Warning! Don’t violate the Child Contingency Rule!
If any amount of alimony (aka maintenance or spousal support) specified in the divorce decree is reduced (a) upon the happening of any contingency related to the child or (b) at a time that can be clearly associated with a contingency related to the child, then the amount of the reduction will be treated as child support, rather than alimony, from the start. Code Sec. 71(c)(2). Reg. §1.71-1T(c)
What is a contingency? A contingency relates to a child if it is dependent on an event relating to the child, regardless of whether the event is likely to occur. Some examples are:
- Reaches age 18, 21 or the age of majority in their state
- Gets married
- Graduates from school
- Leaves home
- Joins the military
- Gets a full-time job
Section 71 of the IRC provides two situations where payments would not qualify as alimony if they are reduced at a time clearly associated with a contingency relating to the child.
The first situation occurs when the payments are to be reduced not more than six months before or after the date on which the child reaches age 18, 21 or the age of majority in their state. And this means all three ages!
Multiple reduction rule
The second situation is when there is more than one child. In this instance, if the payments are to be reduced on two or more occasions which occur not more than one year before or after each child reaches a certain age, then it is presumed that the amount of the reduction is child support. The age at which the reduction occurs must be between 18 and 24, inclusive, and must be the same for each of the children.
The following example shows incorrect advice afforded this client.
Example: Kevin and Karen are getting divorced and their son, Josh, is going to live with Karen. Kevin is going to pay Karen $3,000 per month maintenance plus child support. Kevin’s attorney says “Josh is graduating from high school in 6 years, so why don’t you pay Karen maintenance for 5 years.”
Or the attorney will say, “Since Josh is graduating in 6 years, why don’t you pay Karen maintenance of $3,000 a month for 6 years and then reduce it to $2,000 a month for an extra 3 years. Karen won’t have as great a need when Josh leaves home.”
This is creating a serious tax problem for Kevin. The IRS may consider the reduction of $1,000 a month to be child support because it coincides with a child contingency. The IRS will then go after Kevin to collect the taxes he saved by calling it maintenance and they will make it retroactive from the beginning. Six years (72 months) times $1,000 is $72,000 that he will have to pay tax recapture on!
This is an area of possible malpractice for you if the IRS comes after Kevin and he then decides to come after you. So, don’t tie reduction of maintenance to anything relating to the children!
What If One of us Wants to Keep the House After the Divorce?
It’s no secret that working through the divorce process is a stressful time; figuring out child custody, dividing the household income, and worrying about what comes next are things that a couple worries about long before the proceedings begin.
Concern over the marital home often combines all of these outside stressors into one. Should you sell? What can you afford? Would it best for one person to buy out the other and stay in the home?
All good questions.
As we mentioned in our previous post about divorce mediation and real estate, it’s important to know all of the facts before you make a decision. Here are some factors that DRCC takes into account when dealing with one of the largest marital assets many couples have: the family home.
What if I want to stay in the house?
As with any of the decisions that clients face through mediation, it’s important to work with a trusted mediator who will help you make informed decisions. When DRCC works with clients, we show them the outcome of keeping the marital residence from a cost and tax standpoint. We also analyze the financial outcome of moving.
We realize that it can be very difficult to leave the marital home; the kids were raised there, there are solid relationships with neighbors, the kids have established friendships, and they’re settled in their schools.
However, it is important to balance both the emotional and financial pros and cons. Things to consider are:
~ Will you be able to (or even want to) spend time maintaining a house inside and out instead of spending quality time with the kids during your parenting time?
~ How important is it to you that you are not ‘house poor’?
~ Is this where you envision yourself living for years to come?
By taking into consideration the entire emotional and financial picture, we’re able to assist our clients with making the best decision possible for their future.
What if my spouse wants to stay in the house, but I want to sell?
Divorce really turns routines and lifestyles upside down. It is important to remember that in many situations, one parent who managed the children and household may need to return to work or be retrained for a job. In that case, will they even have the time to care for and afford a larger home or a home with deferred maintenance?
If you are the spouse returning to the workforce, keep in mind that it may be necessary to refinance the home and with the change in household income, it could be difficult for you to qualify. On the other hand, fi you are the parent who was responsible for being the primary breadwinner, your parenting routine will be different moving forward…which could change your work schedule and leave you with less free time for home maintenance.
Keep in mind that the marital residence is generally one of the largest assets in the marital estate and it deserves much analysis of all options available. It is important to us that our clients are not making this kind of a financial decision without proper analysis, guidance, and advice.
What if one spouse makes more than the other?
If you’re thinking about filing for a divorce, you’re also thinking about your finances – the two go hand-in-hand. How can we support two households? How will this affect our retirement? How will this change the way we raise our kids?
And if your spouse makes more than you do, OR you’ve been a stay-at-home parent…this could be a particularly stressful time.
In a recent post by The Good Men Project titled 11 Tips For Protecting Your Money During Divorce, the author states:
First, let me say to stay-at-home moms, “your money” is the money your husband earns to keep the household afloat. When you both agreed that you would stay at home to raise the children there was an implied agreement that the one income would cover the expenses of both spouses and the family. Therefore, if you end up divorcing, don’t think that because you don’t earn a separate income that you have no money to protect.
You and your children will need to be financially secure until you can go back to work, that means you being willing to protect what portion of his income you need to remain financially viable after the divorce is final.
This is a common scenario
It’s not unusual to have a division of labor at the beginning of a marriage. For instance, an agreement is reached that one party will be responsible for being the engineer of the household, responsible for day care for the children, organizing school participation, etc. The other party is responsible for being the primary breadwinner.
By engaging with a professional who will look at the entire financial picture, this could alleviate a lot of the stress you might be feeling. Consulting with a trusted mediator means that your entire family and marital situation is considered in order to make the transition as smooth as possible for everyone involved.
“At DRCC, we take a look at the entire financial picture in order to level the financial playing field,” says DRCC Founder Deb Johnson. “Our mission is to educate and empower our clients and work through this difficult life transition so that, in the end, they have the tools to manage their personal finances going forward.”
When the Wife SHOULD get the House
There are cases when the wife should keep the house, even when doing so will create an unequal settlement. Let’s look at Bill and Barbara (an actual case taken from records in a Colorado courthouse). Bill and Barbara are 45 and 49, respectively, and have been married 18 years. They have one son. Bill earns net $8,500 per month, minus child support payments of $140 and maintenance payments of $2,680 per month. His living expenses are $4,500 per month. Barbara earns net $1,200 per month plus $140 child support and $2,680 maintenance. Her living expenses with the son are $5,300 per month, which creates a negative cash flow of $1,816 per month.
The following settlement was decided by the judge. Barbara will receive the house, which had equity of $44,100 and her IRA worth $5,000. Bill will get his IRA worth $8,900. There are no other assets. Since Barbara got the house with $44,000 worth of equity, she has to pay Bill half of that equity upon the first of the following events: if she sells the house, if she gets remarried, or upon the emancipation of the child. We do not know if she is going to sell the house, or remarry, but we do know that the son is going to reach age of emancipation in four years.
Barbara’s house payment is $1100 per month with 10 years left on the mortgage. According to this scenario, Barbara is heading for poverty from the outset. To be able to pay Bill his half of the equity in the house, she will have to sell the house. This will force her to rent at a much higher cost than her house payment of $1100 per month. In her area, rental prices start at $1200 to $1500 per month.
The following graph shows the result of the court’s decision.
This court order is forcing Barbara into severe poverty. In this case, it seems reasonable that Barbara should have been allowed to keep the house without paying Bill half the equity -- an unequal but equitable settlement.
There certainly are times when the wife should retain the marital residence, particularly when there are children at home, and the wife’s cash flow must be taken into consideration. However, often the wife has much emotion wrapped around the marital residence and wants to keep it from an emotional standpoint. In these cases, it is absolutely critical that a comprehensive cash flow study is done and the settlement proposals be projected forward, especially to see that cash flow and liquidity are not sacrificed at the expense of an emotional decision.