Any parent contemplating divorce understandably wishes to know whether and to what extent he or she will be entitled to receive, or obligated to pay, child support and/or alimony. However, many potential clients we speak to are unfamiliar with a third type of support — commonly referred to as “unallocated alimony and child support” — which in certain circumstances can be a useful (and sometimes critical) tool for resolving support issues in a divorce through negotiated settlements. In simple terms, an unallocated support payment from one ex-spouse to another is an obligation that contains both alimony and child support components lumped together into a single payment.
In order to understand the potential benefits to both parties of an unallocated support obligation, it is first necessary to understand the different tax treatments that apply to child support payments and alimony payments. In a nutshell, child support payments are neither tax deductible to the person making the payments, nor taxable as income to the person receiving the payments. Alimony payments, in contrast, are taxable, meaning that such payments are tax deductible to the payor and taxable as income to the person who is receiving the payments.
When parties agree upon an unallocated support obligation, they are agreeing, for purposes of settlement, to lump child support and alimony together into a single payment, the entirety of which will be treated like alimony for tax purposes (i.e., tax deductible to the payor and taxable as income to the payee).
The fact that the payor receives favorable tax treatment on unallocated support payments while the payee receives unfavorable tax treatment on such payments begs the following question: why would the payee spouse agree to this arrangement? The answer is that, under certain circumstances, it can benefit both parties to combine child support and alimony into a single unallocated taxable support payment. This is typically the case where the spouse paying alimony and child support has a substantial income and the spouse receiving alimony and child support has little or no income of their own. The reason that unallocated support may be beneficial to both parties is that it allows the parties to shift income from higher tax brackets to lower tax brackets. As a result, the payor will ultimately end up keeping more of his or her income because of the ability to use the entire unallocated support payment as a tax deduction and will thereby have more disposable income available with which to pay support. Stated differently, due to the tax savings, the individual paying support may end up with more money than he or she otherwise would have if alimony and child support payments were made separately and, as a result, the receiving spouse (and children) can benefit from an increased payment amount than if they had received alimony and child support separately. In this scenario, the entire family wins and the IRS suffers the loss.
In considering the use of an unallocated support award, it is critical to ensure that the support payment is set in such a manner so as to be an incentive to both the payor and the recipient. Generally speaking, an unallocated support award will not be advantageous for former spouses who earn similar incomes.
At Broder & Orland LLC, we regularly represent clients in Greenwich, Darien and other towns throughout Fairfield County and the state of Connecticut for whom unallocated support payments are advantageous, and we are well-versed in the complexities of such awards and how to use them as a settlement tool to maximize your post-divorce financial well-being.