Tax Issues in Divorce:
Spousal and Child Support

By Staff Writer

The tax issues in Divorce can be overwhelming and complicated. Unfortunately, many couples fail to either appreciate or address those issues. Rather, they often believe that their attorney understands and has reviewed those issues and they trust that the tax issues have thus been fairly addressed in their agreement or in the Court’s decision. Few family law and Divorce attorneys have any training in tax law. Separation Agreements often contain a disclaimer stating that the attorneys have not provided any accounting or tax advice, but the parties rarely consult with outside experts who can provide that advice. Equally as unfortunate, if the attorneys are not well versed in tax issues, they may not adequately present those issues to the Court if the case goes to trial. If the issues are not presented to the Court, they will not be reflected in the Court’s decision.

In this article, we briefly discuss the most common tax issues that you should be concerned with. From here it is your responsibility to either retain an accountant or tax expert or insist that your attorney do so on your behalf. You may, of course, research some of the basic issues yourself. There are many valuable services available, both on line and through traditional business channels where you can obtain that information.

Alimony or spousal support is deductible by the party paying that support and must be claimed as income by the party receiving that support. However, the spousal support must be paid pursuant to a written Separation Agreement or a temporary or final Order of the Court. If the parties amicably and physically separate and agree upon payments to be made by one party to the other, but neither formalize that agreement nor obtain a Court Order, the party paying that support cannot deduct the payments on his or her tax return.

There are many technical rules that apply to spousal support payments that can affect deductibility. To be considered deductible spousal support, the payments must be made in cash (i.e. not in property) to the other spouse or to a third party on behalf of that spouse. For example, the payment of educational expenses or health insurance on behalf of a spouse can be considered deductible spousal support. The parties cannot be members of the same household and they cannot file a joint tax return. These requirements must be met or the spouse making the payment can not deduct the payments.

In addition to the above rules, the payment of spousal support cannot be disguised Child Support. If it is, the payment may be disallowed as a deduction. The rules regarding disguised Child Support are relatively simple and easy to avoid if your attorney is aware of the rules. If the payment of spousal support is tied to contingencies that are clearly related to the children, the payments can be disallowed. For example, if spousal support payments terminate upon the emancipation of a child, the death of a child, or within six months of your state’s age of majority, the payments are clearly related to the children. There are other contingencies that can be considered as clearly relating to the children. For an analysis of those rules, you should consult with a tax expert.

The practical effect of the above rule can be devastating. Your spouse’s attorney may be very aware of the tax implications of the wording of your agreement, even if your attorney is not. If so, after the agreement is finalized, with both parties having negotiated extensively for the tax benefits that they were in need of, the spouse who’s attorney knows the rules advises that spouse to take a different position with the IRS than the agreement contemplated. The IRS may well agree. Unfortunately, a Court may well refuse to revise the agreement, stating that the aggrieved party is bound by the determination of the IRS.

An additional rule governs the payment of property transfers disguised as spousal support. The relevant rule is referred to as recapture. Simply stated, the rule regarding recapture disallows the deductibility of some or all of the spousal support if the payment of that support in the third year of payment exceeds the payment made in the second year by $15,000. This rule is only relevant to final Orders of spousal support and written agreements. Any payments made under a temporary Order of support will not be included in the calculation.

Given the Government’s penchant for rules and regulations, a full explanation of the rules on recapture is well beyond the scope of this Article. If you are paying or receiving spousal support at a level that will vary by a significant amount over the first three years, you must seek the advise of a tax expert prior to finalizing your agreement. If you do not and the IRS disallows some or all of your deduction, your ability to convince a Court to change the agreement may be limited. There is a further reason for consulting with a tax expert with regard to the rule on recapture. If you are paying or receiving spousal support at a significant level, you may be able to use those rules to plan tax payments to your benefit. The rule on recapture may not be a penalty under those circumstances. Rather, it may be a tax-planning tool that can be used to your benefit in negotiating your Divorce or Separation.

The tax rules on Child Support are simple and straightforward. Child Support is not deductible by the party paying the support and the party receiving the support does not claim it as income. This is all you need to know when negotiating the tax implications of direct Child Support payments.