June 1, 2012
Typically the transfer of property between parties, pursuant to a divorce, is not a taxable event. A cash settlement from one party to the other is not counted as income to the receiver, nor is it deductible to the payor. But there are situations in which structuring a settlement as maintenance can be beneficial to both parties. This arises when one party is a high-earner and the other is not.
Example 1: When Andy and Sheila got divorced, Andy owed Sheila an equalization payment of $200,000 which he could pay over time. If Andy paid $20,000 per year plus interest on the unpaid portion, it would be tax-free income to Sheila because it's still a transfer of property. Let's assume Andy earns $190,000 per year and Sheila doesn't work. If Andy has no itemized deductions, the result would look like the following:
Andy Sheila
$190,000 Taxable Income 0
-5,800 Standard Deduction 0
-3,700 Personal Exemption 0
$180,500 Taxable Income 0
$44,462 Income Tax 0
$190.000 Taxable Income 0
-44,462 Less taxes 0
-20,000 Less payments to Sheila $20,000
$125,538 Net Cash $20,000
Example 2: Assume the same facts as in Example 1, except that Andy decides to call the payment maintenance and he pays $25,000 to Sheila and the payments qualify as maintenance. His net after the 2011 taxes and the maintenance payment of $25,000 to Sheila is $127,843, which is $2,305 more than in Example 1. Sheila has no itemized deductions. Her tax liability for 2011 is $1,890 (tax on $15,500 as a single taxpayer). As shown below, her net after taxes is $23,110, which is $3,110 more than in Example 1.
Example of Maintenance Payments
Andy Sheila
$190,000 Taxable Income $25,000
-5,800 Standard Deduction -5,800
-3,700 Personal Exemption -3,700
-25,000 Maintenance payment
$155,500 Taxable Income $15,500
