SPOUSAL SUPPORT BASICS

Spousal support, also called alimony, is a sum of money usually paid by one spouse to another spouse for the support and maintenance of the spouse. The factors the court considers in awarding spousal support are as follows:

1. the past relations and conduct of the parties (fault)

2. the length of the marriage

3. the ability of the parties to work and their respective incomes

4. the source and amount of property awarded to the parties

5. the ability of the parties to pay spousal support

6. the present situation of the parties

7. the needs of the parties

8. the health of the parties

9. the prior standard of living of the parties and whether either is responsible for the support of others

10. the age and educational level of the person claiming spousal support

Generally, judgments of divorce in which spousal support is not granted must either expressly reserve the question of spousal support or rule that neither party is entitled to spousal support.

Regular or periodic spousal support clauses in the judgment of divorce are modifiable at any time. When limitations are placed in the judgment regarding modification, specific language is necessary to try and ensure that the court will honor these limitations. Spousal support may be increased, decreased, or canceled. A modification is based on a showing of a change in circumstances that warrants a modification.

Regular or periodic spousal support is usually taxable to the recipient and is deductible by the payer. The phrase “payment until death” must be part of the spousal support clause for it to be considered as taxable spousal support. This type of spousal support is not dischargeable in bankruptcy. Qualifying clauses such as “payable until remarriage” may be included.

Another type of spousal support, referred to as spousal support in gross, has all the attributes of a property settlement; but it is not taxable to the recipient, not deductible by the payer, and not modifiable. However, it may be subject to being discharged in bankruptcy. This type of spousal support is for an amount certain and has no qualifying clauses such as “payable until remarriage.” The court will look to the intent of the parties to determine the nature of the spousal support.

There are many tax consequences and restrictions in regard to spousal support and spousal support in gross, which your attorney or your accountant should explain to you. Because both federal and state tax laws and their interpretation continually change, your attorney cannot guarantee any tax consequences resulting from your divorce proceedings and the judgment of divorce.

Spousal support is usually paid through the Michigan State Disbursement Unit (MiSDU) for so long as child support is also paid or for so long as the particular county allows. Please note, if only spousal support is ordered, the county need not collect through the MiSDU.

The enforcement of regular or periodic spousal support payments is usually instituted by an order to show cause. Your attorney will explain the procedure to you on request. Spousal support in gross is more difficult to enforce, and there are other procedures available for enforcement.

With respect to health care coverage, your attorney will explain to you, on request, your options, including your right, if applicable, to elect health care under COBRA (a federal law that makes health care insurance portable in some instances) or the health insurance exchange.

THE THREE YEAR ALIMONY TAX TRAP: WHAT IS IT, HOW TO AVOID IT

As if paying alimony weren’t bothersome already, imagine receiving an unfriendly letter from the IRS forcing you into an audit and, worse yet, assessing taxes for three years’ of income you previously deducted. This may sound like a tax nightmare – you pay alimony, you deduct it like your CPA and/or your attorney said, and now you have to pay taxes for it – but, for many guys, it is reality. This often misunderstood and little discussed trap, the recapture rule, has them, and possibly you, coming up with money to pay taxes in addition to money for their exes.

The recapture rule forces the alimony payor to report as income the alimony payments he previously deducted, which means the payee is entitled to reduce from income the alimony payments she previously received. The rule applies when the payments decrease or terminate during the first three calendars years post-divorce and (1) the total payments made in the third year decrease by $15,000 or more from the payments made in the second year or                       (2) the payments made in the second year and the third year are substantially less than the payments made in the first year. Reasons other than the language of your divorce decree can cause the reduction, even reasons beyond your control, like a modification of the decree, failure to make timely payments, inability to make payments and a modification in the amount you pay because your ex no longer needs as much from you.

For example, if in the first year you pay $30,000 in alimony, then in the second year you pay $20,000 in alimony, but in the third year you successfully motion to modify your obligation because your ex has a new job and, as a result, you only pay $4,000 in alimony ($16,000 less than the second year), you’ve triggered the recapture rule. Be prepared to report the first year’s worth and the second year’s worth of formerly deducted alimony payments as income. And you thought you were doing yourself a huge benefit by petitioning to modify the alimony obligation in the third year.  . .

However, the recapture rule does not apply (1) for payments made pursuant to a temporary order, (2) if the payments terminate due to you or your ex’s death, (3) your ex’s remarriage prior to the end of the third year, (4) when the total payments made each year vary, for reasons not in your control, and are tied to a business, property, variable employment or self-employment. In these circumstances, the termination and variable amounts of alimony are foreseeable and assumed.

For example, if you agree in your divorce decree to pay 10% of your income received for your alternative energy business – a business that is in a state of flux – then you would not necessarily have to recapture those payments you deducted in the first year and the second year even if, in the third year, your payment is substantially less than the first year.

As another example, if for a five year obligation in the first year you pay that $30,000, then in the second year you pay that $20,000, but, in the third year, your obligation is terminated because your ex remarriages, you do not have to recapture the payments you previously deducted even though you are paying $0 in the third year.

Then how do you avoid the recapture rule? Discuss these tips with your attorney and your CPA:

No Front Loading: Front loading refers to paying a large amount of alimony in the first few years of your support obligation, maybe while you feel like you have the money and/or when your children are minors and you want to pay family support. The problem, with front loading is, if you reduce the payment substantially in the second year, you trigger recapture. If you do not, but then in the third year the payment is as little as $15,000 less than the second, you also trigger recapture.  Instead, consider extending the front loaded payments over more than three years or transferring an asset or assuming a debt in lieu of front loading the payments altogether.

Section 71 Payments: You could skip the deductibility problem altogether by making payments under IRC 71, referred to as “section 71 payments.” Under this rule, you are entitled to make a series of payments to your ex without tax consequence. The down-side is, the payments are not tax deductible to you.

Tied to Variable Uncontrolled Income: If your income is variable, and those variables are not within your control, then clearly state so in your divorce decree, and be prepared to provide proof to the IRS if an audit comes your way. In your decree, consider stating why your income varies, what factors cause your income to vary, that both you and your ex understand that your income varies and why and that your ex will confirm the same to the IRS. This will keep your ex from disagreeing with you – in an effort to deduct the alimony she previously reported as income – in the future if you are faxed with an audit.

Longer Schedule:  Extend your payments over more than three years, and be sure the amounts you are ordered to pay, and ideally do pay, do not decrease substantially from the first year to the second year and the third year or by more than $15,000 in the third year from the second year.

Increasing Schedule:  Rather than decease your payments over time, consider increasing them. This may make sense, for example, as your ex approaches retirement age, provided you are financially able to make the payments. Be cautious, however, of linking the increase to a loss of child support for your children – the IRS can decide that your “alimony” payments were actually child support because the amount you pay changed when your child support obligation changed. If so, then you will have to report that “child support” as recaptured income, too.

And, of course, always talk to your attorney and your CPA about the best alimony, child support and tax planning strategy for your case. If you do not have this conversation early and often, you may find yourself, three years after your divorce, recapturing all of those payments you deducted and hating the fact of paying alimony even more than you already had.