Although most people are somewhat familiar with child support and alimony, there is a third category of support that you may not be familiar with. Unallocated family support doesn’t get much attention compared to the more common forms of support.
It is a combination of child support and alimony, but receives the same tax treatment of alimony. Labelling payments unallocated family support (UFS) is a helpful technique for families where one spouse makes a significant income and the receiving spouse has little or no income. It is only used when the family has children, and is not suggested if the children are approaching emancipation.
When UFS is properly designated, it is treated the same as alimony for income tax purposes, meaning it is fully deductible by the payer and taxable income to the recipient.
When Might Unallocated Family Support Make Sense?
The most likely scenario when UFS makes sense is when one parent makes a high wage, and the other parent has little or no income. Imagine a father making $300,000.00 per year, and mom stays home with the children. In this example, dad is paying a lot of money in taxes. As we say here in Massachusetts, he is paying a wicked lot in taxes.
Since mom does not work outside the home, she has zero tax liability. By combining child support and spousal support payments under the label of UFS, the support mom receives is taxable to her, but fully deductible by dad.
You may be thinking why would mom go for this, when some of her support would be child support and not taxable income to her? Simply put because transferring a portion of the families tax liability from the high wage earner to the low or no wage earner can actually create more available income to both individuals. Is this smoke and mirrors or some type of magic? No, just our wonderful tax code at work.
When working with clients, I use divorce financial software to run different support scenarios. I can then review reports showing each person’s tax liability and gross and net income, along with the amounts of child support and/or alimony. If using UFS, then all support will show as alimony because the tax treatment is the same, but you already knew that. In actual cases, there are a number of variables and issues to contend with, and negotiating where the “sweet spot” is in terms of taxes and support is just one of them.
Potential Pitfalls of Unallocated Family Support
Once an amount of UFS is set and payments begin, if a future reduction of UFS is tied to a major child-related event, the amount by which the support is reduced can be treated like child support for tax purposes.
If this should occur, then the IRS may consider the payments child support, and reconfigure your taxes to disallow the deduction. Ooops. What type of important events could trigger a reclassification of support?
- The child reaching a specified age, such as 18 or 21 for example;
- Death of a child;
- Child leaving school/graduating;
- A child moving out of the home;
- A child becoming employed.
It is important that the language contained in the divorce agreement, also known in Massachusetts as the separation agreement, is drafted carefully. During the stress of divorce, it can be overwhelming for some people to digest all of this information; especially if someone has not been involved in the family finances for quite a length of time.
Also, don’t underestimate the importance of tax issues during your Massachusetts divorce.
Just can’t get enough of alimony and tax issues? Click here to go to the IRS website alimony section.
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We are experienced divorce mediators and family law attorneys in Medfield, MA. Next Phase Legal concentrates in divorce, including divorce mediation, collaborative divorce, child support, alimony, custody, and related family law issues in the Metrowest Massachusetts area.