The basics of spousal support taxation

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The growing divorce rate in America has led to the creation of various types of spousal support where one ex-spouse is required to pay to the other. In most cases, the higher-earning spouse is required to pay the lower earner a certain amount, although there are exceptions to this. However, the tax rules are not the same for all types of support - some types are reportable as income while others are not. That said, the rules for each kind of support are relatively simple to learn. This article explores the factors that determine how spousal support is classified and subsequently taxed. (For related reading, check out Get Through Divorce With Your Finances Intact.)

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Types of Spousal Support
There are two main types of support that are awarded to ex-spouses today. One is known as alimony and the other is called child support. The former type of support has become relatively less common over time and has largely been replaced with child support for divorcing couples with children. Both types of support are awarded by either a divorce decree, written agreement of separation or decree of support. Failure to pay either one of them can result in further legal action, including garnishment of tax refunds of the payor or additional litigation by the rightful recipient. Different regions typically have different laws that outline the consequences of nonpayment.

Alimony
This type of spousal support is often awarded in divorces where children are not involved. In most cases, alimony payments are tax deductible by the payor and reportable as taxable income by the recipient. However, the following requirements must be met to receive this tax treatment:

Alimony must be clearly specified in the divorce, annulment or separation agreement. No payments that are made under any circumstances outside this agreement can be labeled as such. Alimony must be specified as a mandatory payment in the agreement. Any voluntary payments that are made to one ex-spouse by the other cannot be considered alimony and are not deductible or taxable for the payor or receiver respectively. Alimony payments must be made in cash, or through such liquid payments as checks and money orders. All transfers of noncash property fall outside this category. Deductions of aggregate alimony payments of more than $15,000 that are made in the first or second year may be recaptured in the second or third year if a lesser payment is made that year. (The rules pertaining to this provision are somewhat complicated and those to whom they apply should seek counsel from their tax or financial advisor.) Any provision that payments made to an ex-spouse for the purpose of supporting children or dependents automatically disqualifies the payments as alimony. Payments made by one ex-spouse to another cannot be considered alimony if both spouses still live in the same household when the payments are made. Alimony payments cannot last beyond the death of the paying spouse. If payments are continued into the recipients active accounts, none of the payments can be deducted for tax purposes. Alimony can also be nondeductible and therefore nontaxable if both spouses agree to specify this in the divorce decree.

Alimony paid is reportable as an above-the-line deduction, which means that the payor is not required to itemize in order to deduct these payments. Taxpayers who pay alimony must include the Social Security number(s) of any and all ex-spouses to whom payments are made in order to deduct the payments. Failure to do so will result in disallowance of the deduction. Those receiving payments must provide their Social Security numbers to the paying spouse or face a penalty from the IRS.

Child Support
This form of spousal support is specifically designated to be for the benefit of any children that are supported by the ex-spouse receiving the payments. Child support is never deductible by the payor and is not reportable or taxable as income by the recipient. Any type of monetary payment made by one ex-spouse to another that either ceases, diminishes or otherwise changes upon the occurrence of certain events pertaining to the children, such as their reaching the age of majority or moving out of the house, results in a modification to child support requirements. As mentioned previously, both the IRS and state governments have the authority to garnish any tax refunds due to delinquent payors of child support.

Property Settlements and QDROs
Any initial division of property that is made because of a divorce is usually considered a tax-free exchange of property by the IRS. The recipient takes on the basis of any property received and pays no income tax upon its transfer. Any type of IRA or retirement plan that is transferred from one spouse to another under a qualified domestic relations order (QDRO) is also considered a tax-free exchange of property. (Learn how different rules of asset handling apply to various retirement plans. Read Getting A Divorce? Understand the Rules Of Dividing Plan Assets.)

Which Type of Payment is Better?
As you can see, alimony payments obviously favor the payor, while child support payments are more beneficial to the recipient from a tax perspective. However, there are several factors that divorcing couples should consider when determining the nature and amount of payments that are to be made. Of course, the issue of who will get to claim the dependency exemptions and tax credits for any children involved as dependents is another key issue. If one spouse’s income is too high to be able to claim any potential tax benefits benefits, then it may be wise to allow the other spouse to do so, perhaps in return for receiving taxable alimony payments instead of child support. If the receiving spouse’s income is fairly low, then receiving alimony payments may have little or no impact upon his or her income, and therefore may be elected in return for other benefits to be provided by the payor, such as a more favorable custody agreement. The nature of the payment requirements also depend on the overall circumstances of the divorce.

Bottom Line
Of course, the good will of both ex-spouses is necessary to logically determine what arrangement is best for both parties; therefore, divorcing couples should recognize that it is in both parties' best interests to know these rules and plan accordingly. Failure to understand the tax implications of divorce can often lead to missed credits and deductions that ultimately reduce the income of both parties involved. Couples who are contemplating divorce or who have begun the divorce process may be wise to consult a professional with specialized training in the financial ramifications of divorce, such as a certified divorce specialist. (Use your skills to help people preserve their financial integrity in a failed marriage. Find out more in Become A Certified Financial Divorce Analyst.)

by Mark P. Cussen,CFP®, CMFC (Contact Author | Biography)

Mark P. Cussen has more than 15 years of experience in the financial industry, which includes working with investments, insurance, mortgages, taxes and financial planning. He has two years of experience in writing and editing insurance and securities test training manuals, as well as other financial topics. He has also worked in retail, discount and bank brokerage systems and been involved in a venture capital enterprise in the oil and gas sector. Cussen has a Bachelor of Science in English from the University of Kansas and completed his CFP coursework at the Bloch School of Business at the University of Missouri-Kansas City in August of 2001.