One of the questions I often encounter when working with clients going through a divorce and seeking creative solutions is how to handle bonus income in spousal support calculations. Bonus income can include cash bonuses based on performance or retention, or incentive-based that may include restricted stock units (RSUs) or performance stock units (PSUs), referred to as executive compensation. First, it’s imperative to work with an attorney to determine if there is a legal basis for the income to be subject to spousal support considerations. If it is determined to be included in the support conversation, then structuring how it will be paid out can be very important to both parties' future financial planning and oftentimes involves complex financial considerations.
Here are some key considerations when thinking about bonus income and spousal support.
Structuring Bonus Income in Spousal Support
When it comes to incorporating bonus income into spousal support, there isn’t a one-size-fits-all solution. How bonus income is structured into both parties' cash flow can significantly impact their financial stability after divorce. Therefore, thoughtfully creating a plan that reflects timing and net earnings while accounting for variability, predictability, and long-term budgeting needs is crucial. Below are some common approaches and considerations to help guide this process.
- Include Bonus Income in Monthly Support
Some agreements incorporate bonus income into a fixed monthly support amount. For example, spousal support might be set at $4,000 per month, which is based on both parties' income (actual or inputted) that includes historical average bonus amounts.
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- Pros for the recipient: Provides steady, predictable support. Extremely important if trying to qualify for future mortgage lending needs.
- Cons for the recipient: Does not account for potential increases in bonus amounts in the future.
- Pros for the payor: Clear, concrete monthly payment.
- Cons for the payor: Can be difficult if bonuses fluctuate (or could decrease in the future) and regular monthly salary income is significantly lower.
- Separate Base Support and Bonus Income
Another approach is to calculate monthly spousal support with base income only, such as $2,000 per month, and then allocate bonus income separately as a percentage.
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- Pros for the recipient: Provides flexibility to adjust for variable bonuses and can feel more equitable if they believe future income will increase
- Cons for the recipient: Must have enough regular income to cover monthly needs or have sufficient assets to cover expenses during periods without bonus income support periods.
- Pros for the payor: Can be easier to manage support if the monthly base income is substantially lower. It may also be a good option if they believe future bonus income may decrease.
- Cons for the payor: Requires ongoing tracking and communication about bonus amounts (may also be a con for the recipient).
Defining Bonus Types and Continuity in Agreements
It’s important to clarify what kinds of bonuses are included in support arrangements: performance, annual, retention, new employment signing bonuses, stock-based awards (RSUs/PSUs), etc. Additionally, addressing future potential job changes or new types of bonuses for the payor allows for possible changes and helps ensure the agreement remains relevant and equitable over time.
Gross Versus Net Bonus Splits
Once you’ve decided how to structure bonus income in your support calculations, the next step is determining whether to base the split on gross or net amounts. This choice can have a significant impact on both predictability and fairness. Understanding the differences, along with the factors that affect each approach, can help ensure the arrangement works smoothly for both parties over time and minimize possible disagreements and future conflict.
Net Bonus Split:
- The receiving party gets a percentage of the net bonus after payroll withholdings.
- Challenges: Net income can fluctuate depending on tax withholdings, retirement contributions, and other deductions. Specificity it is critical and important to clarify which payroll withholdings are relevant in determining the net split amount, such as federal, state, and local taxes, retirement contributions, social security, insurance deductions, 401k loan payments, employee stock purchases, etc.
- Be aware that employers may employ the supplement tax rate to bonus income, which is 22% withholding rate, and do not aggregate the bonus income to the employee's total income, which would reflect a more comprehensive tax withholding. When this occurs, the spouse may complain about owing a large amount in income taxes each year. This effect can create a lot of anxiety to the payor spouse, especially if they are in a higher tax bracket, if not understood, and can hinder attempts toward settlement.
- Be sure to include in your agreement which payroll withholdings are included in determining net income amount subject to split.
- Another item to consider for higher income earners is if social security tax withholding should be considered in net if the employee’s base income is above the social security max income threshold annually.
Gross Bonus Split:
- The receiving party gets a percentage of the gross bonus.
- Pros: Allows for the employee to have future payroll changes without having those changes affect the intended support.
- To determine an appropriate gross split percentage, subtract the total tax percentage amounts from 100%, and apply the split amount to the remaining amount - such as 50% or 40% (this amount is typically negotiated between the parties). For example, if the payor is in the 35% federal tax bracket, and the Colorado income tax rate is 4%, the parties agree to not include FICA withholdings, and the party will be subject to 1% Additional Medicare Tax for single taxpayers earning above $200,000 - 100% less 40% applicable taxes leaves 60% to be divided between the parties. If the parties agree to a 50% split of the remaining 60%, then 30% of the gross amount will be provided as support. If the parties agree to a 40% split of the remaining 60%, then 24% of the gross amount will be provided as support.
- The gross split method can address worries surrounding the lower supplement tax withholding that a payor may experience due to large annual tax payments when completing their tax return.
Planning Ahead
Even with a clear structure and a defined split, bonus income can be unpredictable. Taking the time to plan ahead allows both parties to anticipate fluctuations, align support with real expenses, and create a financial plan that supports long-term stability. Thoughtful planning can help prevent surprises and ensure the support arrangement remains workable as circumstances change. Choosing the right approach starts with mapping out your post-divorce budget and answering questions around the predictability of bonus income, whether a gross or net split better aligns with long-term financial needs, and deciding how fluctuations affect your ability to cover expenses and maintain stability.
Taking time to explore these questions with a financial professional can help you make informed decisions and reduce the likelihood of needing adjustments later. Thoughtful planning turns an unpredictable income source into a manageable part of your post-divorce financial picture for budgeting purposes. Contact us to learn more about modeling options and deciding the best way to address bonus income in Spousal Support.