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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.