levitra"> levitra"> Child Support vs. Spousal Support: Tax Benefits and Tax Traps
levitra

Click to go home.

Google
 

Search:
 

Survival Tools
& Resources
Divorce & Finance Blog
Divorce Discussion
Forums
Divorce Help Desk
Divorce Resource Library
Professional & 
Resource Directory
State Divorce Information
New Trends in Divorce
 
 
Divorced or Separated Individuals (IRS Pub 504)
Divorce News
Subscribe to Divorce Interactive News
Ask the Expert
     Financial Planner
Columns
     Parental Guidance
     Child-Centered Solutions
Divorce Interactive Newsletter
Divorce Books
Glossary





Child Support vs

Child Support vs. Spousal Support: Tax Benefits and Tax Traps
By: Jerry Style

Support payments pursuant to divorce receive different tax treatment depending upon whether they are characterized as child support or spousal support (referred to also as maintenance or alimony). This is a potential tax planning opportunity, but there are important pitfalls that need to be addressed in the tax planning process.

Payments classified as child support are not taxable to the payee spouse and not tax deductible by the payor spouse. Payments classified as spousal support are taxable to the payee spouse and tax deductible by the payor. These payments are not only tax deductible, but “above the line” adjustments to income, meaning that the payor spouse does not have to itemize deductions to get the tax break. In theory, divorcing spouses may be able to save money in taxes by taking advantage of this difference, but must be careful in how they do this.

Let’s go through a simple example. John and Mary are divorcing, and their ten-year-old son Matthew will be living with Mary. John has a good job and makes $125,000 per year. As a single individual, he is in a 30% marginal tax bracket. Mary’s income is $25,000, and she will claim Matthew as a dependent. As Head of Household, Mary is in a 15% marginal tax bracket. Let’s assume that an agreement is reached whereby John will pay Mary $1,500 per month in child support and $1,000 per month in spousal support, for a total of $2,500 per month in support. The spousal support portion will be tax deductible to John and taxable to Mary.

John has a bright idea. Why not call ALL payments alimony? John would pay $2,500 per month in spousal maintenance until Matthew reached age 21 and $1,000 per month thereafter. Since John is in a higher tax bracket than Mary, this can reduce the total amount of taxes that will be paid, putting more money in their pockets and less in Uncle Sam’s. They go to an accountant who tells them that such an arrangement would save John about an additional $6,700 per year in Federal and New York State income tax, but would only cost Mary $4,500. John offers to pay Mary the additional $4,500 and offers to split the remaining $2,200 in tax savings.

Pretty good, right? By changing a few words, they reduce their tax by $2,200 per year and each saves $1,100 per year in taxes, for a total tax savings of over $20,000 over the next eleven years.

Any problems? You bet! The IRS has some pretty smart people who work for them too, and they are very much aware that the difference in tax treatment of support payments is a potential area of abuse. They have thus created a revenue code called the “Child Contingency Rule” that says that if payment of spousal maintenance is reduced as a result of a contingency relating to a child, the amount of the reduction is considered to be child support from the beginning. Furthermore, if no specific child contingencies are mentioned, BUT the reduction in spousal support occurs within six months of a dependent child’s 18th or 21st birthday, the rule also applies. The Child Contingency Rule would nullify the “creative” arrangement made between John and Mary and would disallow the attempt to deduct the child support as alimony.

Always seek the advice of an expert who knows the intricacies of these complex IRS rules.

Allocating support payments between child support and spousal support is one of many tax-planning opportunities in divorce, but tax planning must be done with great care.



DivorceInteractive.com tries to provide quality information, but cannot guarantee the accuracy, completeness or adequacy of the information, opinions or other content posted on the site. It is not intended as a substitute for and should not be relied upon as legal, financial, accounting, tax, medical or other professional advice. It should not be construed as establishing a professional-client or professional-patient relationship. The applicability of legal principles is subject to amendment by the legislature, interpretation by the courts and different application by different judges and may differ substantially in individual situations or different states. Before acting on what you have read, it is important to obtain appropriate professional advice about your particular situation and facts. Access to and use of DivorceInteractive.com is subject to additional Terms and Conditions. DivorceInteractive.com is a secure site and respects your Privacy.


Home  |  Advertise With Us  |  Professional & Resource Directory
Divorce News  | Glossary  | Divorce Discussion Forums
Change Area Code  | Terms & Conditions/Legal Disclaimer  |  Privacy Policy  |  About Us   |  Contact Us

2001-2010 DivorceInteractive.com  All Rights Reserved.