Child Tax Exemptions, Deductions & Divorce

February 28, 2017

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Q: What is a dependent exemption?

  • As applied to your child, the dependent exemption is an amount of money that you are permitted to subtract from your adjusted gross income. The dependent exemption reduces the amount of income on which you will be taxed (in effect, an exemption operates the same as a deduction).
  • In 2016, the dependent exemption is $4,050 per child. The right to claim exemptions, however, phases out at higher income levels. In 2016, the phase-out begins at $259,400 for single parents and $285,380 for single parents who claim head of household status.

Q: How is the right to claim a child’s dependent exemption determined in a divorce situation?

  • Only one parent may claim a dependent child on his or her tax return in any given year. The parent who claims that child as his or her dependent is also the parent who claims that child’s dependent exemption.
  • According to the IRS, the default parent, in terms of claiming the dependent exemption for a child in a divorce situation, is the one with whom the child lives for greater than 50% of the time during that tax year. (Note: The IRS refers to the parent with whom their child lives for greater than 50% of the year as the “custodial parent.”)
  • In 50%/50% custody situations, the default parent is the parent with the higher adjusted gross income.

 

Q: Can the non-custodial parent ever claim a child’s dependent exemption on his or her tax return?

  • If the divorcing parents agree that the child’s dependent exemption may be claimed by the non-custodial parent, the IRS will allow this.
  • Such an agreement should be clearly stated in the parents’ Property Settlement Agreement (PSA) and Final Order of Divorce/Divorce Decree.
  • The custodial parent will need to complete and sign IRS Form 8332 each and every year that the non-custodial parent is permitted (by the PSA) to claim that child’s dependent exemption. The non-custodial parent must attach this form to his or her tax return every year that he or she claims that child’s dependent exemption.
  • Parents also have the option of alternating their child’s dependency exemption on an every-other-year basis, or as they otherwise agree.

 

Q: Are there other tax benefits that are attached to the child’s dependent exemption?

  • The parent who claims the child’s dependent exemption is also the parent who is eligible for the child tax credit (if applicable, depending on the parent’s income).
  • The parent who claims the child’s dependent exemption is also the parent eligible to claim that child’s educational tax credits, also known as college credits and, as of 2015 the American Opportunity Credit (if applicable, depending on the parent’s income and other factors)

 

Q: Are there tax benefits that remain with the custodial parent (despite the non-custodial parent claiming that child’s dependent exemption)?

  • The custodial parent remains the only parent eligible to claim the earned income tax credit.
  • Also, only the custodial parent (not necessarily the parent who claims that child’s dependent exemption) is eligible to claim the child and dependent care tax credit (also known as the day care credit).
  • Note: The same rules apply if a parent is eligible, through his or her place of employment, for a Flexible Spending Account (FSA).
  • If the parents share the child’s custody 50%/50%, the IRS defaults to the parent with the higher adjusted gross income, i.e., the parent with the higher adjusted gross income is treated as if he or she is the “custodial parent.”
  • In 50%/50% custody situations, parents often negotiate which one will have the custodial parent benefits for income tax purposes (as opposed to letting the IRS default dictate the outcome).
    • This is custom, but not specifically addressed by the IRS.
    • The IRS reasoning: There are 365 days in a year (an odd number). Therefore, a true 50%/50% custody share is impossible.
    • NOTE: Only one parent may claim the earned income tax credit and the child and dependent care tax credit.

 

Q: Which parent is eligible to file as Head of Household?

  • A parent who is single and has a dependent child living in his or her home may be eligible to file taxes as “head of household.
  • Only the custodial parent – the parent who cares for the child greater than 50% of the time – is eligible to file his or her taxes as head of household.
  • Unlike the dependent child exemption, the right to file as head of household is not exchangeable between parents.
  • The head of household tax status, versus filing as “single,” often lowers your tax bill (but phases out at higher income levels).
    • Head of household status often lowers your tax rate, thereby lowering your tax bill. .
    • If you claim the standard deduction (versus itemizing your deductions), that number will be higher, thereby lowering your tax bill.
  • The specific criteria follows:
  • Your spouse did not live in your home for the last 6 months of the year for which the taxes are filed (this applies to parents who are separated, but not yet divorced).
  • You will not be filing a joint return with your spouse (this applies to parents who are separated, but not yet divorced).
  • You paid over half the cost of maintaining your home for that tax year.
  • Your child lived in your home over half the year, i.e., you are the “custodial parent” (even if the other parent claims that child’s dependency exemption).
  • Your child is considered a “qualifying child”, meaning he or she has not turned 19 by the end of the tax year (if not a full-time student), or is younger than 24 at the end of the tax year (if a full-time student for at least 5 months during the tax year), or is permanently disabled.
  • In 50%/50% custody situations, parents often negotiate which one will have the right to file as head of household (as opposed to letting the IRS default – that only the custodial parent is permitted to file as head of household – dictate the outcome).
    • This is custom, but not specifically addressed by the IRS.
    • The IRS reasoning: There are 365 days in a year (an odd number). Therefore, a true 50%/50% custody share is impossible.
    • NOTE: Only one parent may file as head of household (as it related to a child).
    • With more than one child, in a 50%/50% custody situation, parents sometimes each care for a child greater than 50% of the time and, as a result, each parent is potentially eligible to file their taxes as head of household.

 

Q: At what age is a child no longer considered a “dependent”

  • To qualify as a dependent, your child must be under the age of 19 on December 31 of the tax year in question.
  • However, if your child is a full-time student (as defined by his or her school), he or she may be your dependent for income tax purposes as long as he or she is under the age of 24 on December 31 of the tax year in question.
  • If your child is permanently and totally disabled, there is no age limit.

Posted by Robin Graine, JD, Virginia Supreme Court Certified Mediator

This blog and its materials have been prepared by Graine Mediation for informational purposes only and are not intended to be, are not, and should not be regarded as, legal advice.  This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship.  Internet subscribers and online readers should not act upon this information without seeking professional counsel.

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Financial Investigation Tips for Second Marriages

June 2, 2015

INTRODUCTION by ROBIN GRAINE, JD, Virginia Supreme Court Certified Mediator

As a divorce mediator, I am keenly aware that many of my clients will enter into second (and sometimes third and fourth) marriages. In fact, the U.S. Census Bureau reports that, within five years of a divorce from a first spouse, a whopping one in five Americans says “I do” a second time.  A two marriage record is OK . . . but a two-time personal divorce statistic is really hard to deal with for most people.

Hopefully, whatever mistakes you made in your first marriage will not be repeated in your second attempt. If some of the problems in your first marriage had to do with money, this article will help you with essential and necessary ways of determining what you are getting into the second time around.

Though it may be uncomfortable to do the investigation necessary to ensure “financial bliss,” successful remarriages need to start with openness, trust, and a mutual value system. If you are concerned about your financial future with your new bride or groom, you may need to open up your tax files as big as you open up your heart . . .  it really should not be a problem.  If it is, there’s your first warning that things might not be as perfect between you as you had thought.

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Graine Mediation’s guest blogger, Julian Block, who is a leading national tax professional and attorney, has this to say about protecting yourself financially before you say “yes” to a second marriage:

Tax Reminders for Couples Contemplating Tying the Knot—Again

As an attorney and author who has written and lectured extensively about the tax aspects of marriage and divorce, I frequently receive questions from couples contemplating marriage.

One of my standard recommendations is that they consider the tax consequences beforehand, especially when one of them or both of them are remarrying. My advice: Before they commit to a walk down the aisle, each should consider whether to ask the other for copies of tax returns. In my experience, it’s particularly important for women to do that.

To illustrate how I would advise them, let’s say it’s going to be a second or third marriage for both John and Marsha—something that’s not uncommon nowadays, judging from the SundayStyles Section of the New York Times.

Something else that’s no longer uncommon is that her holdings considerably exceed his. Possible reasons why she’s wealthier? Much-married and several-times-widowed Marsha inherited assets from her spouses; or a couple of divorces resulted in her receiving several sizable settlements; or she was one of the Facebook staffers who were enormously enriched by its IPO.

Both Marsha and John are old enough for membership in AARP. Their ages matter because the divorce rate is extremely high for people over age 50—particularly for those who remarry.

Mindful of those stats, Marsha had John assent to a prenuptial agreement (just as she did in advance of earlier marriages). What else might Marsha do? I counsel her to ask for copies of John’s federal and state returns. Depending on what they reveal, she might decide that it’s prudent to stay single or, if they do wed, to file separate returns.

Following are summaries of scenarios I created that, albeit unromantic, are based on actual events.

Fear of filing:  It turns out that John hasn’t filed returns, something that’s common across all levels of society. It’s vital that Marsha know his potential liability for back taxes, penalties and interest. Also, he must specify when he will file returns and arrange for installment payments that will square him with federal and state tax agencies.

My advice, should Marsha wed: She files separate returns and doesn’t mix her assets with his assets. Also, she asks John to fill her in on what other shoes might drop.

A less troubling scenario that’s nonetheless problematicWhile John has filed 1040s, he owes considerable amounts in back taxes, and interest charges continue to mount. Marsha’s tactics, assuming they wed: Again, file separately and not comingle assets until he has squared accounts with the IRS. There’s a snag if they file jointly and are due a refund; the IRS can apply the refund to his back taxes.

John has filed returns and owes no back taxes: Marsha should still scrutinize certain deductions and other items on his returns. Let’s focus on some of the easier ones.

 Alimony payments: John’s returns reveal that he makes alimony payments to his ex-wives that he didn’t mention to Marsha;

Dependency exemptions for children not living with John due to divorce or separation: A divorce settlement (or settlements) allows him as a noncustodial parent to claim such exemptions.  He never told Marsha about those children;

Gambling: John’s returns show substantial amounts of gambling winnings for “other income” on line 21 of the 1040 form. Those returns also show offsetting deductions for gambling losses on line 28 of Schedule A. Losses are deductible only up to the amount of winnings. Does he have nondeductible losses that far exceed winnings? Perhaps the amounts wagered indicate that John gambles compulsively;

Schedule C: John files a Schedule C for his dental practice. A cursory review of amounts entered for business receipts and expenses suggests he’s understating gross receipts and overstating expenses. Whereas dentists in his area typically claim expenses equal to about 50 percent of gross receipts, his expenses equal about 75 percent of gross receipts. A plausible explanation for the discrepancy is that John doesn’t deposit currency payments received from patients into the practice’s bank account, and he tells his accountant to use bank deposits to calculate gross receipts. Is John trying to pull one on the IRS?

Schedule A: Line 4 shows he claims hefty itemized deductions for medical expenses (allowable to most persons only for the part above 10 percent of adjusted gross income). Deductions could be easily explained as attributable to payments for insurance premiums and expenses usually not covered by insurance—for instance, dental work, hearing aids, glasses, medically required home improvements or private duty nurses. Or the reason for substantial write-offs might be that, like Tony Soprano, John sees a shrink several times a week. Not to imply that there’s anything wrong with those visits; still—like the restorative powers of chicken soup—it can’t hurt and might help for Marsha to determine how much John has in common with Tony or, worse yet, Norman Bates.

Donations: John’s a chintzy contributor, whereas Marsha is a generous giver. This may not be a deal breaker, but they should discuss charitable donations before marriage.

Withholding: Each year, John receives big refunds, deliberately as a form of forced savings or simply by neglecting to claim enough exemptions on his W-4. But interest-free loans to the IRS are anathema for someone like Marsha, who meticulously monitors her withholding from wages and outlays for estimated payments. Her returns may show small balances due. It’s preferable that they discuss before marriage how they’ll handle withholding.

In the midst of all these thorns, there are some roses. Assume John has a substantial capital loss carry forward and no unrealized capital gains. At $3,000 a year, it will take many years to use up John’s carry forward. She, however, has a substantial unrealized capital gain. Marriage means Marsha can realize the gain and offset it against John’s carry forward.

Similarly, suppose he operates a business that’s unprofitable. He has a hefty net operating loss carry forward; but not enough other income to absorb the carry forward. Marsha has sizable income. Marriage enables him to apply his carry forward against her income.    

—————————————————————————————————————–

Julian Block writes and practices law in Larchmont, N.Y. and was formerly with the IRS as a special agent (criminal investigator) and an attorney. He is frequently quoted in the New York Times, the Wall Street Journal, and the Washington Post, and has been cited as: “a leading tax professional” (New York Times); “an accomplished writer on taxes” (Wall Street Journal);and “an authority on tax planning” (Financial Planning Magazine). This article is excerpted from “Julian Block’s Tax Tips for Marriage and Divorce,” available as a Kindle at Amazon.com and as a print copy at julianblocktaxexpert.com. Law professor James E. Maule, a professor at Villanova University School of Law and Graduate Tax Program, praised the book as “An easy-to-read and well-organized explanation of the tax rules.”  The National Association of Personal Financial Advisers says it is “A terrific reference.”

This blog and its materials have been prepared by Graine Mediation for informational purposes only and are not intended to be, are not, and should not be regarded as, legal advice.  This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship.  Internet subscribers and online readers should not act upon this information without seeking professional counsel.


When Should Married Couples Check ‘Married, Filing Separately’?

March 1, 2015

Graine Mediation is pleased to introduce Julian Block, JD as our guest blogger this week.  Mr. Block is a leading authority on tax planning for divorce and the author of Julian Block’s Tax Tips for Divorce, from which this article is an excerpt.

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Married couples need no reminder that they can benefit from joint filing when one mate earns all or considerably more of the income than the other. That tax break, though, can become a trap for spouses who decide to split, but don’t obtain a divorce or a legal separation. They still have the option to file jointly, assum­ing both partners are willing to do so. Nevertheless, one or both might find it more advantageous to file separately. The financial implications are huge.

Among other drawbacks for joint filers: they’re jointly and severally liable. That means married persons remain on the hook even if their marriage breaks up after they file a joint return. So if the IRS audits their return and demands extra taxes, it can dun either mate for the entire amount of any additional taxes, penalties and interest that becomes due.

Nevertheless, there are some drawbacks to filing separately. Whatever a couple’s reasons for avoiding tax togetherness, the two of them may be in for an unpleasant and expensive surprise when filing time rolls around. The taxes they’ll pay as married persons filing separately can be considerably more than the taxes they’d owe as joint filers or even as two unmarried persons.

There are other drawbacks for married persons who choose to file separately. One is that both of them must use Schedule A of Form 1040 to itemize their deductions for charitable donations and the like or that both must use the standard deduction.

Special rules for married persons living apart. Fortunately, there’s a way out of these traps for many married persons. An often overlooked break entitles them to be treated as if they were unmarried for the year in question—provided they fulfill certain requirements. The result: Even though they aren’t divorced or legally separated, they’re excused from having to use the rates for a married individual filing separately and, instead, receive the benefit of the more favorable rates for a head of household.

To take advantage of head of household rates, you have to pass a four-step test.

  •  Step 1: You file a separate return from your spouse.
  •  Step 2: Your spouse didn’t live with you at any time during the last six months of 2014. You and your spouse must live in separate residences, warns the IRS, and the courts agree. The Tax Court has ruled that a hus­band failed to qualify as a head of household when he and his wife agreed to live in separate areas of the same residence. Thus, living apart under one roof doesn’t pass muster.

In another dispute, the court reminded Laurel Hopkins that sharing the same quarters for as little as one day during the last six months of the year can be fatal. Before more than six months had elapsed during the year at issue, Laurel and her husband, William, had ceased to live together; but during the balance of the year, she sometimes let William stay overnight be­cause he was unable to find a dwelling.

As she paid all the household bills and was the sole support of their two children, Laurel, not unrea­sonably, believed herself entitled to file as a head of household. Unfortunately, in the course of a subse­quent IRS audit, Laurel let slip that William sometimes stayed in her apartment. On the basis of that admission, the feds determined that Laurel’s proper filing status was that of a married person filing separately. Though sympathetic to Laurel’s predicament, the Tax Court agreed with the IRS that a wife who shelters a homeless husband at any time during the last six months of the year disqualifies herself for head of household status.

 To avoid getting caught in an audit trap like Laurel, don’t chat yourself into loss of a tax break. Confine your answers to the questions raised.

  •  Step 3: You paid more than half of the cost of keeping up your home for 2014.
  •  Step 4: Your home was, for more than half of 2014, the principal residence of your child, stepchild or adopted child, whom you can claim as a dependent.

You aren’t necessarily disqualified from filing as a head of household just because you’re unable to claim the child. As the parent with custody—the mother, in most cases—you continue to be eligible, if you sign IRS Form 8332, which allows the 2014 exemption to be claimed by your spouse, the parent without custody.

When couples live apart by mutual agreement, they might be able to work out an arrangement whereby each spouse can claim a dependent child and each qualifies as a head of household. Congress enacted this special provision that treats married persons as unmarried individuals primarily for the benefit of abandoned wives (or husbands). But it worded the provision broadly enough to cover couples who have separated and who live apart by mutual agreement—without any actual abandonment.

Julian Block writes and practices law in Larchmont, N.Y. and was formerly with the IRS as a special agent (criminal investigator) and an attorney. He is frequently quoted in the New York Times, the Wall Street Journal, and the Washington Post, and has been cited as: “a leading tax professional” (New York Times); “an accomplished writer on taxes” (Wall Street Journal); and “an authority on tax planning” (Financial Planning Magazine). This article is excerpted from “Julian Block’s Tax Tips for Marriage and Divorce,” available as a Kindle at Amazon.com and as a print copy at julianblocktaxexpert.com. Law professor James E. Maule, a professor at Villanova University School of Law and Graduate Tax Program, praised the book as “An easy-to-read and well-organized explanation of the tax rules.” The National Association of Personal Financial Advisers says it is “A terrific reference.”

This blog and its materials have been prepared by Graine Mediation for informational purposes only and are not intended to be, are not, and should not be regarded as, legal advice.  This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship.  Internet subscribers and online readers should not act upon this information without seeking professional counsel.


Head of Household Requirements – 2013

November 26, 2013

taxesThere is no getting around the fact that divorce triggers lots of tax questions.  One of most befuddling of those new tax dilemmas for divorcing couples is the availability of the Head of Household filing status.  To clear up some of the mystery, here is some up-to-date information to help you decide what you should be negotiating for in your divorce settlement:

You can only claim Head of Household if:

You are unmarried or considered unmarried (see below under “Terms”) on the last day of the year,

  • You have paid more than half the cost of keeping a home for the year,** and
  • One or more qualifying persons lived with you in the home for more than half the year.

There are two exceptions to the residency requirement for temporary absences and for dependent parents:

Temporary Absences: During the period of temporary absences due to “illness, education, business, vacation, or military service,” the taxpayer and the qualifying person are still considered to be residing in the same household. To count as a temporary absence, “It must be reasonable to assume the absent person will return to the home after the temporary absence.  You must continue to keep up the home during the absence.” (IRS Publication 501)

  • Dependent Parent(s):  A parent can be a qualifying person even if the parent does not reside at the same home as the taxpayer.  The taxpayer must pay more than half the cost of keeping a home that was the main home for parent(s). (IRS Publication 501)

TERMS:

Unmarried: Taxpayer is legally separated (no such thing in Virginia), a decree of divorce/final order of divorce or a decree of separate maintenance has been issued by the court [IRS Code §7703(a)].

Considered Unmarried: A taxpayer may be “considered unmarried” for the purpose of qualifying for Head of Household tax status if:

  • he or she has a child, stepchild or foster-child residing at his/her home for more than half of the year for which he or she is entitled to a deduction (pursuant to IRS Code §151, 152) (even if deduction is given away with IRS Form 8332) [IRS Code §7703(b)(1)]
  • he or she provides for more than half the cost of maintaining a home for him/herself [IRS Code §7703(b)(2)], and
  • he or she is legally married, but has lived in a separate residence from spouse for the last six months of the year (July-December) [IRS Code §7703(b)(3)]

Deductions: A married person who files as Head of Household may choose either the standard deduction or itemized deductions (regardless of which method is used by the other spouse, if still married, which is the opposite of how the IRS does things when spouses file as “married filing separately” (where the two spouse’s choice of standard of itemized deductions must match).   (IRS Publications 501 & 504)

  COMPARISONS:

 Standard Deductions:

Single or Married Filing Separately: $5,950

Married Filing Jointly (or Qualifying Widow with Child): $11,900

Head of Household: $8,700

Tax Basis Comparisons

$30,000 Gross Income

Single 15%      HH 15%

$40,000 Gross Income

Single 25%      HH 15%

$50,000 Gross Income

Single 25%      HH 25%

$60,000 Gross Income

Single 25%      HH 25%

$70,000 Gross Income

Single 25%      HH 25%

$80,000 Gross Income

Single 25%      HH 25%

$90,000 Gross Income

Single 28%      HH 25%

$100,000 Gross Income

Single 28%      HH 25%

$125,000 Gross Income

Single 28%      HH 25%

$150,000 Gross Income

Single 28%      HH 28%

 

Posted by Elizabeth Downing Revell, Mediation Assistant and Robin Graine, JD, Virginia Supreme Court Certified Mediator

This blog and its materials have been prepared by Graine Mediation for informational purposes only and are not intended to be, are not, and should not be regarded as, legal advice.  This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship.  Internet subscribers and online readers should not act upon this information without seeking professional counsel.


Kids are Priceless, but Pricey

May 28, 2013

Everyone knows it is costly to raise kids today.  Their electronic gadgets alone are off the charts.  We all know that the costs add up, but have you ever totaled them all?  According to an article in KidsPost, by Tracy Grant, using numbers from a 2010 report, the total cost from birth to age 17 is $226,920.  Even adjusted for inflation, that is a $41,064 increase since 1960!  Ms. Grant points out, too, that big kids (15-17 year olds) cost approximately $2,000 more per year than their younger counterparts.

Where does all the money go?

expenses

What has changed?

Child care costs. 67% of mothers now work, compared to 33% in 1960.  Healthcare, too, has gone through the roof.

Save a few bucks.  How about a thousand bucks?

All of those extra items that you toss in the shopping cart, thinking it is no big deal, turn out to be a big deal.  According to Ms. Grant, those books, toys, movies, etc., add up to about $1,100 per year!

It is worth noting that most of the largest expenses for kids are shared with their parents, such as housing and food.  Therefore, if you are looking to save money, or simply spend less, you will need to consider both your mega-expenses as well as all of the little ones that add up.

Posted by Kristina Duncan Hoege, Freelance Paralegal

This blog and its materials have been prepared by Graine Mediation for informational purposes only and are not intended to be, are not, and should not be regarded as, legal advice.  This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship.  Internet subscribers and online readers should not act upon this information without seeking professional counsel.


The IRS’s “Child Contingency Rule” Could Cost you a Bundle of Money If You Fail to Plan Appropriately

April 23, 2013

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Q: What is the IRS’s “Child Contingency Rule”?

A: The IRS’s Child Contingency Rule states that when alimony payments end on or around the same time as a child-related event (e.g. graduating from high school) all alimony payments leading up to that child-related event may be reclassified, by the IRS, as child (not spousal) support.  Further, the Child Contingency Rule states that any tax benefits received by the payer of support, and any taxes paid by the receiver of alimony (which is later reclassified as child support) are to be returned – the payer will owe the IRS money and the receiver will receive a refund of taxes previously paid on alimony received.

Q: What triggers the Child Contingency Rule?

A: Support payments that would otherwise qualify as alimony may be treated as child support, by the IRS, to the extent that the payment is reduced or eliminated either:

  • On the happening of a contingency relating to your child (e.g., graduation from high school, turning 18); or
  • At a time that can be clearly associated with the contingency.

However, you can overcome those presumptions by showing that the determination of the time at which the payments are to be reduced/eliminated was determined independently of any contingencies relating to your children. In other words, that the timing was mere coincidence. For example, if you can show that the period of alimony payments is customary in your local jurisdiction (such as the “rule of thumb” in Northern Virginia that the alimony duration is often equal to one-half the length of the marriage) you may be able to overcome the presumption and, therefore, overcome the harsh IRS penalties for tying alimony to a child-related event.

Q: What sorts of other “child-related” events is the IRS looking for?

A:  Per the IRS, a contingency relates to your child if it depends on any event relating to that child. It does not matter whether the event is certain or likely to occur. Events relating to your child include the child’s:

  • Reaching a specified age or income level;
  • Graduating high school;
  • Becoming employed;
  • Dying;
  • Leaving the household;
  • Leaving school; or
  • Marrying.

 

Q: What are the time parameters for the Child Contingency Rule?

A: The IRS may automatically reclassify your alimony payments as child support payments, pursuant to the Child Contingency Rule, in the following situations

  • The payments are to be reduced not more than 6 months before or after the date the child will reach 18, 21, or local age of majority (18, in Virginia)
  • The payments are to be reduced on two or more occasions (only in families where there are 2 or more children) that occur not more than 1 year before or after a different one of your children reaches a certain age from 18 to 24 (the IRS defines “a certain age” as the age of your first child at the time of your first stepped down reduction in alimony). This certain age must be the same for each child, but need not be a whole number of years.

Much of the information for this article comes from IRS Publication 504, online

Posted by Robin Graine, JD, Virginia Supreme Court Certified Mediator

This blog and its materials have been prepared by Graine Mediation for informational purposes only and are not intended to be, are not, and should not be regarded as, legal advice.  This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship.  Internet subscribers and online readers should not act upon this information without seeking professional counsel.


Alimony Recapture Rule

April 16, 2013
Tug o' war

Tug o’ war

“Alimony Recapture” is a tricky and often misunderstood IRS rule (Internal Revenue Code (IRC) §71) that is designed to prevent front loading of alimony payments which, the IRS presumes, are actually a property distribution “disguised” as alimony to save on taxes due. Of course, not everyone who is vulnerable to the recapture rule is trying to disguise a distribution of property as alimony, but the rule is supposed to be applied uniformly, regardless of motivation.

Alimony Recapture applies, in certain cases, where there is an award of alimony[1] from one ex-spouse to the other ex-spouse, that decreases in amount during the first three post separation years[2].  “Recapture” refers to the IRS’s right to force the payer of alimony to pay back, to the IRS, all tax benefits received as a result of alimony payments made to his or her former spouse during those first three years.  (After the third full year, the concept of recapture becomes irrelevant.)

This would be, for many ex-spouses, a tax tragedy.  Recapture aside, alimony is a very generous tax deduction that is almost always of primary importance when negotiating a divorce settlement wherein support of an ex-spouse is appropriate and feasible.  Specifically, 100% of the alimony paid is allowed to be deducted from the payer’s gross income, thereby reducing his adjusted gross (taxable) income, dollar-for-dollar, in the amount of the alimony paid for that year. The ex-spouse who receives alimony, however, must pay taxes (also dollar for dollar) on those alimony payments received.

The rules of recapture are not overly complicated.  They are, however, like so many IRS promulgated dictums, befuddling for most people because they are written in such a convoluted manner and sound, pretty much, like gobbledygook. In a nutshell, the tax benefits of paying alimony will be recaptured by the IRS if, in the 3rd year after your alimony payments commence, you pay greater than $15,000 less in alimony than you paid in the 2nd year. Or, if, during the 2nd and 3rd years, you pay  “significantly less” in alimony than you paid in the 1st year. The term “significantly less” is the IRS’s word, not mine, and it is not defined in the statute.  Luckily, the IRS has provided a recapture worksheet that makes trying to figure out what they mean by “significant” a nullity.  In other words, if you run your numbers through the worksheet and they show that you fall under the recapture rule, you do.  Period.  (“Significant” of not!)

The worksheet and further explanation of the recapture rule can be found in IRS Publication 504 Divorced and Separated IndividualsThat publication forth a nice example that most people find helpful when trying to understand the concept of recapture.  Below is the IRS’s example and their worksheet, straight from Pub 504:

IRS Example: You pay your former spouse $50,000 alimony the first year, $39,000 the second year, and $28,000 the third year. Using these numbers, you report $1,500 as income on your Individual Income Tax Return (Form 1040, line 11). Your former spouse, on the other hand, reports on her Income Tax Return (Form 1040 line 31a), a $1,500 deduction. See worksheet, below:

Worksheet 1. Recapture of Alimony—Illustrated

Note. Do not enter less than -0- on any line.

1.

Alimony paid in 2nd year

1.

$39,000

2.

Alimony paid in 3rd year

2.

28,000

3.

Floor

3.

$15,000

4.

Add lines 2 and 3

4.

43,000

5.

Subtract line 4 from line 1

5.

-0-

6.

Alimony paid in 1st year

6.

50,000

7.

Adjusted alimony paid in 2nd year
(line 1 minus line 5)

7.

39,000

8.

Alimony paid in 3rd year

8.

28,000

9.

Add lines 7 and 8

9.

67,000

10.

Divide line 9 by 2

10.

33,500

11.

Floor

11.

$15,000

12.

Add lines 10 and 11

12.

48,500

13.

Subtract line 12 from line 6

13.

1,500

14.

Recaptured alimony. Add lines 5 and 13

*14.

1,500

* If you deducted alimony paid, report this amount as income on Form 1040, line 11.
If you reported alimony received, deduct this amount on Form 1040, line 31a.

So, what facts and circumstances usully exactly triggers the IRS’s Alimony Recapture rule? Typically, it is triggered by a reduction or termination of alimony payments caused by one or more of the following:

  1. a.    A lump sump payment scenario;
  2. b.    A settlement agreement/divorce decree in which alimony payments are decreased over that first three year post separation period;
  3. c.    A settlement agreement/divorce decree that allows for alimony payments to cease prior to the end of the first three years post separation;
  4. d.    A change made to your separation or divorce agreement, by the court or by agreement, due to the recipient’s decreased need, or the payer’s decreased ability to pay, that ignores the recapture rule; or
  5. e.    The payer’s failure to make alimony payments on time, or at all.

You will note that, even if you do everything “right”, for purposes of legal enforceability (i.e., you consult an attorney, who puts the agreed-upon changes in writing, and you execute the document with the same formality as the original agreement, etc.), you still cannot assume that you will be free from the punishing effects of the Alimony Recapture Rule. It’s the old “knew or should have known” scenario.

Are there exceptions?  Yes.  There is no Alimony Recapture if:

  • you made alimony payments over the three year post- separation period that varied because they were a fixed part of your income from a business, property, employment-compensation, or self-employment compensation[3]; or
  • your alimony payments decreased as a result of your ex-spouse’s death; or
  • because the spouse receiving alimony got remarried before the end of the 3rd year post separation period.

 

Caveat: There are rare cases when a party might still be better off working to get his or her alimony payments reduced and taking the lumps from the IRS in terms of recapture.  Such a decision will depend on your individual financial circumstances. Run the numbers, do the worksheet, and talk with you CPA and divorce attorney before making such a decision.

Posted by Robin Graine, JD, Virginia Supreme Court Certified Mediator

This blog and its materials have been prepared by Graine Mediation for informational purposes only and are not intended to be, are not, and should not be regarded as, legal advice.  This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship.  Internet subscribers and online readers should not act upon this information without seeking professional counsel.


[1] The Virginia Divorce Code refers to alimony as “spousal support”.  For this article, however, I will be referring to monetary support payments (that are not child support), from one ex spouse to the other, as “alimony” because that is the term used by the IRS.

[2] The three-year period, in which the payer is vulnerable to the recapture rule, begins the first calendar year during which he or she makes an alimony payment under a divorce decree, order for separate maintenance, or written and signed separation agreement, as long as all the other criteria for alimony are met. The 2nd and 3rd years are the next two calendar years, whether or not any payments are made during those years.  Please know that alimony payments made under a temporary support order do not count as part of the 3 years for purposes of alimony recapture.

[3] Alimony payments are sometimes set to correlate with a party’s business earnings, rents received, etc. such as in a case where the parties agree that the former spouse will receive X% of the payer’s gross or net profits from his or her business/real estate income earned for a set period of time post divorce. 


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