By David H. Goodman MBA, CPA/ABV/CFF, CVA
Many people… including some judges and attorneys… get confused about alimony and child support. This is especially true when it comes to understanding how they are defined and treated under the U.S. Internal Revenue Code.
Often judges and attorneys will refer to unallocated support. By this they mean the support is not being declared child support or alimony. It is just support. However, under the Internal Revenue Code, alimony and child support are defined by their attributes, not their names. What a judge calls the support either in the court order or agreement approved by the judge does not supersede the tax code.
Child Support versus Alimony – Why Care?
Alimony is generally deductible by the payer and taxable to the payee. Child support is not deductible by the payer, and not taxable to the payee.
The fact that Alimony is taxed to the payee does not mean that it is always advantageous to the payee to receive child support. In the case of one spouse having high income, the recipient of alimony may be taxed at a lower rate than the spouse paying alimony resulting in lower combined taxes being paid. Judges will consider this and award more alimony to a spouse.
If the parties are living apart, but still married, the issue of alimony does not arise if the parties are filing joint tax returns.
Problems arise when the payer deducts payments made to a spouse or former spouse as alimony, but the payee spouse does not report the income.
How is Alimony Defined?
Often attorneys and judges will award “unallocated” support, meaning they are not designating the payments as either alimony or child support. To determine the tax treatment one must look to how the IRS defines alimony (IRC Section 71):
- Alimony payments must be under a written separation agreementsigned by the parties or a divorce instrument. The agreement must be in place prior to any payments being made. This is a potential problem with negotiated temporary oral agreements even if subsequently incorporated into the divorce decree.
- The payments must be in cash (checks, money orders, wire transfers, etc.). For example, transferring marketable securities are not cash payments
- Alimony must terminate on the death of the spouse – if agreement does not specify, state law may trump. If state law is not clear that payments to a spouse cease on the death of spouse receiving the alimony, then the IRS and courts have ruled that the payments are not alimony.
- Cash payments to a third party on behalf of a spouse may qualify as alimony payments
- Payments not intended to be deductible alimony should be clearly designated as such in the separation agreement. An agreement may specify that a portion of the payments are deductible and a portion of the payments are not. For example, a husband may agree to pay a fixed weekly amount in support and also agree to pay the mortgage on the wife’s home. The agreement may state that the fixed payments are deductible by the husband and includable in the wife’s income, but that the mortgage payments are not deductible by the husband.
- The support agreement does not override rules requiring that alimony not be effectively connected with child life cycle events. For example, reducing alimony paid by the father when a child no longer lives with the mother makes the payments child support.
- Alimony does not have to be approved by the court. However, it must be paid under a signed and dated agreement by the parties. When the parties are living apart, still married, and filing separate returns, the alimony should be paid under the court’s temporary orders. A separate written alimony agreement should be incorporated by reference into the divorce decree or separation agreement.
- Alimony must be fixed. It can be a percent of earnings when the earnings are unknown. For example, in the case of a commissioned sales person.
- Alimony paid in excess of the amount required under the written agreement may not be deducted and is not taxable to the payee spouse.
- Alimony may not be disguised property settlement. There are rules concerning the front loading of alimony.
If the support payments fail to meet any of these requirements, then the payments are not deemed to be deductible alimony. They may be deemed to be either child support or a property settlement. The consequences for the payer are that the deduction will be disallowed and potentially substantial penalties and interest will be assessed on the understatement of tax.
On the other hand, if the payments satisfy these requirements the payments are deemed to be deductible by the payer spouse and taxable to the payee spouse … even if called “unallocated support” or “support for mother and children.”
David Goodman is a certified public accountant specializing in business valuation and litigation support. Mr. Goodman is trained in collaborative practice and is a qualified financial neutral. Mr. Goodman is employed by Gosule, Butkus & Jesson, LLP, Certified Public Accountants. Gosule, Butkus & Jesson, LLP is a full service accounting firm which also provides personal financial planning and wealth management services through its affiliate, Mainsail Advisors Services, LLC.