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Alimony, Child Support and Taxes
The issues of alimony, child support and taxes frequently confuse and confound people as they are going through the divorce process, and that need not be the case. Each has its own factors to consider and can be taken individually for better understanding.
Alimony, which may also be referred to as spousal support or spousal maintenance, is usually a negotiable issue in divorce. Some states use a formulary approach which may limit the negotiations within prescribed parameters or guidelines. In all cases, this is support provided by one ex-spouse to the other for some period of time to facilitate financial adjustments from marriage to singlehood. When the marriage has been long term, and there is a demonstrated need by one spouse, alimony may be awarded for life, or in futuro.
The award of alimony is based upon the need of one spouse and the ability of the other spouse to help meet that need. The two key elements in determining the "need" and "ability" are financial resources, including income and assets, and living expenses of each party. Income for each party will be documented, as will assets and the proposed division of property. The lynchpin will be their respective living expenses. Determining living expenses seems to frequently be one of the most difficult tasks in the divorce process. Frequently, people are aware of the most obvious reoccurring expenses like mortgage, rent, car payment, utilities, etc. which are essentially documented by someone else when billed. What escapes their grasp is what they spend all their other money on. Yet, if this is not itemized during the divorce, they will not be able to continue their current lifestyle, or anything close to it, post-divorce.
If you are the spouse who may prospectively receive alimony, and your expenses are not complete and accurate, you will not know what you will need, will not be able to ask for it, and surely will not get it. If you are the spouse who may prospectively pay alimony, and your expenses are not complete and accurate, it will appear that you have surplus money to share, you will not be able to hold on to it, and it will not be there when you need it. You must know and document your expenses accurately as if your future depends upon it, because it does.
Alimony is usually taxable to the recipient and tax deductible to the payer. There are, however, instances where it may not be taxable to the recipient, nor deductible to the payer. It is important to understand what you are agreeing to. Assuming the taxable/deductible scenario, if you were to receive $4,000 per month, and you are in the 25% tax bracket, you would owe $1,000 taxes on that alimony and therefore, only have $3,000 available to spend on your needs. That is the reality. If you were the one paying $4,000 per month, and were able to take the tax deduction in the 25% bracket, you would actually save $1,000 in taxes. Therefore, the $4,000 would really only cost you $3,000.
Child support is money paid by one parent to the other for the needs of the child(ren). The payment essentially is an equalization payment based upon the proportionate incomes of each parent, what each parent directly provides for the child(ren), and what is needed to reimburse the parent who is providing more and/or has fewer resources. Each state has clearly defined child support calculation guidelines which must be adhered to. The challenge that sometimes arises is knowing what numbers to enter into the calculations, particularly income. Divorce financial professionals frequently refer to a two-inch manual entitled "The Determination of Income for Child Support" dedicated to this single issue. Such must be used in conjunction with your attorney's interpretation of your state statute.
Child support will be payable until the child(ren) reach the emancipation age and/or emancipation event as per the laws of your state. There is considerable variation on these factors among the states and your attorney will advise you. Child support is not taxable to the recipient, nor tax deductible for the payer. This, as per the Internal Revenue Code, is uniform in all states.
There are, however other tax considerations related to the children. The one that immediately comes to mind for most parents is to agree on who will claim the child(ren) as dependent(s). The value of the personal exemption for each child will vary depending upon each parent's tax bracket. That is usually where everyone stops, but there is much more to consider. And it gets complicated. First issue is that the Parenting Plan will only be applicable for as long as the child(ren) remain unemancipated according your state laws. Your Marital Dissolution Agreement may contain further agreement concerning which parent claims the child(ren) after they are no longer dependents in the eyes of your state, but remain dependents according the IRS. If you can agree on this now, it will may save a lot of grief in the future.
Additional tax considerations related to children are conditional on which parent each child actually spent more time with and/or which parent actually claimed the child as a dependent. The tax dollars involved in various deductions and tax credits which may be available are significant. I recently had a case that involved one toddler child, so there were seventeen years of child related tax issues to consider until emancipation at age 18 in my state. I identified more than $96,000 in potential tax benefits that my client, the mother, may or may not receive, based upon decisions that would be made at this time and written into the parenting plan. That did not even include tax advantages beyond that while the child attends college, nor anything about qualifying for additional student aid, or not.
Other tax benefits to discuss with your divorce financial professional, tax advisor, and attorney each have qualifying requirements where one parent may qualify, but the other does not. The goal should be to make decisions that allow you as co-parents to take advantage of as many tax benefits as possible and preserve dollars in your combined pool of money. There is no sense in unnecessarily giving additional dollars to the government that could have been used to provide for your child(ren), and/or create greater need for increased alimony to the less-moneyed parent.
In summary, the additional tax benefits available to the parent who claims the child are: the child tax credit, American opportunity credit, and lifetime learning credit. Tax benefits available to the parent with whom the child spent the most days/nights during the tax year are: head of household filing status, credit for child care expenses, exclusion for dependent care, earned income credit. All of these have additional qualifications which one parent may meet, but the other does not. The best overall options should be considered. Student aid will be based upon the parent with whom the child spent the most days with during the year preceding each annual application.
Both alimony and child support involve commitments for large sums of money for some number of years. Whenever there is a discussion about financial issues stretching out over numbers of years, that starts sounding a lot like financial planning. It is highly advisable to get some help with this from someone who specializes in the finances of divorce and can work with your attorney as your financial consultant. The decisions you make at this time will have a permanent impact upon your future financial stability.