Alimony vs. Child Support on Your Taxes
Alimony is tax deductible to the payor and taxable to the recipient, and child support is taxable to neither the payor nor the recipient. For this reason, alimony payors sometimes want as much support as possible to be in the form of alimony, and recipients want as much as possible to be in the form of child support.
When the payor's income is higher than the recipient, it may be advantageous to both parties to pay alimony rather than child support. The tax advantages of alimony allow the payor to increase the after-tax level of support to the recipient. Sometimes the higher-income spouse agrees to pay additional incidental expenses of the other spouse, such as medical insurance, or life insurance on the payor's life, home mortgage payments, and car payments. But it is important to make sure that these payments meet the IRS guidelines as alimony.
Care must be taken in writing the marital settlement. Divorcing spouses must clearly distinguish between payments that are property settlement and those that are alimony. Alimony payments, which are tax deductible to the payor and taxable to the payee, are different from property settlements, which are generally without tax consequences to either spouse. A distinction between the two is critical if for no other reason than tax consequences.
Transfers between divorcing spouses are not taxable, nor are transfers between spouses incident to divorce. Transfers incident to divorce are those within one year of the end of the marriage or those "related to the cessation of the marriage." Such transfers related to the cessation of the marriage can happen up to six years after the divorce. That six-year period can be extended under certain conditions, if "legitimate legal and business impediments preclude a transfer within that six-year period."
A caveat is in order. Because many couples pay and receive support in the form of taxable alimony, the IRS has a set of multi-faceted restrictions that "can be a trap for the unwary taxpayer who gets too greedy in characterizing support as alimony. One set of restrictions tests to make sure alimony is not 'front-loaded' - that is, too concentrated in the period immediately after the divorce. The term for this is 'excess alimony.'"
The terms and conditions of alimony must be spelled out. One spouse cannot just being paying the other money he or she considers alimony and hope to claim it as a tax deduction. The IRS will not accept this. A written separation agreement is necessary if the spouses making payments of support to the other during this separation wants to claim a tax deduction for these payments. By the way, payments of support such as this are not uncommon, and are often called "separate maintenance" or "alimony pendente lite" (essentially, "alimony until the litigation"). Basically, the IRS needs something more than the spouses' say so in order to properly allocate deductions and income. Even if a divorce decree states that certain payments are alimony, the IRS need not accept a court's characterization. For its purposes, the IRS Code and associated rules are controlling. Spouses, however, can agree in a separation instrument or a court-imposed order what payments or portions of payments would not be considered alimony. The court order will serve the same function for the IRS as a written agreement would.
Divorcing spouses must remember what are called "IRS recapture rules." Recapture applies to alimony payments when the alimony paid decreases by more than $15,000 annually within a three-year period after a divorce. If in a three-year period a taxpayer's alimony decreases by more than $15,000 from the amount of the proceeding year, the IRS regards the alimony payments as property distribution and recaptures the obligor's income retroactively. In this, the IRS recovers the tax benefit of a deduction or a credit taken by a taxpayer and disallows the deduction. Recapture prevents a divorcing couple from dividing their property and calling the distribution alimony.
Resources & Tools
CARE WITH PENSIONS -- The distribution of any ERISA (Employee Retirement Income Security Act)-qualified pension, profit sharing or bonus plan may have adverse tax consequences because under the I.R.S. Code and ERISA these benefits are not assignable, and can only be transferred via a QDRO (Qualified Domestic Relations Order).
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