One of the first things anyone in the middle of a divorce should do is meet with their accountant. Understanding the tax consequences of alimony, child support, retirement distributions, etc. can help prepare you for the effects of the divorce on your finances. Among the things you will want to discuss with your accountant and family law attorney is how alimony vs. child support will impact your taxes.
Alimony and Taxes
The IRS has strict rules regarding what qualifies and what doesn’t qualify as alimony payments. Among these, individuals cannot file joint tax returns, and the payments must be stipulated within a divorce or separation agreement. Further, the spouses cannot reside within the same household at the time the payments are made.
If you are paying alimony and the divorce was finalized before December 31st, 2018, then the amounts you pay are tax-deductible. You can deduct these from your taxable income, which can significantly lower your tax liability.
Conversely, if you are receiving alimony payments from your ex-spouse, and these payments were ordered prior to December 31st, 2018, the IRS requires you to claim these payments as taxable income. That December 31st date is crucial for both parties. That’s because the Tax Cuts and Jobs Act removed the deduction for alimony payments as well as the requirement to claim such payments as taxable income for divorce agreements finalized after that date.
Child Support and Taxes
Where alimony is paid to support an ex-spouse, child support is paid to support the needs of the children. It’s an important distinction, and the courts want to see that the funds go towards the purchase of items such as food, clothing, housing, medical care, and other basic needs. Because child support payments are made to support the needs of children, it is not considered tax-deductible or taxable income. This means that the recipient parent does not have to claim the payments as income, and the parent making the payments cannot deduct them from their taxable income.
Where divorced parents need to exercise caution is when claiming children as dependents on their taxes. In most cases, this is addressed within the divorce decree. Some parents forego the right to claim the child as a dependent altogether, while others chose to alternate years.
Other Important Tax Considerations
There are many potential tax consequences of divorce. Among these is your filing status. You can only file as “married filing jointly” or “head of household” if you were married on the last day of the year. Another important consideration is if there is a qualified domestic relations order to distribute funds from retirement accounts or pension plans. If there is, then the recipient spouse needs to claim these as income.
Finally, the IRS won’t allow you to deduct legal fees from your divorce from your taxable income. However, they will allow you to deduct legal fees stemming from the receipt of tax advice from your attorney. Thus, it is worth taking the time to discuss everything from capital gains generated from the sale of real property, to the long-term benefit of claiming a child as a dependent.