Family Support Risks and Rewards

family support

What is Family Support?

Family Support is the common term for what courts refer to as “unallocated alimony and child support” and a tool for maximizing the after tax cash flow for both households after divorce.

In cases where the divorcing parties have minor children and disparities in their incomes it is likely a judge will order alimony and child support as two separate payments in two separate amounts with different duration.

  • Alimony (spousal support) is intended to provide for continuation of the lower earning party’s standard of living and training if necessary to reenter the work force. Alimony can last for a number of years or a lifetime depending on the circumstances and the jurisdiction where the divorce is being completed. Alimony is taxable to the recipient and tax deductible for the payer.
  • Child support is intended to provide for basic needs of minor children from the marriage and ensure they have a similar standard of living in both new households. Child Support usually ends when the minor child turns 18 years old or graduates from high school, whichever comes last. Child support carries no tax liability for the recipient and is not deductible to the payer.

In some cases it makes sense financially to play with the allocation between these two payment amounts in order to provide the best bang for the buck and maximum cash flow to the newly formed separate households. Family Support can be a powerful tool for maximizing the after cash flow for both households but it comes with complications.

First an example using a single income household then we will talk about the risks and rewards:

Meet Sue and Dave

 

Facts

  • live in California
  • have been married for 17 years,
  • have two minor children aged 10 and 13
  • Dave makes $360,000 per year
  • Sue has been a full time mother and homemaker since the birth of their oldest child and has no earned income
  • Child sharing agreements have been reached with Sue remaining the main caregiver with 60% and Dave with 40% time share

Traditional Results

  • Child support is determined to be $3,983 per month
  • Spousal Support (alimony) is determined to be $5,845 per month
  • Sue’s Net (after tax) Disposable Income = $9,375
  • Dave’s Net (after tax) Disposable Income = $10,743
  • Total Net (after tax) Disposable Income = $20,118

Family Support Results

  • Child Support is set at $0 per month
  • Family Support is determined to be $12,527 per month
  • Sue’s Net (after tax) Disposable Income = $9,600 (+$225 per month)
  • Dave’s Net (after tax) Disposable Income = $11,000 (+$257 per month)
  • Total Net (after tax) Disposable Income = $20,600 (+$482 per month)

Rewards

  • If used appropriately Family Support allows the parties to achieve a higher net transfer of cash flow from the payer to the recipient by moving the income from the payer’s high income tax bracket to the recipient’s lower bracket.
  • The payer, Dave, simply has a larger tax deductible payment which increases his after tax funds available to pay support. Sue pays taxes on the family support in her bracket at a lower rate. The net benefit to the family cash flow is $482 per month, $5,784 per year or $57,840 over ten years.
  • The benefit of the cash flow increase is shared almost equally between the parties. $225 per month to Sue and $257 per month to Dave.

Risks and Complications

  • Family Support is typically a temporary agreement used to help maximize cash flow during the months or years divorce negotiations are pending and can help facilitate economic transition into two separate households. Opinions are mixed on how the IRS or state taxing authorities would look at longer term payments characterized this way and if they may try to “recapture” a portion of the tax deduction taken by the payer.
  • Click here for information from the State of California taxing authority which does recognize Family Support as fully tax deductible.
  • At least one federal court has invalidated a family support order in terms of deductibility to the payer (Wells v. Commissioner)
    • In order for family support to be deductible at the federal level it cannot be disguised child support so cessation of payments should not be contingent on child related events such as attaining the age of 18. Notice the example of Dave and Sue uses a ten year duration for payments for that exact reason.
    • The payments must also terminate upon the death of the recipient. This is a requirement for any alimony payment to be deductible.
    • With careful drafting by an experienced attorney we think Family Support can pass muster for long-term deductibility.
  • Both parties must fully understand the tax consequences before agreeing to Family Support. Sue will now have to make large estimated tax payments or face penalties and interest on unpaid taxes.
  • Courts do not typically order Family Support because the law requires them to maintain jurisdiction over child support as a matter of public policy.
  • Even if Sue and Dave chose to write Family Support into their agreement, either party could walk into court a week later, ask the judge for child support and expect to be granted the guideline amount effectively terminating their original agreement and potentially triggering tax trouble.

Help is out there.

Be sure to consult your Wellspring Divorce, tax and legal advisers about the risks of Family Support and applicability to your personal situation and stay out of the court system because a judge will never order Family Support for longer periods. Amounts and duration used in the hypothetical are not meant as advice or opinion for what you should expect in similar circumstances.

Divorce Mediation – The Balance of Power

Divorce Mediation

is a process that requires transparency, equality and a level playing field in order to facilitate a successful resolution.

Balance of Power

It is common for one party to hold all the cards when it comes to financial knowledge and power in a marriage. We have the economic theory of comparative advantage to thank for this reality. Comparative advantage at its simplest says the person most suited for a task should be the one to perform it or risk wasting valuable economic resources. In a marriage this means the spouse most skilled in financial management, most interested in financial issues or most concerned about their financial future will take over management of the family finances. Some times, especially in the marriages of two bust professionals, it comes down to simply giving the tasks to the spouse who has the time. Trust is abundant during happy marriages and the non-managing spouse will often not be a part of the day to day budget and investing decisions, instead choosing to trust their spouse has it all under control.

Like it or not this kind of decision making creates a power imbalance unless the couple regularly works together to keep one another in the loop. Unfortunately we know from experience this rarely occurs. We also know from experience and research that financial disagreements are the most common disagreement leading to divorce. We have to keep in mind all of the emotional undertones of money. Money means power, safety and security and allows American families to buy, borrow and save for the things they believe will make their lives and the lives of their children more comfortable such as nice homes, iPads, automobiles and organic food.

When a power imbalance begins to develop these emotions start to come to a head. A woman anxious about her family’s financial security may start to remedy the power imbalance later in life by asking the questions she never cared to ask before. How much is in our retirement savings accounts? How are the funds invested? Are we on track? Do we have a financial adviser we trust? A man anxious about how the family bills are paid may want to engage in tasks previously left to his wife. Can I look at our budget? How much credit card debt do we have? How much do we spend every month? Marriages end when these questions begin to come up because many couples lack the tools to navigate the difficult conversations, especially when one person’s expectations are not met when they get answers.

Divorce Mediator’s Job

When one party to a divorce holds all the financial data and knowledge it creates a major power imbalance. A divorce mediator’s job is to level the playing field for the couple. What may have been acceptable during marriage when trust was prevalent doesn’t pass muster in divorce financial planning. In order for a couple to successfully navigate a divorce mediation they must have the same information from which to make decisions. Transparency must be mandated by the divorce mediator and the mediator must help to create this transparency where necessary. This may mean

  1. assisting in the gathering of financial data and documents,
  2. facilitating conversations between the parties,
  3. engaging other financial professionals to assist in educating clients to level the playing field

If a mediator is unable to provide this balance of power and create a level playing field for clients to operate from in a divorce mediation the parties may struggle to meet minds on the financial picture. You may even start to distrust the other’s intentions and leave the divorce mediation process seeking an advocate who will level the playing field through formal financial discovery such as depositions and subpoena’s.

Wellspring Divorce Advisors Can Help

If you are navigating mediation and feel at a disadvantage when discussing financial issues, Wellspring Divorce Advisors can act as a consultant to the divorce mediation process and help to level the playing field so you can negotiate the most financially advantageous settlement possible. We also have trained mediators who can work as a financial issue specific mediator during your divorce mediation.

Housing Prices About to Get Crushed in Southern California?

Our Divorce Financial Planning business offers an interesting insight into the real estate markets of our communities. We see more homes bought and sold by our clients than all but the top 2% of realtors. In most cases we are also actively engaged in helping our clients make decisions about if or when to buy and sell. In doing so it is important to keep our finger on the pulse of prices and the factors that affect them.

In 2012 real estate prices in Southern California were stable seeing minimal growth in valuations. The market was slow and listing versus selling price spreads were negative meaning most property was selling at or below list prices. The higher the price the bigger the spread and the longer it took to sell. In early 2013 mortgage interest rates sank to such low levels that buyers began to realize they could be missing an opportunity to lock in low rates. At the same time the inventory of homes for sale was anemic thanks to the perception in the sellers market that prices were stagnant and it was not a good time to sell.

I believe the combination of low inventory of homes for sale and buyers starting to come into the market has created a bubble. I started to notice this in full swing during the Spring when homes first began universally selling above list prices and getting multiple bids. The low inventory of homes meant multiple buyers were competing and forced to offer continually higher purchase offers in order to risk getting out bid. The neighbors started to see homes selling at 10% premiums to their list price and realized they could now sell their own home and break even when two years ago they would have done a short sale. Here comes the bubble.

Buyers are worried the competitive offer environment will price them out of the homes they wish to purchase so they make progressively higher bids. Sellers start flooding the market with listings. The competitive purchase offer environment drys up thanks to increased inventory and rising interest rates. I expect prices may fall back to their 2012 levels while interest rates continue to rise over the next six months.

This bubble has made it difficult for many divorcing couples and individuals to make a decision about how to handle their family residence. As part of our Divorce Financial Planning conversation we are making sure clients understand that our current outlook on real estate prices may mean they need to consider alternative methods for valuing the home or mean they need to abandon the idea of keeping the residence thanks to the inflated price level. If you believe prices will fall you may not want to appraise a home today and buy it from your spouse. I am also advising clients that now may not be the best time to buy as I expect prices will be lower by next year.

 

 

Navigating Divorce Mediation – How to Manage the Process for Clients

Clarity about process in Divorce Mediation is absolutely mandatory for success.

The concept of Divorce Mediation has proliferated in America in the last thirty years as divorcing parties have realized that divorce court should be an option of last resort. Divorce Mediation supports the decision making of the people whose lives are actually affected by the decisions and allows divorcing individuals a sense of control of the outcome IF it is done right.

Divorce Mediation is a delicate process. Here are some things to keep in mind when considering Divorce Mediation.

  1. Balance of Power: Too much power on one side of the table creates an unsafe environment. The power could be due to the marital dynamic, control of financial resources of access to information. A skilled Divorce Mediator will recognize the power imbalance together with the dynamic creating it and set out to level the playing field.
  2. Safe Container: Lack of a safe container leaves couples feeling lost in the ambiguity of a complicated decision making process set a midst a legal dispute. A skilled Divorce Mediator will insure the couple is constantly apprised of where they are in the process, next steps in the process, homework assignments to be completed and time-lines for their completion and maintain an awareness for the parties of the legal process they are engaging in.
  3. The Mediator: “Mediators” are unregulated. There is no credential that guarantees a Divorce Mediator has the requisite knowledge and experience to assist a couple in navigating the largest financial transaction of their lives. Together with the proliferation of the Divorce Mediation process has come the proliferation of Divorce Mediators. Individuals with backgrounds varying from business owners to lawyers to accountants and financial advisors to Marriage and Family Therapists and Psychologists to law school graduates who never passed the bar exam and para-legals have hung up shingles as Divorce Mediators. Divorce Mediation is a process that can be taught. What can not be taught is the human dynamic that occurs during the process. For this reason it is important to engage a Divorce Mediator with experience and training specific to Divorce. This probably means a Lawyer and/or Certified Divorce Financial Analyst.
  4. Costs: Beware the flat fee Divorce Mediation. I have never seen a couple successfully navigate and complete a divorce for a flat fee. It is an unfair expectation to set a client up for. Often the professional will reach the extent of the time they have allocated for the flat fee and ask for more money or begin to dis-engage and abandon the parties before the Divorce Mediation process has been completed. Divorce mediation is not always cheap. Failed mediation proceedings may be a complete waste of money and time. I see Divorce Mediation proceedings fail all of the time.
  5. Divorce Mediation Defined: Just because you resolve your differences outside of court does not mean you are engaging in Divorce Mediation. Mediation is a process where a Neutral facilitator guides a couple through decision making around legal, emotional and financial issues that must be resolved in a divorce. Most Divorce cases resolve outside of a court room in settlement conferences, Collaborative Divorce of formal settlement proposals via letters between legal counsel. Couples need to understand that Divorce Mediation is not the only way to resolve their differences outside of court. Many will be better served by a process where they have legal counsel actively engaged which usually does not occur in Mediation.

Divorce Mediation participants need to advocate for themselves and demand clarity regarding process expectations and costs. I will cover each of the items above in more detail in future blog posts