As we learned in our last post, child support for the most part is a non-taxable event but what about spousal support or as it was formerly known here in New Jersey: alimony? What are the tax implications for payments from one spouse to an ex-spouse for their own support and not of their children? The short answer is spousal support / alimony is a taxable event unless otherwise stated in your Memorandum of Understanding.  Forgive the shameless plug but this is an instance in which you really want your divorce mediator to have both a legal and financial background like I do as this topic can get pretty tricky and is definitely more complicated that can be explained here.

First some background.  Regardless of your belief in spousal support / alimony, the idea behind it is that marriage is an emotional as well as a financial partnership so spousal support / alimony is meant to compensate one spouse financially for the dissolution of this economic part of the partnership recognizing that each party made contributions ot the  marriage that allowed both parties to enjoy a certain measure of financial success.  Notice I keep saying spouse as spousal support / alimony is not simply a payment an ex-husband makes to an ex-wife (although it quite often is) but rather a payment from one spouse to another spouse and with more women achieving positions of prominence in the corporate world and being compensated financially for it, there are instances in which an ex-wife is paying spousal support / alimony to an ex-husband.

In the most simple of examples, spousal support / alimony is a taxable event.  The party who pays it gets to deduct it from their taxes and the party who receives it must claim it as income so this does present some unique tax challenges for both parties.  For example, let’s say the receiving party needs $500 in support to make ends meet and receives $500 a month in spousal support / alimony.  While that may be fine on a month to month basis, come tax time, that $500 will be effectively reduced to $375 assuming a 25% tax rate after taxes so in reality, they are short $125 a month or $1500 a year while the paying party received a tax benefit for the deduction they received by claiming it on their taxes.  Your New Jersey divorce mediator can help each of you with options such as “grossing up” the amount or making it a non-taxable event.

Another issue to watch out for when it comes to spousal support / alimony is calculating it especially when done in conjunction with child support.  Because spousal support / alimony is a taxable event and child support is not, parties sometimes manipulate the amount of each payment so that while on a month to month basis you are receiving the same amount of dollars, the amount being received in child support is higher and spousal support / alimony is lower.  Maybe it looks like a tax savings for each of you since child support is a non-taxable event but this can have disastrous consequences depending on how close the children are to emancipation since child support ends for the most part at age 18.  There you would be no longer receiving any money even though the dollars were intended as spousal support / alimony and in reality they came over as child support.  Don’t think this happens?   I’ve seen it with my own eyes and is one of the dirty tricks people try and pull during divorce mediation session and the subject of a previous article that you can read here.

I hope you’ve found this series of articles helpful and encourage you to contact us should you have any questions about divorce mediation or if you’d like to schedule a free, no obligation consultation to learn more about our divorce mediation services.  Please note that this article is not meant to be construed as legal or tax advice and that since everyone’s situation is unique, it’s always best to consult with your accountant, mediation service, or NJ mediator regarding your specific situation.

###

Equitable Mediation Services is a New Jersey divorce mediation practice serving Somerset, Mercer, Middlesex, Essex, Morris, Union and Hunterdon counties including the towns of Edison, Parsippany, East Brunswick, West Orange, Bridgewater, South Brunswick, Hillsborough, Livingston, Randolph, Maplewood, West Windsor, Summit, Plainsboro, Millburn, Morristown, Montgomery, Madison, Readington, Branchburg, Warren, Princeton, Metuchen, Lawrenceville, Pennington, Short Hills, Bernards, Bedminster and surrounding areas.

In our last post, we talked about tax implications of equitable distribution and gave you some things to be aware of when discussing this aspect of your divorce with a New Jersey divorce mediator.  In today’s post I’d like to address the topic of child support as for couples with children, it serves as the financial foundation of your children’s lives and will go a long way towards ensuring they do not become the economic victims of divorce.

Before we begin, it is important to understand that child support unto itself is not a taxable event.  It is simply a transfer of assets from one party to another for the financial well-being of the couple’s children.  And while one of you is “writing the check” and actually making a payment to the other parent, both of you are paying child support in that the amount of the check one party writes is not meant to cover 100% of the expense of he children.  The receiving party pays for the children by using their own funding sources to also absorb a percentage of the children’s expenses as calculated on the New Jersey Child Support Guidelines.  So with child support, there is no declaration of it on the “check writing” parties’ tax return or no need for the recipient to claim it on theirs.  But that doesn’t mean there aren’t tax related issues when it comes to child support.

The first thing to be aware of is that of daycare costs.  Currently, parents of children who use daycare can get a “Child and Dependent Care Credit” on their tax return.  This can be worth a substantial amount of money to the party who receives such a credit so it’s important to discuss how this will be handled in mediation.  As part of the calculation of the New Jersey Child Support Guidelines, you and your NJ divorce mediator can make sure that while one party may receive the refund from the IRS, the other party is compensated in the form of lower child support payments to normalize the parties.  This in no way constitutes a reduction in support nor is it meant to encourage not paying the proper amount of child support. There may also be credits available to parents who send their children to summer camp as well so be sure to discuss this during mediation.

Next is the issue of medical insurance and expenses.  Currently child support covers the first $250 of medical expenses in any given year but what about for parents who are paying the health insurance premiums for their children and writing a check for child support to the other parent?  As is the case with child care, when calcuating the correct amount of child support, your New Jersey divorce mediator will be able to let each party know what the offset to the one party will be so that each party shares in the cost of providing health insurance to their children, even though it is one parent’s policy who is actually covering them.   You may also find yourself in a situation where one of you has a “MedSpend” account which allows for pre-tax dollars to be put into an account to be used for medical expenses.  And while there are no hard and fast guidelines here, again, this is an excellent topic to address with your mediator as there will be tax implications

In our next post, we’ll take a look at the impact of taxes on spousal support / alimony and what you should be aware of when speaking with a New Jersey divorce mediator.  Please note that this article is not meant to be construed as legal or tax advice and that since everyone’s situation is unique, it’s always best to consult with your accountant, mediation service, or NJ mediator regarding your specific situation.

###

Equitable Mediation Services is a New Jersey divorce mediation practice serving Somerset, Mercer, Middlesex, Essex, Morris, Union and Hunterdon counties including the towns of Edison, Parsippany, East Brunswick, West Orange, Bridgewater, South Brunswick, Hillsborough, Livingston, Randolph, Maplewood, West Windsor, Summit, Plainsboro, Millburn, Morristown, Montgomery, Madison, Readington, Branchburg, Warren, Princeton, Metuchen, Lawrenceville, Pennington, Short Hills, Bernards, Bedminster and surrounding areas.

There’s not much as a New Jersey divorce mediator I can do to prevent the IRS taking it’s share of your earnings, but for couples using our mediation service, I can help you avoid some unpleasant surprises down the road with regard to your divorce and the potential tax liabilities on your equitable distribution, child support or spousal support / alimony.   In today’s I’d like to address equitable distribution.

For those of you unfamiliar with the concept, equitable distribution is simply the division of your marital assets and liabilities to determine what share each of you will receive as part of your divorce settlement.  When it comes to taxes and equitable distribution, there are two issues at hand we need to look out for in mediation.  First is that of unwittingly creating a tax issue with the transfer of an asset when one should not be created and the second is not taking into account the pre-tax and post-tax value of such an asset being transferred.

In the first instance the IRS’ rule is that the transfer of assets which take place as a result of a divorce decree will not result in a taxable event.  Notice I didn’t say are never subject to tax but rather when transferring the assets, the transfer will not result in a taxable event but when the recipient goes to exercise those assets they will pay any subsequent taxes due at that time.  For example, as part of a settlement, your soon to be ex agrees to give you $10,000 from their 401k as part of your equitable distribution and let’s assume you are both 45 years old.  Normally, if your ex would take a distribution from their 401k prior to age 59 1/2, they would get hit with taxes and a 10% early withdrawal penalty.  However by using what’s known as a QDRO, we can avoid the taxes and penalties on this transfer as long as it is the result of your divorce and outlined in your Memorandum of Understanding.

In the second example, when calculating your equitable distribution you’ll want to make sure to understand which assets are subject to tax and which ones are not.  For example, let’s say you’ve been married 25 years and have a stock portfolio that you first assembled when you got married which has tripled in value and you’ve never touched it.  Your ex decides to give you 100% of that asset in exchange for an equal amount of cash from your savings account.  On the surface, this looks like a fair trade and a dollar for dollar match but it’s not.  The cash is just that: cash while the stock portfolio has increased in value and you will pay some hefty taxes on the gains of those stocks once you go to sell them, reducing your total by a substantial percent.  In order for this to be fair and equitable, you’d need to be compensated an additional amount to make up for that tax burden or each take a share of the stock and the cash so you each have the same tax burden.

In our next post, we’ll take a look at the impact of taxes on child support and what you should be aware of when speaking with a New Jersey divorce mediator.  Please note that this article is not meant to be construed as legal or tax advice and that since everyone’s situation is unique, it’s always best to consult with your accountant mediation service, or NJ mediator regarding your specific situation especially when it comes to taxes as the IRS is not an organization you want to get on the bad side of!

###

Equitable Mediation Services is a New Jersey divorce mediation practice serving Somerset, Mercer, Middlesex, Essex, Morris, Union and Hunterdon counties including the towns of Edison, Parsippany, East Brunswick, West Orange, Bridgewater, South Brunswick, Hillsborough, Livingston, Randolph, Maplewood, West Windsor, Summit, Plainsboro, Millburn, Morristown, Montgomery, Madison, Readington, Branchburg, Warren, Princeton, Metuchen, Lawrenceville, Pennington, Short Hills, Bernards, Bedminster and surrounding areas.