Avoiding Taxes With Spousal Support Awards
If you’re feeling like spousal support awards really aren’t all that generous, you’re not alone. Spousal support is one of those things that, in my practice, varies widely. The law governing spousal support is far from clear, too, so even determining whether someone will receive spousal support is difficult and often convoluted. We have to look at a lot of different factors, some of which are pretty loosey goosey, if I do say so myself. There’s no hard and fast, black and white, bright line rules when it comes to spousal support. So, I’ve seen awards that are very wide ranging; from the generous (though that doesn’t happen all that often these days) to the not so generous.
I see spousal support awards that are permanent and ones that are temporary. I see some that are for one amount and stay constant at that amount. I see ones, too, that gradually taper downward. I see awards that are specifically designed to help the recipient spouse get education or training, so that she can begin to make a better life for herself without any financial assistance.
If you’re interested in the nitty gritty of spousal support awards, you’re not alone. And, as you begin to contemplate your possible separation or divorce, it’s a really good idea for you to take some time out to analyze your situation and get a general idea of what you can expect. You’re smart, and you’re in the right place.
As a matter of fact, there’s lots of information out there to help you as you begin to perform an analysis of your unique situation, so that you can begin to determine whether or not you’ll receive spousal support and, if so, how much and for how long. In fact, if you’re interested, I have written lots on those exact subjects, too, and am happy to point you in the right direction. Click here to learn about the law regarding spousal support, including what the factors are for determining whether you’ll receive it, how much you might receive, and for how long. Click here for a discussion on the different types of spousal support. Click here to learn about how spousal support terminates and one way of avoiding it terminating on you, and click here for one more way you can avoid your award of spousal support terminating. If you’re worried you’ll have to pay spousal support to your husband, instead of the other way around, click here.
Okay, now that all of that is out of the way, let’s talk about what we’re here today to discuss. Specifically, how can you avoid tax consequences with your spousal support award?
First of all, let me say quite plainly: I am not a tax lawyer. I have never worked as a tax lawyer. I’m not really prepared to give you in depth advice about taxes or potential tax consequences. If you’re super concerned, or if your case presents a unique and complicated tax issue, you should talk to a CPA or a tax attorney.
Still, in my years of working as a family law attorney, I have learned a few things about tax, and I’m happy to share the things that I do know with you.
Tax and Spousal Support
If you’ve done any research at all, you already know that spousal support is generally considered taxable to the person receiving it, and tax deductible to the person paying it. So, assuming that you’re the one receiving spousal support, it means that, come April 15th, you’ll have to claim the money you receive as spousal support as income, and then you’ll pay taxes on it.
Since it’s not money earned from a job, though, there’s no withholding throughout the year. That means that you’ll have to hold on to some money throughout the year so that when you complete your tax return (or your tax preparer completes it for you), you’re able to pay what you owe to the IRS. Obviously, that also means that you receive less than it looks like you receive, because you later have to pay taxes on it.
If you’re already feeling like spousal support really isn’t all that generous, you’re probably a little alarmed at the thought of paying taxes on the money you receive, too. You’ll receive even less than your separation agreement (or the judge’s order) says you’ll receive. If you’re finding it difficult to imagine how to pay for everything on an already meager award, the taxes thing can send you over the edge.
It’s a little confusing, too, because child support doesn’t work that way at all. Child support is not considered income to you, nor is it tax deductible to your husband. It’s more like “free” money; there are not strings attached in the same way.
So, is there anything you can do to avoid the tax consequences? What can you do to preserve as much of your spousal support award as possible, or to squeeze as much as you can out of what you receive?
What’s a girl to do?
Avoiding tax consequences with your spousal support award
Before I go too far, let me say this: most women do end up paying taxes on their spousal support awards. Still, with a little creativity, it is possible (sometimes) to avoid it. If you’re going to avoid the tax consequences, you have two basic options.
1. Including a provision in your separation agreement
Like with so many other things, a separation agreement gives you a lot of freedom. Though we really can’t change the law on a case by case basis, we can modify it a little bit by drafting a little bit creatively. In a separation agreement, you’re limited only by your creativity (or the creativity of the people who are helping you draft) and, of course, what you can get the other side to sign.
As you probably already know, a separation agreement is really no good unless both you and your husband sign it. You can draft a separation agreement that gives you everything, but, of course, then he wouldn’t sign it (if he has any sense at all, anyway). So, any time you’re drafting an agreement, you do have to keep in mind that you’re limited by what you can reasonably expect to convince your soon to be ex husband to sign.
Still, you should know that it’s a possibility. In fact, it’s relatively new possibility. We can include a provision in your separation agreement that says that you won’t have to claim your spousal support as income, and that your husband won’t be able to claim it as a deduction. I won’t bore you with the nitty gritty details, but that’s pursuant to some specific provisions under the Internal Revenue Code.
Will he sign it? That’s always the tricky part. If he has an attorney, probably not. Keep in mind that this specific provision is not only a benefit to you, but it’s a burden to him. It’s much less likely that he’d sign this (considering that it means that all the money he pays for spousal support can’t be deducted!) than it is that he would sign something that benefits you and doesn’t harm him. Still, it’s an option, and it’s something that we can at least try to include.
2. The “recapture” rule
Another way you can avoid paying taxes on your spousal support is through the so-called recapture rule. It applies when spousal support payments decree or end altogether within the first three calendar years after divorce and one of two other possible conditions are met. First, the total payments made in the third year decrease by $15,000 or more. Second, in the alternative, the spousal support would not be taxable where payments made in the second and third year are “substantially less” than payments made in the first year.
So, how might you avoid paying taxes by using the recapture rule? In many cases, a lump sum award of spousal support will do the trick.
Lump sum spousal support
Obviously, you’re probably not jumping up and down for joy so far, because everything is so iffy. It’s not like it’s easy to sneak a little provision like we just described into your separation agreement. Certainly your husband (well, your soon to be ex husband) doesn’t want to agree to that! He wants to deduct any spousal support he pays from his taxes; it’s really the only good part (from his perspective) of having to pay spousal support, and it’s fairly likely that he won’t give it up without a fight.
Spousal support that is awarded all at once (in a lump sum) isn’t handled the same way as spousal support that is awarded over a longer period of time.
Of course, lump sum spousal support isn’t all that easy to calculate, as you can probably imagine. If you know anything about spousal support, you already know that there’s no formula that we absolutely have to use. Usually, we do still start using the guidelines (even though they aren’t binding), just to give us an idea.
Lump sum spousal support is more easily determined in shorter term marriages. In most cases, the length of marriage has a lot to do with how long spousal support will be awarded. That’s not “the law” exactly; it is, however, one of the factors provided in the statute. Still, most attorneys and judges make decisions about how long support should be awarded based on how long the marriage lasted. In shorter term marriages, where support lasts for a couple of years up to something like half the length of the marriage, it’s fairly easy to calculate how much you’d receive over that time period.
With permanent spousal support, though, we don’t know how long you’ll live to receive it (or he’ll live to pay it). We don’t know whether you’d remarry or cohabitate, which would terminate your support earlier, too. We have to guess, and that makes it extra difficult because it’s sort of a gamble anyway. So, how do we calculate it? We run guidelines, and figure out a number. We multiply it out by a reasonable amount of time that you might be expected to receive support. How much? It’s hard to say; its highly individualized. Of course, as you can probably imagine, no husband would agree to paying it all up front unless he also received a fairly substantial discount, so we’ll discount it some. Ultimately, it’s a point for negotiation.
In a shorter term marriage, we’re probably talking about spousal support that would be received for half the length of the marriage or less. That’s easier to calculate, because it’s a finite number of years. These are the most typical cases where I see lump sum support awarded. In a longer term marriage, it’s much more difficult to calculate, which makes it more likely that one party or the other will disagree (either it’s too much and one party is willing to take his chances, or it’s too little and the other party is afraid she’s selling herself short) and we’ll never reach an agreement. Still, it’s a possibility!
As you can tell, it’s difficult (but not necessarily impossible) to avoid tax consequences relating to your spousal support award. For more information, or to meet with an attorney to figure out what kind and how much spousal support you might want to ask to receive, give our office a call at (757) 425-5200.