Settlements leading up to the formal end of a Houston marriage include details of payments transferred from one former spouse to another to satisfy support or property sharing obligations. Divorcing spouses should be aware of future tax implications, whether exes are on the paying or receiving end of these payments. Internal Revenue Service rules for child and spousal support differ.
There are no tax deductions for non-custodial parents who pay child support and no tax penalties for custodial parents who receive it. Alimony is deductible from the gross income of payers and is taxable as income for recipients. The IRS is aware that tax advantages can tempt some individuals to disguise reasons for post-marital payments.
IRS Code Section 71 prohibits payments other than qualified alimony, like child support or property settlement terms, to be designated as alimony. A Texas divorce agreement may state certain payments are alimony. However, payments may not qualify under tax rules as alimony.
Spouses who divorced in 2006 had an agreement that included no explanation as to why the ex-wife received $50,000 from her former husband. During an audit of the woman's taxes and subsequent trial, questions came up about deposits to the former wife's business accounts. In the course of the legal action, the woman stated she felt payments from her ex should not be taxed as income, since they were linked to a marital property settlement.
The spouses' divorce agreement lacked clarity -- the reason for the money transfer was missing. The court's interpretation was, because the agreement didn't state the cash was something other than alimony, the woman was liable to pay taxes on the income as if it was designated alimony.
The takeaway lesson is to understand clearly how spousal support is viewed by the IRS for alimony payers and recipients. A divorce agreement should reflect which payments are designated as alimony, according to federal tax law requirements.
Source: Forbes, "Alimony That Does Not Look Like Alimony" Peter J. Reilly, Apr. 30, 2014