Dammit, Jim, I’m A Lawyer Not A Tax Accountant!
People become attorneys to practice law not to crunch numbers, and yet family law attorneys spend most of their time calculating property division, alimony and child support. The lack of accounting experience means that some of these well-meaning attorneys are not negotiating ideal settlements. You can use Divorce Financials family law software to examine the tax implications of a settlement.
The Best Settlement Is Sometimes the Worst Settlement
Many state use formulas for alimony and child support. The idea is that formulas remove bias and make negotiation simpler. This is especially easy when using settlement statement software. You plug in a few numbers about each spouse’s income and lifestyle expenses, the number of kids, the custody arrangement and *bam* the program spits out numbers. Easy.
However it’s important to realize that the formulas are only a starting point. As long as both parties agree, attorneys can come to a deal for different alimony and child support amounts. Why would you want to? Because sometimes tweaking the numbers can actually reduce the payer’s obligation while still giving the recipient more money each month. How is that possible? Through the magic of taxes.
Divorce and Taxes
Here’s the issue in a nutshell: alimony is income, child support is not, at least according to the IRS. This means the payer can deduct alimony in certain cases, thus paying lower taxes, and the recipient must pay taxes on alimony received. Child support is neither deductible by the payer nor taxable by the recipient. What does that all mean?
By exchanging alimony and child support on a dollar for dollar basis, you change each party’s tax situation. The same money is changing hands but the amount of taxes each party owes is different. There is often a sweet spot where each party is paying the least amount of taxes and divorce software for attorneys makes it easy to examine different payment scenarios to find this optimal balance.
In addition, there are tax advantages to an alimony buyout. Attorneys use divorce planning software to calculate a lump sum that has a value equivalent to the alimony payments. The payer or recipient might prefer that lump sum over monthly payments, in part because it could be advantageous to pay all the taxes in one year rather than over time.
Family law practices employ outside accounting firms to do this kind of analysis, but that isn’t necessary with modern legal practice management software. Attorneys can do their own tax analysis, provide better solutions to their clients, and save money for themselves. Download a demo of Divorce Financials and explore tax optimization for yourself.