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Tax Consequences for Physicians

[By Staff Writers]

Tax considerations are critical when preparing divorce agreements; and an understanding of the applicable sections of the Tax Code is essential for all medical professions in this situation.

In short, alimony is deductible for the payer while child support is not; so it is important for a separation agreement to stipulate that taxpayers report the payments in the same manner. If the person making the payment reports it as alimony, the recipient must include it in income.

The IRS Code Rules

However, when determining whether payments made to a former spouse are alimony or child support, the IRS looks not merely at the agreement, but at how the payments are used. The Code has specific rules for alimony. The payments must be: 

• Made pursuant to a divorce decree or separation agreement,
• Made by a payer who is not living in the same household as the recipient, and
• Payments may not extend beyond the lifetime of either the payer or the recipient.

The last provision can be a trap under some divorce decrees. For example, a doctor makes monthly installments designated as alimony. However, lump-sum payments also designated as alimony are payable under the agreement. In some states, such payments must be made even if the former spouse dies. Alimony payments are not deductible when made to a former spouse after he or she has died.

Front Loaded Payments

In some divorce decrees, alimony payments are front-loaded. Large alimony payments are made in the early years, and then payments dwindle later on. The IRS sometimes challenges whether these arrangements actually are alimony. Property transferred during marriage that is incident to the divorce is not alimony. Such transfers have no tax consequences and should not be claimed as alimony.

Exceptions

While most physician-payers want support payments to be deductible, there are exceptions. In a recent case, the divorce decree ordered one spouse to pay alimony. However, the payer had very little taxable income. Most of his income was from tax-exempt bonds. After negotiations, it was agreed that the payer would not take the alimony deduction, and the recipient spouse would exclude the payment from income.

Child Support

Child support is not deductible for the payer, and the recipient may exclude it from income. However, the parent who has custody of the child or children receives the dependency exemption, but the parties can agree that the payer will receive the exemption(s), provided he or she contributes more than 50% to the costs of the child’s support.

For the non-custodial parent to claim the dependency exemption(s), IRS Form 8322 must be signed by the custodial parent and filed with the IRS. But, you may claim the exemption in alternating years, if you wish.

Assessment

In sum, when negotiating a divorce settlement, there are a number of tax traps to avoid. In some cases the payer may not want alimony payments to be deductible. In other cases payments designated as alimony may not qualify under the Code. The medical business advisor and attorney must determine what is best for his or her client.

Conclusion

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Filed under: Accounting, Financial Planning, Risk Management, Taxation | Tagged: alimony, child support, divorce | 6 Comments »