Daniel Jaffe, a prominent Beverly Hills family lawyer, may surprise you when he names the most important financial consideration when getting a divorce. It's not who gets the house or the business or the retirement money.
Essentially, it's who gets the tax deductions.
For the Record
Los Angeles Times Thursday February 25, 1993 Home Edition Business Part D Page 2 Column 3 Financial Desk 2 inches; 38 words Type of Material: Correction
Divorce and taxes--A column last Friday about tax planning for divorce contained a mathematical error. The hypothetical couple described in the column would have realized a savings of $4,403 by converting non-deductible child support payments into deductible alimony.
Tax planning is one of the most vital, yet misunderstood and ignored, items in a divorce, Jaffe says. And now that the Clinton Administration is seeking to increase tax rates for high-income filers, a cornerstone concept in divorce planning called "bracket arbitrage" is becoming far more pivotal, particularly for the wealthier set.
Clinton's proposed tax hike for high-income individuals will dramatically widen the difference between the highest and lowest tax brackets.
"With tax brackets spreading again, it's time to start playing bracket arbitrage," Jaffe says.
But even middle-income couples--who won't see an increase in their personal income tax rates under the Clinton plan--can save substantial amounts by being aware of the tax implications of divorce, experts say.
Bracket arbitrage pivots around a simple idea. In many divorces--particularly those that involve children--the individual who earns the most money must pay support to the individual who earns less or nothing. If the high-earner can get a tax deduction for those payments, he or she can pay more and still be better off.
Couples with children or large amounts of assets can save tens of thousands of dollars by playing the game.
Bracket arbitrage is surprisingly easy to do. All it takes is a negotiated settlement--rather than a litigated one. And a little knowledge about the tax code.
The simplest and most common form involves turning non-deductible monthly payments into deductible ones, tax experts say. How? Child support--which is neither deductible to the giver nor taxable to the receiver--becomes alimony, which is deductible to the giver and taxable to the receiver. This effectively gives tax deductions to the wage earner who needs them and gives income to an individual who has deductions that otherwise can't be used.
To illustrate, consider a couple with one child. We'll call them John and Jane Smith. John earns $51,000. Jane stays at home with their 5-year-old child, John Jr.
They decide to split up and must decide what to call the support payments John plans to pay to Jane and John Jr.
