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A number of significant income tax issues should be considered in connection with a divorce. For example, alimony is deductible by the person making the payment. However, alimony is taxable income to the recipient. Child support payments are neither taxable nor deductible.
In a recent case (Nancy Gallagher Maes v. U.S., 106 AFTR 2d 2010-6752, Oct. 13, 2010), a federal district court in Montana had to sort out the difference between alimony and child support.
Pursuant to a divorce decree, Nancy Maes received $109,000 from her ex-husband. She originally characterized the payments as alimony income on her federal income tax return. Later, Maes amended her return and classified the payments as nontaxable child support. The IRS denied her refund claim.
At the time of their divorce, Maes and her ex-husband had four children, two of whom were minors. Their final decree of dissolution of marriage contained the terms of the child support agreement and the alimony payments.
The money characterized as alimony in the dissolution decree was scheduled to decrease at specified time intervals. The scheduled reductions would occur in the same years that the Maes' two younger children turn age 20.
However, the dissolution decree was silent about any connection between the payments and the children's ages. Separate provisions of the dissolution decree required the ex-husband to provide child support.
Maes argued that, because the alimony was reduced in years that one of their children turned age 20, the tax code characterizes the payments as child support. The IRS argued that any presumption that the payments are child support is overcome by evidence that the parties did not contemplate the reductions to be made in reference to the children's ages. The court agreed with the IRS.
This case serves as a reminder that taxes are often the last thing on the minds of couples going through a divorce. However, important tax questions such as the characterization of payments as alimony or child support and who is entitled to the dependency exemption for children should be dealt with during the drafting of the divorce agreement. These determinations should not be left to the IRS and the courts.
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