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After a divorce, it’s common for one spouse to make payments to the other as part of the divorce agreement. These payments can be alimony, child support or a mix of both. It’s important to understand the difference between the two because this will help you plan for taxes and put together an agreement that leaves both of you in better shape financially.
Alimony, also known as spousal support, consists of payments that one spouse makes to the other person after their divorce is final to maintain the same standard of living after the divorce. A divorce agreement usually involves alimony when one person makes more than the other; the higher earning spouse pays out alimony. The person paying alimony is typically able to claim the alimony as a tax deduction, while the person receiving alimony needs to report the payments as income.
Considered separately, child support is payment to help raise young children. The custodial parent who is set to spend more time with the kids generally receives child support because they will spend more money on childcare. These payments typically end when the children reach a certain age, usually 18 or 21. Unlike alimony, there is no tax deduction for child support. The person receiving child support also does not need to pay income tax for receiving this money.
Since tax laws are different for alimony and child support, you might want to ask your financial advisor or lawyer whether you could design a divorce agreement that minimizes the total taxes you and your future ex-spouse will owe. If the person making payments will be in a higher tax bracket than the person receiving money, it might make sense to pay more in alimony. The tax deduction typically works better against the higher tax bracket.
If the person making payments is not in a higher tax bracket, it might be better to transfer more property immediately after the divorce rather than paying more in alimony later on. The alimony payments might not be as much of a tax advantage for them, so it might be easier just to settle everything right away if possible. But these are all complicated issues that need to be discussed with your lawyer, accountant or financial advisor.
While you want to minimize your tax burden when you create your divorce agreement, the IRS has some rules in place to keep things from going too far. One situation that can create problems is when all payments are labeled as alimony while some of the money is also used as child support. The IRS will track payment history to see if the payments go down after the children reach a certain age. If that were to happen, they could reclassify part of the payments as child support, and the paying spouse would owe extra in back taxes.
The IRS also watches to see if alimony payments go down within a few years after the divorce. This is because some couples, instead of splitting their property all at once during the divorce, take a few years to divide everything. They do this to add the property money to the alimony to get a higher tax deduction and then lower the alimony payments once all the property has been paid out. If the IRS sees this type of drop, they may cancel the deduction and assess for unpaid taxes.
Alimony and child support are common components of preparing to financially separate from a spouse. It is important to understand what each is and how they differ in order to understand the tax implications for both. Regardless of your situation, we recommend that you seek the advice of your personal financial advisor or lawyer. Only they can provide specific advice on what solutions might best suit your needs.
For more information on financial topics, as well as how divorce may affect your finances, visit our learning center.
This article is for information and educational purposes only; does not necessarily represent the opinion of Protective Life; and, is not intended to serve as financial planning for getting divorced but, instead, to supplement other information specific to your situation. Neither Protective Life nor its representatives offer legal or tax advice. We encourage you to consult with your legal or tax adviser regarding your individual situations before making tax-related decisions. For information about Protective Life and its products and services, visit www.protective.com.