Firstly, we must make clear that alimony and child support are two different types of payments and are taxed differently. States have many terms for spousal support; however, when we think of alimony we think of the amount paid by one former spouse to the other former marital partner under a divorce or separation agreement. In general, payments made to an ex-wife or to an ex-husband (let us not think only men pay spousal support) are taxable to the recipient and deductible to the payor if the payments qualify as alimony. Not all payments to a spouse are considered, for tax purposes, alimony. For payments to an ex-spouse to qualify as alimony, they must meet the following tests:
- Payment must be in cash;
- Payment must be pursuant to a divorce or written separation agreement;
- Divorced or legally separated spouses must reside in separate households when payment is made;
- Payments to a third party on behalf of the payee spouse must be evidenced in writing;
- Liability for payment must not continue beyond the death of the payee spouse;
- The divorce instrument must not designate non-alimony treatment.
On the other hand, payments identified as (or deemed to be) child support, or terminating on (or associated with) a contingency relating to a child are considered child support and are not tax deductible by the payor.
Having stated these general rules, there are times and ways to change the treatment of these payments.
If the two spouses are in different tax brackets, it may be beneficial for both spouses to have the payments (alimony and child support) treated as alimony. Under this scenario, due to the difference in tax brackets, it may be possible to pay a greater sum of money to the ex-spouse and have the net effort of the after-tax payments to the payor spouse being less. Obviously, the greater the spread in tax brackets between the two, the better the savings.
This is the best way to have what would have been considered child support now treated as alimony and deductible. There are certain nuances that one needs to watch out for, such as not to have the payments reduced at a time that can be construed as being based on a contingency relating to a child, such as when a child turns 18.
Every divorce has its own set of circumstances, so a professional must look at each case individually when designing a plan or providing specific advice.
Since 1980, Bruce Richman (CPA/ABV, CVA, CDFA™) has been actively involved in valuations, mergers and acquisitions and other financial and tax consulting matters. He is a Managing Director of CohnReznick, where he is responsible for various valuation projects and consulting services in the United States and, for U.S. clients, internationally.