As defined in Section 71(b) of the U.S Tax Code, alimony and spousal support payments are generally deductible from the gross income of the party making the payments if very specific requirements are met under the Internal Revenue Code. Additionally, they are generally included in the taxable gross income calculations of the party receiving the alimony or spousal support payment. It is also important to note that the lawful source of funds utilized to make a payment for alimony or spousal support is irrelevant for deductibility or gross income calculations. By contrast, child support payments are not deductible by the spouse making the payments or includible in the income of the recipient spouse for tax purposes. It is important to understand what factors are used to determine whether a payment can fit into these classifications.
A separate maintenance or alimony payment will be generally deductible when it is made by one former spouse to another, when they do not live together and no longer file taxes jointly. To determine whether a payment qualifies for treatment as a deductible spousal support payment or alimony one must also consider whether the payment is received under a written, legal divorce or separation agreement and is properly delineated as separate maintenance or alimony in the legal document. Furthermore, the payments must not continue beyond the death of the spouse who receives the payments. Factors that are irrelevant to the alimony or spousal support analysis include whether the payment is a fixed or guaranteed amount, or considered as such for family law purposes. Many other subtleties exists in the law. For example if an amount that presumably qualifies as spousal support decreases based on some future contingency related to a child of the marriage, that portion will be considered nondeductible child support.
A child support payment is any payment that is characterized as such under a separation agreement or divorce decree or settlement. Furthermore, payments that are linked to the financial needs of a child are also able to be characterized as child support payments under U.S. tax law.
Alimony, spousal support, and child support are all forms of payments that can be made to the former spouse following a divorce or dissolution of marriage proceeding. As such, these terms are frequently lumped together in the public consciousness and not given the individual thought and consideration they deserve. As described in more detail above, while alimony or spousal support is paid to the former spouse for a period of years, child support payments are made by the non-custodial parent for the benefit of the children.
Reasons why tax planning for the differences between these types of payments include:
• Deductions and income inclusion – Divorce or separation agreements that fail to use precise wording and express clarity in the intent of the parties can lead to a mischaracterization of alimony or spousal support payments. As such, the expected tax treatment regarding deductions may be unavailable.
• Alimony recapture provisions – The Internal Revenue Code (IRC) contemplates payments that are fraudulently mischaracterized as deductible alimony payments for purposes of tax treatment that are really nontaxable property settlements. Thus, front-loaded payments are often problematic and may trigger unexpected recapture provisions.
• Alimony or support payments to nonresident aliens – Deductible payments made by a U.S. citizen or resident to a nonresident foreign spouse will trigger an often overlooked withholding tax. Failure to account for and pay over the required withholding tax will result in significant unforeseen personal tax liability to the ex-spouse making the payments.
The above covers only a selection of the more prevalent divorce tax issues related to spousal support and child support payments. A number of other potential tax issues relating to alimony and child support issues exist.