Three major issues commonly resolved in a divorce decree or agreement are: alimony, or spousal support; division of property; and child support. Each has its own tax treatment and implications. In general, for federal income tax purposes, alimony is “deductible” from the income of the spouse paying it and considered taxable income to the spouse receiving it.
If the payor spouse has a significantly higher income, there is an incentive to maximize the amount of payments that are considered alimony to the ex-spouse, as opposed to nondeductible payments such as property distributions and child support payments. The recipient (ex-spouse) may be in a much lower income tax bracket and agree to the plan.
It is important to note, however, that the IRS objects to attempts to mischaracterize child support or property divisions as alimony, because of the tax effects.
Child Support Disguised as Alimony
Child support payments are not deductible from the income of the payor spouse for federal income tax purposes. Payments that are specifically designated as child support in the divorce decree or written agreement between the spouses cannot be treated as alimony for income tax purposes.
Moreover, if the spouse making alimony and child support payments pays less than the required total for both, the child support obligation is deemed paid in full first for tax purposes. Only money exceeding the amount of the child support obligation may be treated as alimony.
When Alimony May Be Deemed Child Support
Payments characterized as alimony may be treated as child support if, and to the extent that, the payments are reduced on the happening of a contingency related to the child, such as if the child:
- Becomes employed
- Leaves the home
- Leaves school
- Reaches a specified age or income level
Contingencies Associated with a Child-Related Event
In addition, alimony payments may not be reduced based upon an event “associated with a contingency” related to the child. This is the same concept in a sense, but refers to more indirect methods. If the divorce decree or agreement does not reference a child, but merely sets a date when the amount of alimony is reduced, it may still indicate the alimony is child support if, upon investigation, either of the following is discovered:
- That the alimony is reduced within six months, before or after, the birthday on which the child becomes an adult under local law (typically 18 or 21 years old)
- If there are two or more children of the marriage and at least two reduction dates for the “alimony,” and the reductions all occur within one year (before or after) the date on which one of the children reaches a certain age between 18 and 24 years old
If the alimony provisions satisfy either of the above “tests,” there is a rebuttable presumption that the payments are really child support to the extent of the reduction. Thus, if the alimony amount is reduced one or more times on dates related to a child’s birthday, the amounts by which the alimony is reduced are considered “child support” and are not deductible by the payor spouse for federal income tax purposes.
Rebutting the Presumption
The above are not the only times the IRS may seek to recharacterize alimony as child support. The IRS may scrutinize any major reductions of alimony after a period of years.
Reductions which are made at a specified date on or near the birthday(s) of a child or children, as described above, however, create a “presumption” that the payments were really child support. The taxpayer may “rebut” this presumption. One way to do this might be to show that there is another rationale for the reduction date, such as it coincides with one half the duration of the marriage and/or is a common time for reduction or elimination of alimony under local law and practice.