Alimony as a tax planning tool.

I just got off the phone with a client.  She was upset that I wanted to ask for alimony in our request to the court for a divorce, until she realized that it can actually save everybody money!

Today's Mantra: Tax deduction good!

When is alimony used, and how can even the person paying it be protected?  The law in Connecticut as it is in many parts of the country is that alimony is remedial.  The rule of thumb is that it is used to provide just enough support to help one party or the other get back on their own two feet. 

HOWEVER, the parties can decide to use it for other reasons such as shifting a tax burden.  for instance in the case described above I am anticipating that we may use the alimony to shift part of the burden of the taxes.  

The person paying child support pays the tax on that money, but the person receiving alimony pays the taxes on that money.  In this case my client makes three time what her husband does and they already agree that they will be sharing physical custody.  When that happens the person making more money pays to the other person some child support. 

A recent case where this occurred had a husband who had been stay at home dad, and was just getting back into the job market.  the mother was making about $ 120,000 per year and the father was making about $10,000 per year.  The child support net to the dad was about 300 per week and the for him to have a reasonable home and feed and cloth the children he needed another 500 per week.  this $500 would cost the mom about $600  for payroll taxes and such, the support however would cost her close to $500/ wk because she not only had to pay social security etc, she had to pay income taxes. 

So, how to get more money for both of them?  Have the child support go over as alimony.  this is done by what is called an "unallocated" order.  In other words we never say what the support is, just that it is support from mom to dad.  The IRS treats that like it is an alimony payment. 

So why is that good?  When they file separately, dad is in the lowest tax bracket and actually pays no income tax at all.  He will take on the tax burden from the mom, freeing up mom's money at the highest tax rate, and he will be paying st the lowest.  He can get $875 per week which is $75 more than he would have gotten, and allowing for his tax rate and deductions he will pay about $30 more in taxes than he would getting the same money as child support and alimony.

Mom on the other hand transfers the money and the tax burden to dad, saving her $ now.  Assuming the money from the top of her tax bracket was the money being used, she saves close to $100 per week and transfers $75 of it to dad, keeping 25 of it for herself. 

Thus after taxes there is an additional 70/week for the family as a whole. Mom gets protected by putting non modifiable limits on the payments and the term they are made for.  The children benefit because everyone has an extra $3700 each year.