment cannot be explicit or disguised child support.
Obviously, it should be relatively easy to determine whether the above requirements are satisfied in the case of a U.S. divorce or separation agreement. But they may be more challenging to meet in the case of a foreign divorce or separation agreement.
Tax Implications for a U.S. Citizen Who Is a U.S. Resident, Paying Alimony to a Nonresident
For the purposes of this item, it is assumed that the recipient of the alimony payment is a U.S. nonresident.
The source of the alimony income is based on the residence of the payer spouse (see, e.g., Manning, T.C. Memo. 1979-146, aff'd, 614 F.2d 815 (1st Cir. 1980), and Housden, T.C. Memo. 1992-91). Therefore, if the payer is a U.S. resident, the alimony is considered U.S.-source income.
Under Sec. 871(a)(1), the payer is required to withhold tax on the alimony payment at a 30% rate, unless the recipient provides the payer with a completed Form W-8BEN, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting (Individuals), that states that, pursuant to the treaty between the United States and the recipient's country of residence, a withholding tax rate of less than 30% on the payment is allowed.
For example, Article 17, paragraph 5, of the 2001 United States–United Kingdom income tax treaty provides that an alimony payment made by a U.S. resident to a U.K. resident is exempt from tax in both the United Kingdom and the United States, except that if the payer is entitled to relief from tax (a tax deduction) for the payment in the United States, the payment is taxable in the United Kingdom.
The treaty's technical explanation further provides that deductible alimony payments made by a U.S. resident to a nonresident of the United States are taxable exclusively in the recipient's state of residence, i.e., the United Kingdom. Thus, the payer does not need to withhold any tax on the alimony payments.
However, the payer should obtain an individual taxpayer identification number from the recipient, so that he or she can complete the appropriate Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons, and Form 1042-S, Foreign Person's U.S. Source Income Subject to Withholding, at year end.
If the payer has to withhold 30%, then the payer has to remit the withholding tax via the Electronic Federal Tax Payment System (see IRS Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities, p. 41 (2014)).
Is the Alimony Deductible to the Payer If the Payment Is Not Taxable in the Recipient's Country of Residence?
Chief Counsel Advice (CCA) 200251004 provides that a payer is permitted to deduct alimony payments paid to a foreign recipient on the payer's U.S. tax return even if the recipient, as a resident of a treaty country, is not required to pick up the alimony as income.
Tax Implications for a U.S. Citizen Who Is a Resident Overseas of Paying Alimony to a Nonresident
As discussed above, the source of the alimony is based on the payer's residence. Therefore, if the U.S. citizen payer resides in Liechtenstein, for example, the alimony payment is not subject to U.S. withholding tax, since the payment is from a non-U.S. source.
Thus, these payments do not have to be reported to the IRS on Form 1042 and Form 1042-S at the end of the year.
The U.S. payer's deductibility would be the same as if he or she were a U.S. resident, as discussed above, if the recipient is a resident of a treaty country. But if the U.S. payer and the recipient reside in a nontreaty country, is the U.S. payer still allowed a deduction for the alimony payment? CCA 200251004 quotes General Counsel Memorandum 29633, which states:
This office, however, is of the opinion that to disallow the husband's deduction here merely because the alimony payments are exempt income to the wife, would not give proper standing to the exclusion provision, section933, and have the effect of nullifying it. Sections 61, 71, and 215 are, in this office's opinion, all interrelated. Section 61 is the general definition section which provides for the inclusion in gross income of certain items, whereas section 71 is a section relating to particularized rules for one of those income items. Similarly,section 215 amplifies section 71. In this connection it is important to note that section 61(a) specifically provides for exemptions to gross income, one of these being that contained insection 933, relating to income from sources within Puerto Rico. Thus, sections 61 and 71 must be read subject to exemptions from income contained elsewhere in the Code.
The CCA then observes:
Thus, there is no absolute requirement that the recipient be subject to U.S. tax on the alimony or separate maintenance payments for them to be deductible [on the payer's return] under 215, even though 71 and 215 are intended to be reciprocal when the payer and recipient are subject to U.S. income tax. Rev. Rul. 56-585 states the purpose of 215 is to relieve the payer from taxation of the entire net income when part of it went to the recipient as qualifying alimony or separate maintenance payments. When there is an express statutory exclusion of otherwise-includible payments from the recipient's income, this does not bar the payer's deduction.
Thus, since the recipient is not required to include the alimony payments in income pursuant to Secs. 61 and 71, as it is non-U.S.-source income, this should not result in the U.S. payer's being denied an above-the-line deduction under Sec. 215.
U.S. Tax Implications for a Nonresident of Receiving an Alimony Payment
If the alimony payment is non-U.S.-source income, then it is outside the scope of U.S. taxation, and there is no impact to the nonresident recipient.
However, if the alimony payment is U.S.-source income, then one of the following will result:
- If 30% was withheld correctly, the nonresident has nothing further to do or file with the IRS;
- If there was properly no withholding, the nonresident needs to file a Form 1040NR, U.S. Nonresident Alien Income Tax Return, attaching Form 8833, Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b), stating why he or she qualifies for no tax under the respective treaty;
- If 30% should have been withheld but was not, the nonresident needs to file a Form 1040NR and pay over the appropriate tax to the IRS; or,
- If 30% was withheld and it should have been a lower rate, the nonresident needs to file Form 1040NR, attaching a Form 8833 to claim a refund based on the lower rate of withholding under the treaty.
A U.S. citizen payer should be allowed a deduction on his or her U.S. tax return for alimony payments made to a nonresident. However, it is important for the U.S. resident payer to withhold 30% tax on payments to a nonresident recipient unless Form W-8BEN is provided. Otherwise, the payer could be liable for the withholding tax.
Anthony Bakale is with Cohen & Company Ltd. in Cleveland. For additional information about these items, contact Mr. Bakale at 216-774-1147 or firstname.lastname@example.org. Unless otherwise noted, contributors are members of or associated with Cohen & Company Ltd.