The Taxpayer Relief Act of 1997 has provided significant changes to
the income tax map for individuals and businesses. Some changes which affect the
arena of separation and divorce are as follows:
The sale of a home is easier due to a new exclusion for capital
The dependency exemption is more valuable because three new
credits and a deduction are tied to it.
The lower capital gains income tax makes property with a low
basis more valuable.
New IRA rules can make it easier to utilize IRA funds for
alimony and equitable distribution.
The foregoing changes are incorporated in the following materials.
Child support payments made by payor are not deductible
pursuant to Section 71. These payments are treated as family expenses under
Section 262(a) and are not deductible. See IRC ß261.
Alimony tax treatment does not apply to any payments or
portions thereof in the nature of support for minor children. However, where a
property settlement agreement, divorce decree or order of court does not allocate a
specific portion of a periodic payment as child support, then generally no portion of
the payments thereunder will be considered to be child support.
Direct expenses paid by an obligor pursuant to a child support
order are not deductible as business expenses even if non-payment would subject
payor to incarceration for contempt, rendering payor unable to work.
The Pennsylvania support court and the parties may allocate
child support and alimony. Some considerations are as follows:
Generally, an unallocated spousal and child support order
will be favored by the payor because the payor will be eligible to deduct the entire
monthly amount paid for federal income tax purposes.
Generally, an allocated spousal and child support order
will be favored by the payee because the recipient will not be required to claim as
income that portion designated as child support. Only the spousal support amount
shall be taxable to payee.
In some instances the payee may find it advantageous to
withdraw the claim for spousal support and/or alimony pendente lite to receive only
child support, because this amount will be nontaxable to the payee. For example,
assume the obligee is earning $2,000.00 per month and obligor is earning $3,000.00
per month and there is an action pending for spouse and two children. The
Pennsylvania Supreme Court Guidelines dictate an award for two children in the
amount of $696.00, all of which would be nontaxable to the payee or an award for
spouse and two children in the amount of $787.00 which, if unallocated, would be
entirely taxable income to payee. Therefore, it may be in the best interest of payee
to withdraw his or her claim for spousal support and only proceed with the child
support claim, to avoid the $787.00 per month from being income taxable ($787.00 x
12 = $9,444.00 x .15% = $1,416.60 income tax; $9,444.00 - $1,416.60 = $8,027.40 net
support compared to $696.00 x 12 = $8,352.00 support).
In the situation where the payee has no income it may be
advantageous to both parties to enter an unallocated spousal support and child
support order. The payee will most likely be in a substantially lower tax bracket
than the payor and will therefore pay lesser taxes on amounts received.
In certain instances it may benefit both parties to
designate an additional payment to payee as spousal support, enabling the payee to
pay income taxes with the additional amount. The payor may deduct fully the
entire amount paid.
In certain instances it may be to the benefit of both
parties to reach an agreement wherein payor, in addition to paying spousal support
and child support on an unallocated basis, agrees to pay payee's taxes incurred in
regard to the unallocated Order.
The IRS federal income tax refund intercept procedure is
effective for a court order for child support only or for unallocated child and spousal
support/alimony pendente lite where arrears are due to nonpayment of the order.
Pre-1985 rules. Payments under former Section 71(b) [now
Section 71(c)] were also required to meet two additional requirements to be deemed
The decree, instrument or agreement had to "fix" the
amount of child support.
The payments were for the support of the transferor's
Under pre-1985 rules, if the periodic payments were received by
the payee for the support and maintenance of himself or herself and the minor
children, but the decree failed to designate a specific portion of the payment as child
support, and provides for no automatic reductions, then the entire payment was
includable in the obligee's gross income (and is deductible by the obligor). IRC Reg
In an attempt to finally resolve the uncertainty promulgated by
the vast number of conflicting cases, the United States Supreme Court defined the
term "fix" in the case of Comm. v. Lester, 366 U.S. 299 (1961). Pursuant to a
written agreement, Mr. Lester was required to make payments for spousal and
child support. While the agreement did not allocate spousal and child support
payments, there was an automatic reduction in the amount of the payments as each
child died, became emancipated or married. Further, the entire payment
terminated on wife's remarriage. The Commissioner ruled that the terms of the
agreement were sufficiently clear to fix a portion of the total payment as child
support. The Supreme Court, disagreeing with the Commissioner, held that
payments would not be treated as child support payments unless they were
expressly designated as such in the agreement. The statutory requirement is strict
and carefully worded. The Court determined that "a sufficiently clear purpose" on
the part of the parties was not sufficient to shift the tax. Finally, the Court
reasoned that the agreement did not curb the recipient's absolute discretion as to
how to utilize the support payments, notwithstanding strong hints in the agreement
concerning the portion of the total payment which was allocable to child support.
The Internal Revenue Service acquiesced to the Supreme Court's holding in the
Lester case and adopted the Court's position in Revenue Ruling 62-53, 1962-1, C.B.
The case law made it clear that the payment would be
considered to be alimony unless the decree, instrument or agreement expressly
specifies the portion or amount of the payments intended as child support.
Additionally, the case provided as follows:
An interference from the document does not "fix" a child
support obligation. Consequently, reductions that depend on future contingencies,
from which the amount of child support can be inferred, were not sufficient to fix
the child support.
State laws that designate a portion of unallocated
payments as child support did not operate to fix a portion as child support under
The Tax Reform Act of 1984: A Repeal of Lester.
The Tax Reform Act of 1984 amended Section 71 to significantly
expand the treatment of a payment as alimony by radically redefining what
payments are considered "fixed" as child support. The rules under the Tax Reform
Act of 1984 apply to all agreements or decrees entered after January 1, 1985 and to
certain pre-1985 agreements or decrees whose alimony or support terms were
modified after January 1, 1985.
A contractual payment is "fixed" as child support if the payment
is one of the following:
Subject to reduction on happening of a contingency
"relating to" the child such as attaining specific age or income level, marrying,
dying, leaving school, leaving spouse's household or obtaining employment.
Subject to reduction at a time which can be "associated
with" a contingency related to the child.
A specified contingency may "relate to" a child regardless of
whether the event triggering the contingency is certain or likely to occur.
There are two specific situations where a reduction in payment
will be presumed to be "associated with" a contingency relating to a child:
Reduction to payments not more than six months before
or after the date the child is to attain age of 18, 21 or the local age of majority. Any
time there is a reduction at a future calendar date, each reduction must be
examined separately with regard to each child's age. Close attention must be paid
to these "trigger dates" when representing the payor spouse otherwise a portion of
the payment may not be deductible.
Reduction of payments on two or more occasions which
occur not more than one year before or after a different child attains a certain age
between the ages of 18 and 24 inclusive, with the measuring age the same for each
child. The latter provision applies where the parties have more than one child and
there are two or more separate reductions involving two or more of the payor's
children, and is discussed further herein. See Temp. Regs. 1.71-1T(c) Q&A-18.
These two date-based tests in the Regulations to Section 71(c)
operate independently of each other. Consequently, if a reduction in payment falls
within the purview of either test, it is presumed that the reduction is "associated
with" a contingency related to a child and will be treated as child support.
Since it is possible for a reduction in payment to fall
within the second test and yet avoid the first, the Regulations effectively impose a
more rigorous "clearly associated" test upon taxpayers with more than one child.
The second test is more complicated than the first test, as
the IRS will look to whether the cessation or reduction of all or a portion of support
occurs one year before or after a child attains a certain age between 18 and 24
inclusive on two or more occasions. Temporary Regulation ß1.71-1T(c), Q-18 sets
forth the following example as an illustration of when payments are reduced on two
or more occasions which occur not more than one year before or after a different
child of the payor spouse attains a certain age between the age of 18 and 24,
Albert and Betty are divorced on July 1, 1985. Their two
children, Carl (born on July 16, 1970) and David (born on
September 23, 1972), are 14 and 12 respectively. Albert
must pay Betty $2,000.00 alimony per month. The
divorce agreement provides that the alimony payments
are to be reduced by $500.00 on each of two dates,
January 1, 1991 and January 1, 1995.
On the first reduction date, January 1, 1991, Carl is 20
years, 5 months and David is age 18 years, 3 months. On
the second reduction date, January 1, 1995, Carl is 24
years, 5 months and David is age 22 years and 3 months.
The regulations prohibit reduction on occasions that occur
not more than one year before or after Carl and David
attain a certain age between 18 and 24 inclusive.
Each occasion of a reduction occurs less than one year
before or after a different child attains the age of 21 years,
4 months. The first reduction date occurs less than one
year before Carl turns 21 years, 5 months and the second
reduction date occurs less than one year after David turns
21 years, 3 months. Thus, each reduction date occurs
within one year from the date Carl and David reach age
21 years, 4 months.
By arranging the reduction dates side by side, the "clearly
associate" date becomes more apparent:
1st Reduction Date 1/1/1991
2nd Reduction Date 1/1/1995
20 years 5 months
24 years 5 months
18 years 3 months
22 years 3 months
1 Year Prior 1/1/1991
1 Year After 1/1/1991
19 years 5 months
21 years 5 months
17 years 3 months
19 years 3 months
1 Year Prior 1/1/1995
1 Year After 1/1/1995
23 years 5 months
25 years 5 months
21 years 3 months
23 years 3 months
Less than one year apart for each; Midpoint = 21 years, 4 months
The presumed "trigger" age of 21 years, 4 months is within one year of
the age of a different child at both reduction dates. Therefore, both of the
reductions would be presumed to be "clearly associated" with the children.
Payments under the divorce decree totaling the amount of the reductions
($1,000.00) would not qualify as alimony payments, and would be treated as
nondeductible child support paid by Albert.
The Temporary Regulations do not require that the parties
intended that the reductions be related to the children. The second date related test
can inadvertently cause a disallowance of an alimony deduction.
These tests, as delineated by the Temporary Regulations, create
a "rebuttable presumption" that the "trigger age" was intended by the parties or the
court to trigger a reduction of the child support portion of the periodic payment.
Either the Internal Revenue Service or the taxpayer may rebut the presumption by
showing that the time for the reductions was determined independently of the
contingencies relating to a child of the taxpayer. Thus, in the instance of the six-
month test, former spouses can conclusively rebut the presumption by showing that
the reduction in support payments will result in the complete elimination of
alimony "during the sixth post-separation year or the expiration of a seventy-two
month period" Temp. Reg. 1.71-1T(c), A-18.
Additionally, the presumption can be rebutted if the local
custom is to cease alimony payments after a certain period, such as a period equal
to one-half the duration of the marriage. Temp. Reg. ß171-1T(c), A-18.
Although former spouses can elect not to classify alimony as tax
deductible to obligor and tax includable to obligee for federal income tax purposes,
they cannot make a similar election that will classify child support as tax
deductible/tax includable alimony.
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