Spousal Support Tax Issues

Divorce is a time of transition and change. Spouses move out of the marital residence, custodial schedules change, property is divided and spousal support orders are implemented by agreement or by Court order. Spousal support, as defined by the Internal Revenue Code, has tax implications for both the payor and the recipient.

In order for payments to be considered spousal support, the federal tax code has 7 requirements that must be met. If all of the requirements are met, the payments will be taxable to the person receiving the support and eligible as a deduction from gross income for the person paying the support (California Judges Bench Guide 2012).

The 7 requirements are:

1. 1.“The payment is made under a written divorce or separation agreement” – A legal document must record the agreement.
2. 2.“For payments made after the couple is no longer married, they can no longer live in the same household” – Both parties must reside separately for tax purposes that will be explained later.
3. 3.“The payments are in cash or cash equivalents” – Goods cannot be used as payment.
4. 4.“The payments are made to (or on behalf of) a spouse or former spouse” – A relative or friend of the spouse or former spouse cannot receive payment.
5. 5.“The agreement does not state that the payment is not alimony for tax purposes”
6. 6.“The parties do not file a joint tax return” – This point coincides with the second requirement.
7. 7.“The obligation to make the nondelinquent payments does not survive the receiving spouse” – The payments must stop upon death of the spouse receiving the support. (Californiadivorceplanning.com)

Certain payments (mortgage, medical expenses, home insurance, and rent) can be characterized as spousal support and qualify as a deduction for the payer and as taxable income to the recipient if specific tax and legal requirements are met. Some life insurance payments fit under this category if the ex-spouse that is receiving the payments owns the life insurance policy (Susan Bishop’s “Understanding and Calculating Alimony in California”).

In some cases when taxes are due, the party that has received spousal support payments does not have the funds to pay the tax. To avoid this problem, the spouse receiving spousal support should make quarterly estimated tax payments to keep his or her outstanding obligations to the IRS and Franchise Tax Board from growing too large.

Another method is to not have the spousal support treated as deductible and taxable payments (only if both parties agree). The spouse receiving the payments must attach a copy of the agreement to the tax return they file for each year that the payments are made (Susan Bishop’s “Understanding and Calculating Alimony in California”). This can be done in a few different ways and is often part of a spousal support buyout.

Paying or receiving spousal support will be an important component of your post-divorce financial situation. It is important to understand the terms of your settlement agreement and their impact on you. If you have questions regarding spousal support, please contact The Law Office of Matthew J. Rudy for a Free 1-Hour Consultation.