The Fundamentals of Spousal Support Taxation

The growing divorce rate in America has led to the creation of various types of spousal support where one ex-spouse is required to pay to the other. In most cases, the higher-earning spouse is required to pay the lower earner a certain amount, although there are exceptions to this. The tax rules are not the same for all types of support – some types are reportable income while others are not. This article explores the factors that determine how spousal support is classified and subsequently taxed.

There are two main types of support that are awarded to ex-spouses today: alimony and child support. Both types of support are awarded by a divorce decree, written agreement of separation or decree of support. Failure to pay either one of them can result in further legal action, including garnishment of tax refunds of the payor or additional litigation by the rightful recipient. Different regions have different laws outlining the consequences of nonpayment.

This type of spousal support is often awarded in divorces where children are not involved. In most cases, alimony payments are tax deductible by the payor and reportable as taxable income by the recipient. However, the following requirements must be met to receive this tax treatment:

• Alimony must be clearly specified in the divorce, annulment or separation agreement. No payments made under any circumstances outside this agreement can be labeled as such.
• Alimony must be specified as a mandatory payment in the agreement. Any voluntary payments made to one ex-spouse by the other cannot be considered alimony and are not deductible for the payor or taxable for the receiver.
• Alimony must be paid by cash, check or money order. Transfers of noncash property fall outside this category.
• Deductions of aggregate alimony payments of more than $15,000 made in the first or second year may be recaptured in the second or third year if a lesser payment is made that year. (The rules pertaining to this provision are somewhat complicated and best explained by a tax or financial advisor.)
• Payments made to an ex-spouse for the purpose of supporting children or dependents do not qualify as alimony.
• Payments cannot be considered alimony if both spouses still live in the same household when the payments are made.

Alimony paid is reportable as an above-the-line deduction, which means the payor is not required to itemize to deduct it. Taxpayers who pay alimony must include the Social Security number(s) of any and all ex-spouses to whom payments are made to deduct the payments. Failure to do so will result in disallowance of the deduction. Those receiving payments must provide their Social Security numbers to the paying spouse or face a penalty from the IRS.

This form of spousal support is specifically designated to benefit any children of the ex-spouse. Child support is not deductible by the payor or reported as taxable income by the recipient. Certain events pertaining to the children, such as their reaching the age of majority or moving out of the house, result in a modification to child support requirements. Both the IRS and state governments have the authority to garnish any tax refunds in an effort to collect delinquent child support.

Any initial division of property resulting from divorce is usually considered a tax-free exchange of property by the IRS. The recipient takes on the basis of any property received and pays no income tax upon its transfer. Any type of IRA or retirement plan transferred from one spouse to another under a qualified domestic relations order (QDRO) is also considered a tax-free exchange of property. (For more, see: Divorcing? The Right Way to Split Retirement Plans.)

From a tax perspective, alimony payments obviously favor the payor, while child support payments are more beneficial to the recipient. However, there are several factors divorcing couples should consider when determining the nature and amount of payments to be made. Who will claim the dependency exemptions and child tax credit for any children involved as dependents is one issue. If one spouse's income is too high to take advantage of the tax benefits, it may be wise to allow the other spouse to do so, perhaps in return for receiving taxable alimony payments instead of child support.

If the receiving spouse's income is fairly low, receiving alimony payments may have little or no impact upon his or her income, and therefore may be elected in return for other benefits to be provided by the payor, such as a more favorable custody agreement. The nature of the payment requirements also depends on the overall circumstances of the divorce.

Divorcing couples should recognize it is in both parties' best interests to know these rules and plan accordingly. Failure to understand the tax implications spousal payments resulting from divorce can lead to missed credits and deductions, ultimately reducing the income of both parties involved. Couples who are contemplating divorce or who have begun the divorce process may be wise to consult a professional with specialized training in the financial ramifications of divorce, such as a certified divorce specialist. 

(For related reading, see: Get Through Divorce With Your Finances Intact.)