Unlike alimony, child support is neither tax deductible to the parent paying it or taxable to the parent receiving it. The child it benefits does not have to pay taxes on it, either. But tax laws are rarely that black-and-white, and there are some exceptions and loopholes regarding who pays the taxes on this money.
Explanation
"Tax neutral" does not mean that no one pays taxes on this money or that it's exempt. It is treated as income generated by the paying parent, and it is taxed as income. The IRS doesn't care that you personally don't have use of this money. You earned it, and the IRS will want its percentage.
Exception
Because alimony is taxable to the recipient, care should be taken with the verbiage of any divorce decree, support order or separation agreement. The receiving parent can be taxed on this money if it is not clearly and specifically called "child support" in the decree. If a decree awards $500 a week, and it is defined as just "support" with the intention that $300 of it is alimony and $200 is child support, the recipient could end up paying taxes on the child support portion if the allocation is not spelled out.
Inequity
Parents receiving child support are not required to give an accounting of what it was spent on, so if the recipient treats some of it as pocket money or uses it to her own benefit, in effect she's enjoying income that she does not have to pay taxes on.
Loophole
Parents can be creative with their support arrangements, says Jerry Style, a financial planner who is certified to assist couples with divorce issues. For instance, if the paying parent is in a 30 percent tax bracket and the receiving spouse is in a 15 percent tax bracket, it's possible to define child support payments as alimony or spousal support in the divorce decree. The spouse in the 15 percent bracket would then pay the taxes on it and would owe significantly less to the IRS than the paying parent would have if he had been taxed on it. Generally, the taxes she would be paying are offset by her receiving an increased share of a marital asset.
Warning
Style says that the IRS has implemented a revenue code that it calls the child contingency rule to defend against such arrangements. The rule states that if alimony payments decrease or stop in connection with an event related to the parties' children--usually the emancipation of the child at the age of 18 when child support would normally stop--the IRS is then allowed to treat the difference as child support and can do it dating all the way back to the first payment. For instance, if one parent was paying the other $1,000 a month for two children and calling it alimony, then started paying only $500 a month after one child reached the age of majority, the IRS could tax the difference of $500 from the inception of the support order to the present. This could result in a huge tax liability, or the paying parent would have to continue making support payments even after all the children have left the nest.
