f you are divorced and have young children, there’s a good chance that you are paying or receiving alimony or child support (or both) under a divorce decree. What’s the difference? The distinction is important to the IRS.
Currently, alimony is deductible by the party who pays it and taxable to the party who receives it. Child support is neither deductible nor taxable.
Depending on what side of the fence you’re on, you should negotiate for payments to be characterized as either “alimony” or “child support” as part of a divorce agreement.
How to qualify for alimony deductions
Just saying that payments are alimony won’t suffice. According to the IRS, these are the requirements that must be met if you’re hoping to qualify for alimony deductions:
- You don’t file a joint return with your ex-spouse
- Payments are made in cash or an equivalent
- Payments follow the instructions of a divorce or separation agreement
- The agreement doesn’t designate the payment as not being alimony
- You and your spouse aren’t members of the same household when the payment is made
- There’s no liability for making the payment after your spouse dies
The following alimony payments aren’t considered deductible:
- Non-cash property settlements in a lump-sum or installments
- Payments that are a spouse’s part of community property income
- Payments to keep up the property owned by the person paying alimony
- Use of the property owned by the person paying alimony
- Voluntary payments
The terms can often be worked out to the satisfaction of both parties. For instance, the deduction for alimony can be valuable to someone who pays alimony and earns more while the taxable income may not cause any dire consequences to someone who earns less.
According to the new tax bill, alimony will not be deductible or taxable starting in 2019. This may also affect divorce and separation agreements executed in 2018 and modified in 2019 and beyond.
Keep these rules in mind when your 2017 tax return is filed. The staff at Dye & Whitcomb can help you determine tax issues related to your alimony payments.
Maybe your spouse helps out at your small corporation without pay. Although wages are taxable and fringe benefits cost your company, you could be missing out on tax-saving opportunities for hiring your spouse. Consider the following:
- You’re saving money in the company 401(k), but what about your spouse? If certain requirements are met, your spouse can contribute to the plan while the business deducts contributions made on his or her behalf. Frequently, your spouse can build a tidy nest egg within the tax law’s contribution limits.
- If you’re paying a hefty bill for your spouse’s health insurance coverage, hiring your spouse as an employee will likely save money.The amount of your company’s payment is deductible by the business — just like it is for any other employee — even if you’re self-employed.
- You typically can’t deduct your spouse’s travel expenses like you can for yourself if he or she is accompanying you on a business trip.However, if there’s a legitimate business reason for your spouse to make the trip, the travel expenses — such as airfare, hotels and 50 percent of the cost of meals — become deductible.
- Is your spouse planning to attend school to improve business skills?If he or she enrolls in courses through an educational assistance plan, the cost is generally deductible by your business. For the employee-spouse, annual benefits of up to $5,250 are exempt from tax.
- Does your business provide group-term life insurance coverage on a nondiscriminatory basis? Then you know the cost is deductible by the business and the first $50,000 of coverage is tax-free to employees. As a bona fide employee, your spouse can be covered under the plan.
There’s one catch: S corporation owners generally can’t deduct fringe benefits for any employee owning 2 percent or more of the company. This prohibition extends to coverage for an owner’s spouse. Your tax advisor can help you determine when it makes sense to put your spouse on the payroll.
Suppose a relative wants to borrow money for a business venture or to buy a home. It’s true that family loans can raise problems. But if you’re going to do it, take the tax law into account. Otherwise, you could have an unexpected problem on your hands.
Here’s what to watch out for
It all has to do with “imputed interest” rules that may apply if you don’t charge the going rate of interest on the loan. Essentially, the IRS treats the loan as if interest were required, even if you’re not charging any interest, or you’re imposing an unusually low rate. Thus, the interest is “imputed” to you — the lender — based on IRS figures.
In other words, the IRS treats it like you’ve received taxable interest from the relative, even though you may not be getting a penny. Thus, you could be facing a tax bill that you probably weren’t counting on.
Fortunately, the tax law provides two exceptions to these “imputed interest” rules:
- If you lend your relative less than $10,000, you have no tax worries, unless the money is used to purchase income-producing property. You can charge no interest (or an extremely low interest rate) without any tax repercussions.
- If the money is a gift, you also don’t have to deal with interest. You and your spouse can each give up to $14,000 ($15,000 in 2018) to an individual each year.
There are additional complexities for some family loans, but those are the main tax rules to address. If possible, stay below the thresholds for either of the two exceptions. Alternatively, charge an interest rate and use a formal loan document resembling one found at a bank. Your professional advisors can help you with the details.