Having payments structured as alimony can be an effective tax planning tool. Why? Because alimony is deductible by the payor (typically the higher earning spouse) and taxable to the recipient; the former family unit can reduce, often significantly, its overall tax burden. As we have been exploring in this blog series, sometimes payments the parties identified as alimony turn out to be something else…
The CPA preparing Pat’s tax returns just called to say that $96,000 of the payments made under the agreement will be presumed as child support by the IRS. Pat is dumbfounded. The payments were made according to the separation agreement; they were made in cash to the former spouse. All alimony and child support payments have been made on time. The agreement indicated that the payments were to be alimony and the parties expected that they would be deductible by Pat and taxed to Jamie.
How did this happen?
As required by the separation agreement, Pat paid Jamie $6,000 per month for three years until Taylor turned 18, then paid $4,000 per month for one year until Avery turned 18, at which time the payments were reduced to $3,500 per month.
Under these circumstances, the rebuttable presumption is that the payments in excess of $3,500 per month are deemed child support.
Certain spousal support payments (alimony) are deemed to be child support regardless of how they are described in a divorce decree or separation agreement. When a written instrument calls for a reduction in payments as a result of a contingency relating to a child, those payments will be treated as child support for income tax purposes regardless of the description in the written instrument. Examples of contingencies related to a child include the child attaining a specified age, marrying, dying, leaving school, or a similar contingency.
Careful planning may have avoided these consequences.
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