May 1, 2012
When deciding the amount and length of alimony payments, it is easy to run afoul of the Child Contingency Rule. Careful planning will ensure that your client doesn’t end up with an unintended tax obligation.
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:
Reaches age 18, 21 or the age of majority in their state
Gets married
Graduates from school
Leaves home
Joins the military
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.
The following example shows how this rule is easily violated.
Example: 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 maintenance plus child support. Kevin’s attorney says “Josh is graduating from high school in 5 years, so why don’t you pay Karen maintenance for 5 years.”
Or the attorney will say, “Since Josh is graduating in 5 years, why don’t you pay Karen maintenance 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.”
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 $72,000 that he will have to pay tax recapture on!
This is an area of possible malpractice if the IRS comes after Kevin 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!
