Archive for July, 2015

The IRS Turns Alimony into Child Support…If You Are Not Careful

“Josh” and “Bethany” completed their divorce just over a decade ago yet they recently received an IRS notice regarding their support payments and an assertion that part of the support was actually child support over all those years. How could that be and what triggered it?

The IRS is getting more aggressive in reviewing support agreements. In this case the triggers were nothing the taxpayer could do anything about. The date of birth for their sons is listed as dependents and is part of the electronic file that is submitted to the IRS. Likewise the amount of support paid along with recipient’s Social Security number is also listed on the return.

What is the issue and why is it important? The agreement between this couple included a change in the amount of support being paid in the tenth year of the agreement. That change was coincidental with the youngest boy turning 19 and the older boy turning 20.

This is why it matters – the IRS assumes that the change in support payment was because of a change in the ages of the boys or a change in their circumstances. Without going into a lot of detail, if there are two or more children the rules require that they be either 24 years of age or more than two years apart in age to avoid what are called the contingency rules. You can read more in this in question and answer #18 by clicking on this link for the contingency rules.

Josh and Bethany were in shock. The implication was that Josh (the person paying the support) would have to claim income from a decade of payments that the IRS deemed should have been child support. However Bethany would only be able to recover taxes paid for the prior 3 years of returns – a true lose-lose situation.

After a review of the facts and circumstances, there was a chance to fight this. The presumption that the reduction was contingent might be overcome if it can be demonstrated that the timing when the payments are reduced or eliminated was established independently from any “contingencies” relating to the children. If it can be shown that the change was simply coincidental to any event pertaining to the children, the presumption of the IRS might be overcome.

Some of the events for changing the amount of support might be local customs of the courts such a “rule of thumb.” These can include support being paid based on half the length of the marriage. There might have been an agreement about income. Once a given level of income was reached, a change in support would be triggered. Perhaps a fixed number of years are customary in a jurisdiction.

Whatever it may be, if it can be shown that the change was based on something other than a child turning a certain age (or other contingency), the presumption is overcome and the tax and penalties are waived.

While we work with people to get them through such issues, it is far better to have a financial specialist look at your agreements ahead of time. Then you can adjust your circumstance to avoid the problem (and cost or representation) completely.

 

By: Armand & Robbin D’Alo