Alimony. Taxes. People cringe and the thought of either of these topics, and here I am, writing about both in the same blog post. I represent a lot of people who are either seeking alimony from their spouse or are going to have to pay alimony to their spouse. The issue of taxes and alimony is an important one, regardless of whether you are paying or receiving spousal support.
For instance, if you are fortunate enough (or unfortunate enough, depending on your perspective) to be entitled to receive alimony in North Carolina, did you realize that the payments you receive from your spouse are taxable to you? In other words, you have to report the amount of alimony you receive on your 1040 at the end of the year. This also means that you are going to have to pay taxes on that income at the end of the year. This can be a really scary proposition for a lot of spouses who are receiving spousal support. Knowing this simple fact, that alimony is taxable to you, can save you a lot of heartache later. I tell all my clients that are going to be receiving alimony that they should run some projections with an accountant first, just to make sure that they will have enough monthly cash flow, on an after-tax basis, to meet all of their everyday living expenses.
For example, lets say your attorney just negotiated you a great settlement. You are going to be receiving a $5,000 monthly alimony payment from your spouse. You earn a modest salary at at part-time job that you picked up after you separated, which provides an additional $1,000 in after-tax income. Your expenses come out to about $5,900 a month – so this is great, right? Wrong. If you don’t plan your taxes accordingly, you could end up owing lots of money to uncle same at the end of the year – money that you just don’t have.
On the flip side, if you are paying alimony, did you realize that you get to deduct these payment on your income tax return? If your gross income is $15,000 per month now, and you have to pay a $5,000 monthly alimony payment – your monthly gross income just went down to $10,000 per month. This means that you may have even dropped into a lower tax bracket (check with your tax professional about this to be sure). As a result, that $5,000 you are paying in support each month might only be costing you $4,000 a month because of the tax savings. You might even want to call up your HR department and ask them to bump up your withholdings so that less income tax is withheld from your paychecks.
So how should I think about this when negotiating a spousal support payment?
It depends on whether you are the receiving spouse or the paying spouse. If my client is on the receiving end, I will typically negotiate a number that will meet my client’s after-tax needs on a monthly basis. Once we have that number in hand, I will ask for a multiple of that number, typically 20-25% higher, to compensate for the additional tax liability. So in the example above, if you require $5,000 per month, I would probably request $6,250 as a final alimony payment. On the other hand, when I represent the payor spouse, I try to remind them throughout the process that the number they agree to is going to save them thousands of dollars over the years as result of the tax benefits.
These are difficult concepts to understand, even for us lawyers. Think about how complicated it gets when you add child support and complex equitable distribution to the mix. Even the seemingly simplest divorces can get complicate really quick.