Tax Planning Opportunity
By using a taxable payment method such as alimony instead of a non-tax payment method, you may be
able to raise the payment and still get both parties a more desirable monthly payment.
This will happen if the tax effect helps the payer more than it hurts the recipient.
Tarzan's alimony payment dollar will give him a tax deduction of 45% of
the alimony payment made. Jane is in a lower income bracket. The alimony will be taxable to her at 20% of the alimony
payment received. Since Tarzan saves 45% of the payment on his tax return and Jane pays only 20% of the payment on hers,
overall the couple gains 25% of each payment (45% - 20%) due to the difference in their tax brackets. They can both
come out ahead by increasing Tarzan's payment by up to 45% versus a non-taxable payment. (Non-taxable payments are
those labeled as either property settlement or child support.)
Same as above, but using property settlement (non-taxable) numbers. Jane wants to receive
an after-tax amount of $2,000 a month for five years. If Tarzan pays it as a property settlement, he pays $2,000 a month
and Jane receives $2,000 a month. There is no tax effect.
Same as above, but with alimony numbers. If they make the payments
alimony, since Jane pays 20% in taxes, they have to make the payment an amount which, after 20% is taken away, equals
$2,000. This number is calculates as $2,000 / (1 - 0.2), or $2,500. So Tarzan is set to pay $2,500, which, after tax,
is the same to Jane as her $2,000 property settlement payment. But look at Tarzan. When he gets his 45% tax
deduction for alimony, his $2,500 payment is the same to him, after tax, as if he is paying $2,500 * (1 - 0.45) or
$1,375 of property settlement. Tarzan can give Jane $2,000 worth of after-tax payment and cost himself only $1,375 of
after-tax dollars.
How does this example work? The difference came from the government. The IRS gave $1,125 of tax deductions
(45% of $2,500) to Tarzan but collected only $500 (20% of $2,500) from Jane. The difference, $1,125 minus
$500, or $625, is the net tax benefit. This is the amount ($1,375 + $625 = $2,000) by which Tarzan comes out ahead.
What couples typically do is split this benefit, so Tarzan gets $312.50 (or thereabouts) and Jane gets $312.50 (or thereabouts).
Email this page on to a friend.
Disclaimer: We are not giving legal advice. No warranties. We disclaim all legal liability. More...
| 
