Many times when going through divorce, the man we once considered our best friend will turn into our worst enemy. It's likely these hard feelings will affect the way we negotiate a divorce settlement agreement.
But divorcing couples need to keep in mind that, no matter how much animosity they may feel for each other, they have a common enemy in the IRS. If couples allow hard feelings to guide them, they may end up paying at tax time.
When negotiating a divorce settlement, it's critical to take the IRS into consideration. The bottom line: You should always talk with someone with expertise in the tax consequence of divorce before you come to a final agreement. If you receive money from your ex, how it's paid can greatly affect the amount of taxes you will have to pay Uncle Sam.
If the payments are considered "alimony" or "spousal support," they're deductible by the person paying and taxed as income to the recipient. Child support payments, on the other hand, are considered tax neutral and are neither deductible or taxed.
The IRS will consider payments alimony if these conditions are met:
- You must have a formal spousal support agreement that is part of your divorce decree or a separate written agreement.
- Support payments must be made with a check or money order.
- You and your spouse must live in separate households.
- The payments must be completely independent of child support. Your divorce settlement agreement can't provide that when your child reaches a certain age the spousal support will be reduced or stopped. If the IRS learns that you've done this, the agency will reclassify any prior payments as child support — which are not deductible, meaning that you will owe taxes to the government.