As we have noted in other articles, divorce can be just as much an economic issue as an emotional one. And while many people may poke fun (or scorn, or ridicule) at divorce attorneys, a good one might be able to save you more dollars than you realize. A bad one might cost you thousands. And we're not just talking about the settlement.

Many tax issues regarding divorce revolve around the actual divorce agreement. The two main financial issues that most people deal with in divorce are alimony and child support. As you are likely aware, child support payments are not taxable to the person receiving the payments, and are likewise not deductible by the person making the payments. Alimony payments, on the other hand, are completely different. If a payment qualifies as alimony, that payment is taxable to the person receiving the payment, and deductible by the person making the payment.

But in order for a payment to qualify as either alimony or child support, it must be stated as such in the "divorce or separation instrument"...generally the divorce decree. A sloppy or unclear drafting of the divorce agreement may subject you to additional unexpected (and certainly unwanted) taxes. Take the recent case of Judy.

Judy's estranged husband was required to make a monthly payment "for support of spouse and one child." Problem was: the divorce decree never made any allocation of the payment between alimony and child support.

Judy's return was selected for audit, and the IRS argued that 100% of the payments that she received from her "ex" were alimony. Judy, on the other hand, argued that she should be able to exclude an allocable portion of the payments as non-taxable child support. Judy pointed out that the statutes of her state of residence provided support payment guidelines for alimony and child support. And because her ex-husband's payments followed those guidelines, she should be able to exclude at least a portion of the payment (based upon the support guidelines) as non-taxable child support.

While Judy's argument may seem reasonable, it doesn't follow the requirements of the tax code. To be considered non-taxable child support, the law requires that the payment be fixed by the divorce document as an amount payable for the support of a child. Alternatively, if a payment specified in a divorce decree is reduced because of a contingency pertaining to a child (such as death, marriage, leaving school, attaining a certain age, etc.), the portion of the payment equal to that reduction can be treated as child support until the reduction occurs.

Example: Sandi receives a payment in the amount of $700 per month from her "ex". While the divorce decree doesn't necessarily identify that payment as either child support or alimony, the agreement does provide that $400 of the payment will stop when their son Johnny turns age 18. Because of this contingency, $400 of the monthly payment will be treated as child support, while the other $300 will likely be treated as alimony…taxable to Sandi.

But let's get back to Judy. In her situation, neither was the child support "spelled out" in the divorce agreement, nor were there any contingencies to be found in the agreement. Judy was out of luck. The Tax Court sided with the IRS, and all of the monthly amount received by Judy was ruled to be taxable. All because of a poorly drafted divorce agreement.

So for those of you out there who may be contemplating divorce (or even perhaps in the middle of one), it's always a good idea to have somebody who is skilled in the nuances of tax law review your divorce agreement before you sign it. In most cases, that will be your attorney. But if your attorney is not well versed in divorce tax issues (or you decide to perform a "do it yourself" divorce), a few dollars paid to a qualified tax pro to review the agreement might be a very good investment. I'm pretty sure that Judy would certainly agree.

How a payment qualifies for alimony treatment is an issue that we'll not discuss at this time...perhaps some time in the future. Just know that there are specific restrictions and requirements defining what does and doesn't qualify for alimony. If you would like to read more about those requirements and restrictions, do so in IRS Publication 504.

- October 15, 1999

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