When you’re negotiating with your spouse or arguing in court about the level, type, and duration of spousal support, tax issues should never be far from your mind. This article explains the basic rules and major concerns for each spouse—but it’s possible that you’ll need some assistance in making decisions about support, as discussed below.
Spousal support must be reported as taxable income by the recipient and can be deducted by the paying spouse, unless you agree otherwise. (This is the opposite of child support, which is neither taxable nor deductible.) In general, a higher earner will be looking for deductions, and a lower earner will not have to pay much tax on the amount of support received, so the taxable/deductible structure works fine. Any increase in tax for the recipient can often be offset by the significant tax savings for the higher earner, who can make up the difference to the recipient either with an additional payment or in another way. For example, the paying spouse might agree to simply pay the recipient spouse’s tax liability.
You can, however, make spousal support payments nontaxable and nondeductible as long as it goes both ways and you both agree (you’ll state as much in your marital settlement agreement). You might do this if the spouse receiving support is in a higher tax bracket than the paying spouse (this would be unusual, but might happen if the recipient spouse is receiving reimbursement support and has significant assets), or if the paying spouse doesn’t need the tax deduction and the recipient spouse doesn’t want to report the income.
If you do decide to make spousal support nontaxable and nondeductible, the recipient spouse should simply not report the income on that year’s tax return.
If you receive spousal support, you need to plan for the potential tax impact of the income. Unlike an employer, your former spouse won’t withhold any taxes from your support check. If you’re staying at home to care for young children and have no other source of income, paying estimated tax each quarter (to both the IRS and your state) may be a good way to avoid taking a tax hit at the end of the year. If you have a paying job, then increasing withholding from your paycheck is another way to offset the potential impact of support payments.
You may need to spend some time looking at different payment scenarios and how they play out tax-wise, by calculating what your tax liability would be if you received a certain amount of support and what benefit your spouse would receive from the tax deduction. You can check your potential tax liability at the IRS website at www.irs.gov, where tax tables are available. Or you can ask a tax professional to help you look at the tax impact of different amounts of support, so that you can figure out the optimal amount—that is, the amount that puts the most money in each person’s pocket after taxes are taken into account.
The IRS offers a number of publications that may help you as you negotiate support. There's a chapter specifically on alimony, and IRS Publication 505, Tax Withholding and Estimated Taxes, is one, and IRS Publication 504, Divorced or Separated Individuals, is another. Both are available at www.irs.gov or by phone request at 800-829-3676.
Payments made to third parties on your behalf are treated just as though they were paid to you—you have to include them in your taxable income. So, for example, if your former spouse pays the mortgage directly (and this is provided for in your marital settlement agreement or court order) you must report that amount as income.
You can deduct spousal support payments on your income tax return, but not child support or property distributions. So the IRS scrutinizes support paid in the first three years to make sure that you didn’t disguise property distribution or other postdivorce obligations, like attorneys’ fees, as deductible support. If the divorce agreement calls for higher payments in the first postdivorce years and lower payments later, and the IRS believes the early payments are in lieu of property division or other nonsupport items, it can go back and “recapture” retroactive taxes. If your agreement calls for a reduction of $15,000 or more in spousal support during year two or year three after your divorce, you may find Uncle Sam knocking at your door to discuss recapture.
When you negotiate your spousal support agreement, it’s important to make sure that you don’t tie the termination of spousal support to anything related to your kids—for example, the time they leave home or when they finish college. If you do, the IRS might consider the payments child support rather than spousal support—and child support payments aren’t tax deductible.
If you’re making payments to a third party instead of to your spouse, but you’ve agreed (in your settlement agreement) that the payments constitute spousal support, for tax purposes those payments are treated as if they were paid to the recipient. In other words, you can deduct them (at least in part) as support payments. Certain payments are not fully deductible, though, including payments related to a jointly owned home. If you and your spouse continue to own the home together and you pay all the expenses, you are allowed to deduct only half of the mortgage payment as spousal support. But you can take half of the mortgage interest deduction as well.
There are a lot of tax issues and financial considerations to be aware of during a divorce. Make sure you take the time to understand these issues. Please see the Divorce & Taxes section of our website.
Excerpted from Nolo's Essential Guide to Divorce, by Emily Doskow.