Do Your Clients Understand The Tax Implications Of A Settlement?

Recently the U.S. Internal Revenue Service announced that it would be increasing the number of audits on tax returns that include alimony either paid or received. A report from the Treasury Inspector General found that in 2010 over $2 billion of alimony was not reported correctly. So what does that mean to you as a family law attorney? You aren’t a tax accountant and yet it’s still important you offer at least a little token advice to your clients about the tax implications of divorce and financial settlements.

Alimony Vs. Child Support

To most clients, alimony and child support are pretty much the same thing: a check from one ex to another. However to the IRS they are very different. Alimony is income; child support is not. That means alimony is deductible to the payor, and must be reported as income by the recipient so it can be taxed. Child support is “invisible” in the eyes of the IRS, neither deductible nor taxable.

Attorneys use this to their advantage. They can trade off alimony and child support to create a tax-optimized settlement. Family lawyer software like Divorce Financials makes it easy for family law attorneys to analyze a host of alimony and child support scenarios to find the one optimal for the client, and often even for the ex.

Should You Get Involved?

You are an attorney so you already know that you have to be careful what kind of advice you give. You should recommend that your client speak with a tax professional about how the divorce will change their tax situation, but does that mean you shouldn’t say anything at all?

It may be worth stating the tax difference between alimony and child support. You don’t need to get into long explanations about why they are different or the financial implications of various plans, but a simple observation that alimony can be deducted or must be reported, depending on whether your client is paying or receiving, can be enough to give the client a head start.

Specialized divorce financial software gives you to tools you need to optimize a property settlement or support agreement but software doesn’t take the place of old-fashioned good advice. A carefully chosen word, along with a disclaimer that you are not a tax professional, can help your client avoid a mistake in the future.

Download an evaluation copy of Divorce Financials and try the tax optimization and other tools to see how easy it is to create a fair settlement.