To answer your first question, alimony payments paid by you will generally be taxable to your ex and deductible by you. Child support payments will not be deductible by you or taxable to your ex. Proper planning by you and your ex can minimize the overall tax bite of the divorce and thereby make more after-tax dollars available. The allocations of payments to alimony, child support and property settlements can dramatically impact the deductibility of alimony and the after tax cash available to you and your ex to live on going forward.
In a negotiated written settlement, you will need to meet all of the following requirements for deductible alimony treatment:
all payments must be made in cash or its equivalent
your agreement should have no provisions that state that you and your ex are opting out of alimony treatment for income tax purposes
you and your ex must not reside in the same household after the settlement
alimony must terminate on the death of your ex.
The IRS is aware that many taxpayers attempt to convert property settlements incident to divorce or child support obligations into tax-deductible alimony. The Tax Reform Acts of 1984 and 1986 enacted rules designed to prevent excess front loading of property settlements into alimony payments. The rules come into effect to the extent that annual alimony payments decrease in excess of $15,000 during the first three calendar years. If you fail the test and do not meet certain allowable exceptions, a portion of your alimony payments will be viewed as non-deductible.
To further complicate the planning, care must be taken to not have the agreement provide that alimony reductions will occur based on a contingency relating to a child (i.e. the child attaining a specified age or income level, dying, marrying, leaving school, leaving your ex’s household, or gaining employment) or at a time that can be clearly associated with a contingency relating to a child (i.e,. a reduction occurring within six months of the child attaining the age of 18, 21 or the local age of majority). Carelessness in the drafting of these provisions can result in alimony deductions being disallowed from the inception of the agreement through to the time of the reduction.
As you can see, while there are some obstacles to overcome through proper planning, substantial tax benefits can be attained with the cooperation of your ex in structuring the settlement.
Henry Guberman is the partner in charge of the matrimonial accounting department of Parente Beard LLC. He is Certified in Financial Forensics, and Accredited in Business Valuation with the AICPA. He is also a Certified Divorce Financial Analyst with the Institute for Divorce Financial Analysts. He has been a CPA since 1980 and has extensive experience in providing expert consulting and testimony services to assist counsel and their clients in marital disputes. He can be reached at (212) 736-8269.