income tax planning

Divorce and Taxes.
In this world nothing is certain but here are some tax tips!

Tax tips for married people and business owners are often well known but what about tax tips for people going through a divorce? If you are going through a divorce it is very likely that you have a number of things on your mind, the least of which is probably taxes. However, that may be extremely dangerous for your financial future. It�s evident that your divorce will shake up your financial situation and when analyzing financial changes any accountant would suggest considering tax effects. So what do you need to know about your taxes if you are going through a divorce? To start you need a basic understanding of current tax laws including current alimony tax liability laws.

According to the Income Tax Act payments of alimony are deductible by the alimony payer as long as a number of conditions have been met

a) Payment must be made pursuant to a decree, order, or judgement of a competent tribunal or pursuant to a written agreement.
b) Payment must be made as alimony or maintenance of the recipient and/or children of the marriage.
c) Amounts must be payable on a periodic basis.
d) At the time of the payment and throughout the remainder of the year the spouses must be living apart as a result of a divorce, a judicial separation, or a written separation agreement.

Essentially, in plain English (a) the alimony payment amount must be agreed upon by both parties, (b) the payment must actually be for the purposes of alimony, (c) payments must occur on an ongoing basis, and (d) the spouses must be living apart.

Point C above, basically disqualifies lump sum payments. Any lump sum payments are not taxable to the recipient or deductible for payer. If a taxpayer deducts these amounts they could face substantial penalties and tax audidt information discovered on behalf of one tax payer could trigger an audit for the other ex spouse as well, possibly leading to a Tax audidt of the ex-spouse and further financial scrutiny for all involved.

Point C is a key point to keep in mind when you are negotiating the details of your divorce and alimony payments. The timing of those payments could actually greatly impact your future financial well being. Consider two simple examples detailed below;

Andrew and Jane divorce and they agree that Andrew will pay Jane an alimony payment of $180,000. This payment will occur as a one time payment. How will this affect the alimony tax deductions available to Andrew?

Situation #1 Financial Breakdown:
Andrew�s Expense $180,000
Andrew�s Tax Rate 45%
Andrew�s Tax Deduction $0
Andrew�s Net Tax Savings per year $ 0
Andrew�s Overall Tax Savings (15 years) $ 0

Now consider situation #2
Andrew and Jane agree to an alimony payment setup that will see Andrew pay Jane alimony payments of $1000 a month for the next 15 years.

Andrew�s Expense per year $12,000
Andrew�s Tax Rate 45%
Andrew�s Tax Deduction per year $12,000
Andrew�s Net Tax Savings per year $ 5,400
Andrew�s Overall Tax Savings (15 years) $81,000

In the above example, time value of money and tax rate changes were ignored to demonstrate the point that a simple decision on alimony payment timing can greatly impact your future tax savings. In this case Andrew will save over $81,000 in tax savings by setting up a periodic alimony payment plan instead of a one time alimony payment. You should speak with your financial tax preparer to look at your particular situation.

So although Benjamin Franklin might have been right when he said, in this world nothing is certain but death and Taxes, he may have overlooked the most important factor of both, timing!

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Alimony Tax Liability Laws
Current alimony tax liability laws make life confusing for many as almost one half of marriages end in divorce. This event can affect you emotionally and financially. Going through a divorce is financially taxing enough that additional tax burdens are hopefully avoidable. So how can you avoid taxes when you go through a divorce?

Continue reading on Alimony Tax Liability Laws

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