An important component of any financial transaction is consideration of tax impact. Divorce settlements are no exception to this axiom. Any time a divorce settlement for spousal support, child support, or family support is being considered by divorcing spouses, they need to carefully review the tax implications of their settlement agreement.
Spousal support is typically deductible on both state and federal taxes by the payor and considered taxable income that must be claimed by the receiving spouse. There are certain requirements that must be met for this to be true, such as being paid in cash, check, or money order, not living together at the time the payment was made, and the divorce decree cannot state that the payment is not alimony. Child support, on the other hand, is not deductible for tax purposes, for state or federal taxes.
An alternative to having two separate payments (i.e. one for designated for alimony and one designated for child support) is to have one single “unallocated” payment labelled solely as “family support.” If spouses can agree, it is possible for the paying spouse to make one payment that comprises both spousal support and child support. If this is done and the agreement and divorce decree label the payment as family support, then the whole payment is deductible to the payor and taxable to the payee. At first one may wonder why a receiving spouse would ever agree to such an arrangement. However, there can be benefits in cases where the receiving spouse has very little or no income apart from the support payments. If the receiving spouse has a low enough income, then he or she may not be taxed on that income anyway, while the paying spouse would still receive the much larger benefit of being able to deduct the combined sum of both spousal and child support.
This arrangement is not without some ambiguity. Although deduction of family support is explicitly permitted on your California state income taxes, there is not a completely clear answer as to whether this is permitted on federal income taxes. For family support to qualify as a federal tax deduction, the federal tax code states that it cannot be related or tied to any “child event.” (Such as a clear connection to the family support ending when the child reaches the age of being an adult.) When considering whether your family support payments can be tax deductible for federal purposes, it is very important that you seek the advice of a well skilled tax accountant and family law professional.
Crafting an adequate settlement agreement that benefits both parties in terms of taxes can be complicated, and you need the help of an experienced attorney. Call us today at 619-800-0384 and let us talk with you about your settlement options.