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Alimony and Divorce Agreements

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By Roy Lewis

Divorce can be just as much an economic issue as an emotional one. And, while many people poke fun at (or scorn, or ridicule) divorce attorneys, a good one might be able to save you more dollars than you realize. A bad one might cost you thousands, and we're not just talking about the settlement.

Many tax issues for divorce revolve around the actual divorce agreement. The two main financial issues that most people deal with in divorce are alimony and child support. Child support payments are not taxable to the person receiving the payments, and are likewise not deductible by the person making the payments. Alimony payments, on the other hand, are completely different. If a payment qualifies as alimony, that payment is taxable to the person receiving the payment, and deductible by the person making the payment.

But, for a payment to qualify as either alimony or child support, it must be stated as such in the "divorce or separation instrument" -- generally the divorce decree. A sloppy or unclear drafting of the divorce agreement can subject you to additional unexpected (and certainly unwanted) taxes.

Example #1: Take the recent case of Judy. Judy's estranged husband was required to make a monthly payment "for support of spouse and one child." Problem was, the divorce decree never allocated portions of the payment for alimony and child support.

Judy's return was selected for audit, and the IRS argued that 100% of the payments she received from her "ex" were alimony and subject to taxes. Judy, on the other hand, argued that she should be able to exclude an allocable portion of the payments as non-taxable child support. Judy pointed out that the statutes of her state of residence provided support payment guidelines for alimony and child support, and because her ex-husband's payments followed those guidelines, she should be able to exclude at least a portion of the payment (based on the support guidelines) as non-taxable child support.

While Judy's argument might seem reasonable, it doesn't follow the requirements of the tax code. To be considered non-taxable child support, the law requires that the payment be fixed by the divorce document as an amount payable for the support of a child.

Alternatively, if a payment specified in a divorce decree is reduced because of a contingency pertaining to a child (such as death, marriage, leaving school, attaining a certain age, etc.), the portion of the payment equal to that reduction can be treated as child support until the reduction occurs.

Example #2: Sandi receives a payment in the amount of $700 per month from her ex-husband. While the divorce decree doesn't necessarily identify that payment as either child support or alimony, the agreement does provide that $400 of the payment will stop when their son Johnny turns age 18. Because of this contingency, $400 of the monthly payment will be treated as child support, while the other $300 will likely be treated as alimony... taxable income to Sandi.

Now, let's get back to Judy. In her situation, the child support wasn't "spelled out" in the divorce agreement and there weren't any contingencies in the agreement. Judy was out of luck. The Tax Court sided with the IRS, and all of the monthly support Judy received was ruled to be taxable -- all because of a poorly drafted divorce agreement.

So, for those of you contemplating divorce (or even perhaps in the middle of one), it's always a good idea to have somebody skilled in the nuances of tax law review your divorce agreement before you sign it. In most cases, that will be your attorney. But, if your attorney is not well-versed in divorce tax issues (or you decide to perform a "do-it-yourself" divorce), a few dollars paid to a qualified tax pro to review the agreement might be a very good investment. I'm pretty sure that Judy would certainly agree.

(How a payment qualifies for alimony treatment is not an issue we'll discuss at this time. Just know that there are specific restrictions and requirements defining what does and doesn't qualify for alimony. In the meantime, if you would like to read more about those requirements and restrictions, check out IRS Publication 504).

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