Alimony payments offer a less taxing alternative

By Jeff Schnepper

"Take the money and run" takes on a whole new meaning when it comes to divorce.

With all the emotional consequences of a divorce, the tax implications are rarely the primary focus. However, an understanding of the tax aspects of the marital settlement might allow both parties to walk away with more money.

The key is in the alimony

The difference lies in whether you define the money as alimony or child support. It also depends on the spouse who is supposed to receive the payments having enough faith that his or her ex will cough up the money, regardless of how it's legally defined.

Here's how it works:

The tax code regards payments that constitute "alimony" as tax deductions for the payer and as taxable income to the payee. Payments defined as child support are neither deductible nor included as income. They represent tax-neutral transfers.

Can you trust your ex-spouse?

One caveat -- and it's a big one: If you're concerned about an ex-spouse's financial commitment, the courts have looked much more severely at the failure to pay child support than they have at the failure to pay alimony.

Child support is clearly easier to squeeze out of an uncooperative ex-spouse. In fact, if child support is not paid on time, the Internal Revenue Service has a program providing for the money to be paid directly out of an ex-spouse's tax refund.

Calling payments "alimony" or "child support" in the separation agreement or the divorce decree is not enough. Alimony means the money must be made to a former spouse in cash. The payments terminate when the receiving spouse dies. The money must be paid according to a written divorce or separation agreement, a decree of divorce or separation, or a support agreement.

The conditions

The stipulations don't stop there. The ex-spouses can't live together at the time the payments are made and none of the money can be deducted if it was targeted toward child support. For example, if the payments end or are reduced once a child marries, dies or graduates from high school or college, those funds don't count. The IRS figures, perhaps correctly, that if alimony payments stop once a child leaves the nest, then they weren't alimony. They were child support.

Even if the lower alimony payments are unrelated to the child's future, they had better not occur within six months after the child reaches legal maturity of either 18 or 21. If the payment does, the IRS assumes that it's child-related.

In addition, if you have more than one child and your alimony payments are scheduled to be changed within one year of the time each of your children reaches a specified age between 18 and 24, the amount of the change will be treated as child support.

Be very careful here -- the IRS takes the position that payments that benefit a child rather than a spouse are child support, not alimony.

Continued: Shifting income can benefit both parties

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