You are getting divorced and you need money. You need support – for you, and for your kids. Your soon-to-be ex is willing to pay child support. He says he has no problem supporting his kids. But supporting you? … fuggedaboutit!
Just as you are gearing up to go to war over alimony, your spouse’s lawyer suggests that, instead of paying you child support and alimony, your ex can pay you “unallocated support,” which, as you understand it, is support for both you and the kids. Suddenly, your ex seems to be ok with the idea that he will continue to support you after your divorce. He even offers to pay you a tiny bit more in unallocated support than what you wanted him to pay for alimony and child support. While you are grateful for the offer, you can’t help but be suspicious. There has to be a catch, right?
What You Don’t Know CAN Hurt You
Why would your ex be ok with supporting you if that support is “unallocated” and includes support for you and the kids, but not be ok with supporting you and the kids separately with alimony and child support? The answer is simple: taxes.
The Tax Consequences of Alimony, Child Support, and Unallocated Support
Alimony is tax deductible to the payor spouse and taxable income to the receiving spouse. That means that your spouse gets to deduct all of the alimony he pays you from his gross income for income tax purposes. You, on the other hand, must declare all of the alimony you receive as income on your income taxes. So, your ex’s income goes down and your income goes up based upon how much alimony he pays and you get.
Child support is not tax deductible to the payor spouse. So, unlike with alimony, whatever your ex pays you in child support has no effect on your income, or on his. That makes getting child support better for you than getting alimony.
Unallocated support is a combination of child support and alimony. For income tax purposes, though, unallocated support is treated like alimony. That means that everything your ex pays you in unallocated support gets deducted from his gross income and added to your gross income for tax purposes, even though a part of that money was intended to support your children.
What Difference Do Taxes Make?
At this point you may be wondering whether taxes are really such a big deal. If your ex is willing to pay you more in unallocated support than he is in child support and maintenance put together, shouldn’t you be happy? Maybe. But before you know whether what your ex is offering you is a good deal, or a bad deal, you have to understand what you are really getting.
The important question is not how much your ex pays you, but how much of what your ex pays you do you get to keep? To answer that question you have to subtract the taxes you are going to have to pay from the support that you are going to receive. Because child support is not taxable income to you, you keep it all. With maintenance, you only get to keep a portion of what you receive. The rest goes to pay your income taxes. The same thing is true with unallocated support. So, to really know whether your ex’s proposal is a good one, you have to do the math.
Sample Income Calculation
Let’s use a very simple example. Lets say that you are unemployed. Child support in your case should be $1,500.00 per month. Maintenance, based upon your state’s law (hypothetically) should also be $1,500.00 per month. But, if you will accept unallocated support, your ex has offered to pay you $3,500.00 per month. Which option puts more money in your pocket?
To figure out which option gives you the most money, you need to know your tax rate. The problem is, your tax rate changes based upon how much income you receive. If your only income is $1,500 per month in alimony, your 2014 tax rate would be 10%. If your income is $3,500 per month in unallocated support, though, your 2014 tax rate would be 25%. Using these numbers, your tax calculation would look like this:
$1,500 child support $3,500 unallocated support
= $3,000 total support
– $225 taxes (10% x alimony) – $875 taxes (25% x unallocated support)
= $2,775 money left for you =$2,625 money left for you
As you can see, in this example, even though your ex would be paying you more in unallocated support than he would in child support and alimony combined, you would have more money left in your pocket after taxes if you took child support and maintenance rather than unallocated support. Remember, it is not what you get, but what you keep that matters.
The Bottom Line
If your head is already spinning, you are not alone! (… and this is just a very simplified, hypothetical example!) Calculating the tax implications of various support options is complicated! That is why you should consult with an accountant or a divorce financial planner BEFORE you settle your case. A qualified financial professional can not only help you understand the effect that taxes will have in your case, but s/he can also help you and your spouse work together (assuming your divorce is amicable) so that you can make a settlement that puts more money in both of your pockets by maximizing the tax advantages available to both of you.
What if your divorce is not amicable? It doesn’t matter. You still need to know how taxes on your proposed settlement will affect you. When you do, you will realize that child support, alimony. and unallocated support are not at all equal.