April 1, 2015
A few years ago I wrote about the Child Contingency Rule, an IRS regulation that is designed to prevent child support payments from being disguised as alimony. I think this rule bears repeating since it is not well known, yet easy to run afoul of. Further down you will see an example that ran across my desk just last week.
Sometimes support payments are only seen as being needed while there are children living at home. Kevin and Karen are getting divorced and their son, Josh, is going to live with Karen. Kevin is going to pay Karen $3,000 per month alimony plus child support. Kevin’s attorney says “Josh is graduating from high school in 5 years, so why don’t you pay Karen alimony for 5 years.”
Or the attorney will say, “Since Josh is graduating in 5 years, why don’t you pay Karen alimony of $3,000 a month for 5 years and then reduce it to $2,000 a month for an extra 3 years. Karen won’t have as great a need when Josh leaves home.”
The examples above are not intended to disguise child support as alimony but sometimes it is suggested that some child support be reworded as “alimony” in the agreement if the payor is in a much higher tax bracket than the payee. This is because alimony is tax-deductible to the payor while child support is not. If Kevin is going to be making a total payment (both alimony and child support) of $5,000 per month to Karen, why not make as much of it alimony as possible, saving him valuable tax dollars (and perhaps making the whole idea more palatable – a not inconsequential issue.) As long as the “alimony” ends when the child support would have, he is still making the same payments but getting a tax break.
The problem with all of the examples above is that the IRS would see some of the alimony payments as child support in disguise. The “Child Contingency Rule” says that any alimony that ends at a time that is tied to one or more of the children is not really alimony, it is child support. Any tax deductions (by the payor) and tax payments (by the payee) would be reversed.
Specifically the rule states that if any amount of alimony specified in the divorce decree is reduced (a) upon the happening of any contingency related to the child or (b) at a time that can be clearly associated with a contingency related to the child, then the amount of the reduction will be treated as child support, rather than alimony, from the start. (IRS Code Sec. 71(c)(2). Reg. §1.71-1T(c))
A “contingency” relates to a child if it is dependent on an event relating to the child, regardless of whether the event is likely to occur. Some examples are:
Section 71 of the IRC provides two situations where payments would not qualify as alimony if they are reduced at a time clearly associated with a contingency relating to the child:
Six-month rule
The first situation occurs when the payments are to be reduced not more than six months before or after the date on which the child reaches age 18, 21 or the age of majority in their state. And this means all three ages!
Multiple reduction rule
The second situation is when there is more than one child. In this instance, if the payments are to be reduced on two or more occasions which occur not more than one year before or after each child reaches a certain age, then it is presumed that the amount of the reduction is child support. The age at which the reduction occurs must be between 18 and 24, inclusive, and must be the same for each of the children.
Going back to our example of Kevin and Karen, either situation creates a serious tax problem for Kevin. In the first situation the maintenance clearly ends upon a child contingency. In the second situation the IRS may consider the reduction of $1,000 a month to be child support because it coincides with a child contingency. The IRS will then go after Kevin to collect the taxes he saved by calling it maintenance and they will make it retroactive from the beginning. Five years (60 months) times $1,000 is $60,000 that he will have to pay tax recapture on!
Just last week a draft decree was given to me to review. The paragraph about alimony ended with the sentence: “This alimony agreement shall terminate when the parties’ youngest child, Henry, graduates from high school…” This is a perfect example of violating the Child Contingency Rule!
It is easy to avoid infringing this rule by making sure alimony ends at a time that is not clearly associated with an event related to a child. If it does, but it can be shown that there is another reason why the particular date was chosen, the rule is also not violated. For instance Kevin could pay Karen alimony for half the length of their marriage, or until Karen finishes graduate school.
This is an area of possible malpractice if the IRS comes after the taxpayer and he then decides to come after his attorney. Be aware of the child contingency rules and don’t tie reduction of maintenance to anything relating to the children
