In nearly every divorce, decisions will need to be made regarding property division, alimony, and child support. For almost every decision, including alimony, there are important tax implications that must be considered prior to signing off on the financial terms of a divorce agreement.
Alimony payments are tax deductible to the payor and taxable to the recipient. Any divorce agreement must specifically lay out all alimony terms, if any, including the exact amount of alimony and/or formula for calculating alimony, and the timeline for the alimony payments. In order for a payment to be considered alimony for income tax purposes, it must be made pursuant to a written divorce agreement (commonly called a “separation agreement”) or a divorce decree. Payments made before a separation agreement has been signed or a divorce decree has been entered cannot be considered alimony.
In contrast to alimony, child support payments and payments related to the distribution of your marital estate (such as property settlement) are non-deductible to the payor and non-taxable to the recipient.
The US Tax Court recently upheld two basic alimony principles, reinforcing the importance of preparing and signing a carefully thought-out divorce agreement and the importance of specifically categorizing any and all payments to be made with an eye towards future tax implications.
In Milbourn v. Commissioner of Internal Revenue, the US Tax Court recently affirmed the principal that payments made from one spouse to another can only be considered alimony, and therefore tax deductible to the payor and taxable to the recipient, if the spouses have already signed a divorce agreement outlining the specific terms for alimony payments. If payments are exchanged prior to the signing of the divorce agreement, for example at a time when there is only a draft divorce agreement in existence, those payments cannot be considered alimony for tax purposes. The tax implications of this decision should be considered when one spouse makes support-like payments to another during a separation or before an agreement has been reached.
In Becker v. Commissioner of Internal Revenue, the US Tax Court recently affirmed the principal that a payor cannot allocate a payment that is less than a combined alimony and child support amount to alimony so as to reap the tax benefits. Where the support payments actually made by the payor are less than the amounts specified in the parties’ specific divorce agreement, the support payments made are to be considered to have been made towards the child support portion first, and will only be allocated towards the alimony portion once child support has been fully paid.
It is always best to consult with an experienced divorce attorney while you and your spouse are negotiating the terms of your divorce agreement to ensure that you are financially protected. The tax implications of any one of the terms of your divorce agreement can have further financial consequences to the parties.
About the Firm. Vaughn-Martel Law represents parents and children throughout Massachusetts in divorce litigation, divorce mediation, child custody, modifications, co-parenting, and all aspects of family creation and family law. If you wish to speak to an attorney about a family law matter, we invite you to contact us.