Tax Snippet #6 – Alimony (Spousal Support) has a Big Tax Affect; Child Support is a Wash. It’s boon and bust with alimony. Alimony is a boon to the payor, because it is deducted right off the front page of his/her 1040, thereby decreasing his/her Adjusted Gross Income (taxable income) by the amount of the alimony paid.3 Of course, that means that the receiver of alimony gets taxed on the money received, just as if it were ordinary income (like a salary).
In contrast, child support has no tax affect. It is not considered income to the recipient or a write-off for the payor. Instead, the IRS views the payment of child support simply as money spent for the support of one’s children – money that would have been spent on the kids whether or not there had been a divorce. Therefore, the payor does not get to take a deduction for child support (like he/she would have for alimony) since it is usual and ordinary for parents to support their children with post-tax dollars from their employment with little opportunity for write-offs, etc. Similarly, the recipient of child support does not have to categorize child support as income, for tax purposes, because child support is supposed to be used, as directly as possible, for the support of the kids and, of course, that money was already taxed at the payor’s end.
How does this matter to parents in the middle of a divorce situation? My experience is that it matters a great deal – or, perhaps, should matter a great deal — to many people. It can mean big dollars for some divorcing couples and is an excellent tool in the divorce settlement negotiator’s toolbox. Determining how to divvy-up support between the child and spousal support sides of the ledger can add civility to financial settlement negotiations. Why is that? Because a positive tax benefit to one parent does not necessarily create a negative tax burden to the other. It’s just does not always work that way. Do the math with your accountant, bring it to the table, and you may be able to allow both parents to walk away with something good in the deal.
The Tax benefits to the payor of spousal support may turn a spouse, who is otherwise emotionally resistant to the concept of alimony, into a willing participant. Many people do not like paying alimony. It rubs them the wrong way. A little massage by Uncle Sam, though, can turn that frown into a smile.
With all this negotiating over tax bennies and smacks, is the IRS standing by idly and waiting for your numbers to come in. Of course, not. Where there is play in the tax code, there is the taxman overseeing the game. Be aware that questions bearing on whether dollars sent from one household to the other, post-divorce, are actually “alimony” or “child support”, are usually answered with the IRS’s default: “Child Support”.
As long as a legal amount of child support is clearly being awarded in a divorce case (in Virginia and most other states there are statutory guidelines that must be met), the characterization of support as “alimony” or “child support” is often negotiated in divorce settlement talks. Be aware, however, as the IRS may not always agree with your and your ex-spouses characterization of support as “alimony” or “child support” regardless of how fair the two of you think the deal is. And, they are the boss when it comes to taxes. See Tax Snippet #7, below and, of course, your CPA, if there any questions on this slippery area of divorce tax.
3A deduction is an exact dollar amount by which your gross income (income that is taxable) is reduced. In other words, deductions lower the final amount of income that Uncle Sam can tax. After subtracting deductions from gross salary (page 1 of your Federal Tax Return – Form 1040), the dollar amount remaining is referred to as your Adjusted Gross Income. (Other deductions include IRA deductions, certain educator expenses, health savings account contributions, student loan interest, moving expenses, and a few others.) Deductions are not the same as credits. Credits are taken off the top of what you would have owed to the IRS if you did not have the credits. Credits do not lower your taxable incomes. Instead, they lower the actual tax bill owed to Uncle Sam. (Page 2 of your 1040) The IRS allows, as credits, certain child and dependent care expenses, the child tax credit, residential energy credits, and a few others.) To further confuse you, the Fed’s also have one more deduction that has a different name: Exemptions. Exemptions (page 1 & 2 of your 1040) include the tax breaks you receive for: (a) just being a human being and; (b) for the other human beings who are your dependents (children, dependent relatives).
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Tax Snippet #7 – Don’t Mess with the IRS when it comes to Labeling Support as “Child Support” or “Alimony”. Many parents feel that the minimum guidelines for child support in their state could not possibly meet their child’s needs, but the tax affect of child support (being a wash) does not sit well with the payor. In these cases, divorcing couples often negotiate a division in the characterization of support into both camps: The Minimum Statutory Guidelines Amount = Child Support; The rest of the Support Money = Spousal Support. This can often work well, financially, for divorced parents. Beware, however, that the IRS does not always go along with parents’ tax planning decisions.
In particular, divorcing parents need to be careful where a big change in the amount of alimony is automatically triggered around the time (within 6 months) of a major event in a child’s life (such as graduation from high school). In those cases, the IRS may very well re-characterize those alimony payments as child support and come looking for the payor to pony up. Remember: Don’t mess with the IRS. See your CPA and your divorce attorney.
These Tax Snippets are written based on my observations and experience. I am and not a CPA, tax planner or tax attorney. I am a mediator and former family law attorney. These are, however, some of the key issues that I see over and over again with my clients. This series of articles is intended to help you “get your feet wet” in this mucky area of divorce. If you think any of these issues might affect you, see your tax professional for up-to-the-minute and personally-tailored tax advice.