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Tax Consequences of Spousal Support

Whether you represent the payor or the payee in a divorce or legal separation that includes spousal support, it is important to be aware of the potential tax consequences. The IRS has very clear and detailed guidelines on what constitutes alimony for tax purposes. Properly designated alimony payments are tax deductible by the payor and must be included as taxable income to the payee spouse.
 
Requirements
 
In general, payments are considered alimony if ALL of the following are true: 
  1. The payments are required as part of a divorce or separation agreement;
  2. The payor and the payee spouse do not file a joint tax return with each other;
  3. The payment is in cash (including checks or money orders);
  4. The payment is not designated in the agreement as not being alimony;
  5. The payor and the payee are not members of the same household;
  6. The payment is not treated as, or can not be construed as, child support; and
  7. The payments are not required after death of the payee spouse.  
Payments to a Third Party
 
Alimony payments can, in some situations, be made to a third party under the terms of a divorce or separation agreement. A payor can pay a payee spouse’s medical expenses, housing costs (such as rent, utilities, etc,), taxes, and tuition on behalf of the payee spouse as long as such payments are clearly listed as alimony. Also, a payor can include premiums paid for the payor’s life insurance if the payee owns the policy, as long as the payments are described as alimony. Additionally, for a jointly-owned home, a payor can claim one-half of the mortgage principal and interest and real estate taxes and insurance on the home as long as the payor is required by the divorce or separation agreement to pay all such expenses as alimony payment. Finally, cash payments to a third party made at the written request of the payee spouse may qualify as alimony if both parties agree that they are in lieu of alimony.
 
Child Support
 
Where a divorce or separation agreement includes both alimony and child support, the agreement must clearly delineate the separate amounts for each type of support. If the support is not clearly delineated, it will all be treated as child support. Also, if a support payment designated as alimony is to be reduced upon certain contingencies, such as a child’s becoming employed, dying, leaving the household, leaving school, marrying, or reaching a specified age or income level, the IRS will presume that such payments are child support rather than alimony.
 
Planning Considerations
 
As part any divorce or separation agreement, it is important to consider the tax consequences of all aspects of the agreement. If one party makes considerably more money that the other, it may make sense to designate several allowable third party payments as alimony. Also, sometimes it will be better to designate certain property settlements as periodic alimony payments rather than as a lump sum property settlement. The payee spouse will have to claim these payments as income, but the percentage will be small in comparison to the taxes paid by the payor, assuming there is a wide disparity in income. Such payments can also give the lower-income payee spouse a steady source of income instead of property or assets that have no practical value in the hard financial times following a divorce or legal separation. Be cautious, however, about front-loading too any assets as alimony instead of a property settlement. If you believe that the agreement indicates an attempt to avoid taxes, so will the IRS.
 
If your client has concerns about the potential tax consequences of alimony v. property settlements, alimony v. child support, or alimony as third party payments, it would be wise to consult, or have your client consult, an accountant or other professional tax preparer. Depending on your client’s particular situation, the tax consequences of a poorly drafted divorce or separation agreement could be quite significant.
 
Reference:
 
Your Federal Income Tax for Individuals (2007) ( IRS Pub. 17.)