TAXATION OF ALIMONY AND CHILD SUPPORT
In today’s environment of divorce rate in excess of 50% coupled with changes in the taxability and deductibility of alimony, alimony, child support payments and filing status options have become even more of a hot topic then in the past. This article will attempt to clarify some of the rules.
What is alimony and what are the tax implications?
The first thing to keep in mind is you must separate couples that divorced before 2019 from those divorcing after 2018. The rules have changed beginning in 2019 but I will get to that. The first thing I would like to do is to explain alimony and child support.
Alimony is clearly defined by the Internal Revenue Code and payments which meet the definition of alimony are allowable as deductions (whether or not the individual itemizes) on the return of the payor and includible as income on the return of the payee spouse. This holds true for anybody divorced prior to 2019.
In order for payments to be considered alimony the following tests must be met:
- Payments must be made under a divorce or separation agreement
- The divorce or separation agreement does not designate the payments as child support or a property settlement
- Payments must be in cash
- Divorced or legally separated couples must live in separate households
- The obligation to make payments must end upon the death of the payee spouse
Although the definition of alimony has not changed, in the past decade there have been more couples living together until they can sell their home. It is important to keep in mind that as long as they live in the same home, the payments being made, even if under a divorce or separation agreement are not alimony.
What is considered child support and what are the tax implications?
Child support payments are simply what they say, payments to support the children. There is no deduction to the payor spouse, nor any income to be reported by the payee spouse.
What if not all alimony and child support payments are made during the year?
Unfortunately, sometimes there are individuals who simply cannot keep up with their alimony and child support payments. The tax treatment in such a situation is simply to apply all payments to child support first and then the remainder is considered alimony.
This methodology can be very good or very bad depending on whose perspective you are looking at it from. If you are the paying spouse struggling to pay whatever you can and you still do not receive a deduction for the payments, it can be painful. If, on the other hand, you are the payee spouse, you will have no taxable income to report.
What is a property settlement and are there tax implications?
Property settlements incident to a divorce are defined as transfers from one spouse to another within 1 year of the date which the marriage ceases. Generally, these are not taxable although there are some special rules relating to retirement plans and IRAs. The basis of the property transferred is the same basis that the transferor had in the property, usually its original cost.
Law change for those divorced after 2018
As I mentioned there is a change in the law effective for anyone who was divorced after 2018. If a couple was divorced after December 31, 2018 then, while the definition of alimony is the same, it will no longer be deductible by the payor or income to the recipient. Please keep in mind if you were divorced before 2019 alimony continues to be deductible to the payor and income to the recipient.
FILING STATUS ISSUES THAT OFTEN ACCOMPANY DIVORCE
There are five filing statuses available to taxpayers. These are single, married filing jointly, married filing separately, head of household and qualifying widower. Qualifying widower has nothing to do with divorce but has to do with an individual whose spouse passed away within the last two calendar years before the tax year in question and a household was maintained for a dependent child or stepchild.
Single – In order to file as single, you must be unmarried or separated from a spouse by divorce or a separate maintenance decree.
Married taxpayers can choose to file either a joint income tax return or separate tax returns.
Married filing jointly – You may file a joint return if:
You are married and living together
Married and living apart but not legally separated or divorced
Separated but not by a final divorce decree
Living in a common law state
Married filing separately – If you are married you can always choose to file separately however often times you will pay a higher income tax and will either lose out on or have a reduced benefit of these various credits:
Earned income credit
Credit for elderly or the disabled – unless you lived apart the entire year
Child and dependent care credit – unless you lived apart for the last six months of the year
Adoption credit – Unless you lived apart for the last six months of the year
Ineligible for education credits
Traditional IRA contributions if yours spouse was covered by a retirement plan and Roth IRA contribution limits both start to phase out at $0 of Adjusted Gross Income and are totally phased out by the time you reach $10,000 of adjusted Gross Income.
Head of household – You may be able to file as head of household if you meet all the following requirements.
You are unmarried or considered unmarried on the last day of the year or lived apart from your spouse for the last six months of the year.
You paid more than half the cost of keeping up a home for the year.
A qualifying person lived with you in the home for more than half the year (except for temporary absences, such as school). However, if the qualifying person is your dependent parent, he or she doesn’t have to live with you.
Head of household has a preferred tax rate to that of filing single.
Conclusion
This article discusses very general questions relating to alimony, child support and property settlements. Each situation is unique and as always if you’re not sure of the rules, then check with a tax professional.
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