The reason why various types of spousal support were created is due to the increasing rate of divorce in America. Generally, whoever has the highest-earning income is required to pay the lower earner a specific amount although there are exceptions to the rule. There are different tax rules for all types of support - some types are considered to be reported as income while others are not. It’s actually simple to learn the rules for each support but you may still need some assistance in making decisions about them. We will discuss how each support is taxed in this article and which payments will be beneficial for you from a tax perspective.
What are the types of Spousal Support?
The two main types granted to divorcees today is alimony and child support. Child support recently became the most common for divorcing couples with children while alimony is no longer granted that often anymore. These two types of support are granted through either a divorce decree, written agreement of separation, or decree of support. Whichever type you’re into right now, failure to pay any of them may result in a further legal action such as garnishment of tax refunds of the payor or additional litigation by the rightful receiver. Some regions treat the consequences of nonpayment differently than others.
What are the basic rules?
Unless you and your ex-spouse agree otherwise, spousal support is required to be reported as taxable income by the recipient and can be deducted by the paying spouse. Generally, whoever has the highest income will be the one to look for deductions while the low earner will not have to pay that much on taxes based on the amount of support received. It means there is no problem when it comes to the taxable/deductible system. If there is an increase in tax for the recipient, its sometimes offset with the substantial tax savings for the higher earner and can make up the difference to the recipient either with additional payment or in a different way.
However, you have the option to make spousal support payments nontaxable and nondeductible provided that its fair for the same parties and an agreement is reached. This typically happens when the recipient belongs to a higher tax bracket than the paying spouse. It also happens if the paying spouse doesn't find tax deductions necessary and the recipient spouse doesn’t want their income to be reported.
If both of you agrees to make the spousal support nontaxable and nondeductible, it’s no longer necessary for the recipient spouse to report the income when filing for tax return on that specific year.
What happens if you’re the one receiving support?
The potential tax impact of the income by the recipient must need to be planned. Your ex-spouse won’t withhold any taxes form your support check and if you want to avoid having to pay substantial amount of taxes by the end of the year, it’s best to pay estimated tax each quarter especially if you’re a stay at home spouse caring for your young children without any other source of income. Another way to offset the potential impact of support payments is to increase withholding from your paycheck provided you have a stable, paying job. If you want to find out the severity of the tax impact of different amounts of support, consult a tax professional to help you out. This way you’ll know what to do with the potential tax liability you might have to deal with during tax time.
What happens if you’re the one paying support?
Spousal support payments are deductible when filing your income tax return. You cannot include child support or property distributions. The IRS is very particular when it comes to the support paid in the first three years because there are those who disguise property distribution and other postdivorce obligations such as attorney fees as deductible support. If the IRS finds out that the early payments are in lieu of property division on other nonsupport items instead of giving higher payments in the first post-divorce years and lower payments later according to the divorce agreement, they may have to “recapture” retroactive taxes.
Another thing to remember is to never tie the termination of spousal support to anything that is related to your kids such as when they leave home or graduate from college in the spousal support agreement you negotiated. The IRS will consider that child support instead of a spousal support - and child support payments do not qualify as tax deductible.
Conclusion
It’s important that both parties understand the tax implications of divorce and must plan accordingly to not miss credits and deductions that will eventually lead to a reduction of income on both parties involved. Both must look after each other’s interest and if are still having a hard time understanding, must agree to consult a tax professional and someone who specializes in the financial consequences of divorce.
