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I have a friend considering a marriage of convenience. She is looking to marry another women so she can gain a sizable discount on childcare from the location the 'spouse' is employed at, and the 'spouse' can receive a discount on education fees from the school my friend works at and benefit from the friend's family insurance plan.

It would be purely for convenience. They would not be commingling any assets and would presumably be filing taxes separately.

They obviously would have to pay the cost for the marriage license and eventually for a divorce in 4-5 years, which they are aware of. I'm wondering if there are any other hidden costs or financial risks associated with such a marriage of convenience?

My friend currently has one child and would likely have another during the 'marriage'. I'm already checking with other sources to ensure the wife wouldn't gain any parental rights in this case.

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    Jurisdiction will matter here. Main problems with this unethical and unwise action would be (1) potential fraud charges for a 'fake' marriage; (2) the other 'spouse' making use of available tools to get value from the marriage [jointly passing over debts, taking money on divorce, etc. all depending on jurisdiction]; (3) having the other spouse be the presumed parent in the case of future children, complicating that child's legal life in the future and also possibly creating needs for child support payments etc.... The list goes on and on. A lot could go wrong here. – Grade 'Eh' Bacon Nov 24 '17 at 16:12
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    @Grade'Eh'Bacon Actually it is legal and not something one can be charged for fraud from. One can debate the moral implications separate from the legal ones, but as they are both already US citizens there is no legal fraud involved in their plans. – dsollen Nov 24 '17 at 16:27
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    It might not be immigration fraud, but you've stated it is being done specifically for insurance reasons - so, insurance fraud is a possibility. I am not a lawyer, and don't live in the US, but I'd be surprised if purposefully entering a sham marriage to gain financial benefits wasn't considered fraud. – Grade 'Eh' Bacon Nov 24 '17 at 16:32
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    We frequently tell people to avoid loaning money to friends and family and to avoid things like buying a house with an unmarried friend because of all the things that can go wrong. This proposition takes unwise to a whole new level. The fact that there are kids here complicates things exponentially. – Ben Miller Nov 24 '17 at 17:13
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    Married Filing Separately might well offset a lot of savings from the marriage. – Dilip Sarwate Nov 24 '17 at 17:56
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Setting aside the morality and ethics of false wedding vows, yes, there are many things that can go wrong with this plan.

Marriage is a merging of two people (and two households) into one, legally. You can't simply marry, but decide to keep everything separate; it doesn't work that way. Sure, a prenuptial agreement might help with the planned separation, but it by no means would be foolproof. Your "spouse" will have rights at divorce time, and usually you can't simply sign all those away on a prenup.

For the kids, setting aside the confusion you would be causing them, you can't count on the prenup being able to ensure the custody situation later. A judge decides what is best for the child, and can ignore previous agreements.

But let's now assume that when it is all over, nothing is contested and both parties agree on everything. While you are "married," you will almost certainly end up paying more in taxes than you are now, due to the marriage penalty. Tax rates will be higher, tax credits are harder to qualify for, and tax deductions have lower limits. You can't avoid this by simply filing separately; in fact, in most cases, that makes the taxes worse.

In short, this is an extremely risky way to save money. Don't do it.

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    Now, for the moral component: False wedding vows are immoral and unethical. You would be lying to your spouse, your state, your employers, your kids, your God, and yourself. – Ben Miller Nov 25 '17 at 14:13
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    You can do whatever wedding vows you want. No need to use vows incompatible with what they are intending. – Loren Pechtel Nov 26 '17 at 5:10
  • @LorenPechtel I'm less concerned with the words chosen during the ceremony, and more concerned with telling everyone that you are married when you do not consider yourself to actually be married. – Ben Miller Nov 30 '17 at 3:08
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Yes, there definitely are very high potential costs. If your friend lives in a Community Property state1, then half of all the assets2 she acquires after the marriage automatically become her wife's, and and half of her wife's debts (likewise acquired after the marriage) become hers.

Thus, it's vital that they both generate net worth sheets before the marriage. If her prospective wife has a lot of debt, she'd have incentive to hide it, and then claim that it was acquired after the marriage. Get a prenup!! (EDIT: IANAL. You'll need one to know exactly how to write a pre-nup to get the best possible -- but obviously imperfect -- protection from bad behavior on the part of her spouse.)

1 Washington, Idaho, California, Nevada, Arizona, New Mexico, Texas, Louisiana and... Wisconsin.

2 Excluding gifts, inheritance and insurance payouts.

  • Reasons for the down-vote would be appreciated. – RonJohn Nov 25 '17 at 0:41
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    I am not the downvoter, but your answer implies that getting a prenup would solve any potential problems with this arrangement. – Ben Miller Nov 25 '17 at 14:26
  • @BenMiller "solve any" is a pretty strong statement, especially since lawyers know how to break pre-nups (especially if they're poorly written). However, in a situation like this, it's a darned site better to have one than to not have one. – RonJohn Nov 25 '17 at 14:36
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    A prenup would not solve the problem of hidden debt. – Loren Pechtel Nov 26 '17 at 5:11
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    You're suggesting a pre-nup to avoid hidden debt--but you're not showing how a pre-nup provides the slightest help in dealing with it. – Loren Pechtel Nov 26 '17 at 21:06
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Taxes

Your friend would have to pay higher taxes as well. Currently she presumably files as Head of Household and her friend files as Single.

In 2017, the IRS says:

Head of Household: $9350
Single or Married filing separately: $6,350
Married filing jointly: $12,700
Personal exemption: $4050

$9350 + $6350 = $15,700

So currently they can deduct the first $15,700 of their combined income. If they marry, that will drop to $12,700. That's a loss of $3000.

Tax brackets, 2017.

Example

Let's say your friend has an income of $50,000 and her friend also has an income of $50,000. So

$50,000 - $9350 - 2 * $4050 = $32,550
($32,550 - $13,350) * .15 + $1335 = $4215

Your friend, with one child, pays tax of $4215 now, in the 15% tax bracket.

$50,000 - $6350 - $4050 = $39,600
($39,600 - $37,950) * .25 + $5,226.25 = $5638.75

Her friend, with no dependents, pays $5638.75 now, in the 25% tax bracket.

$4215 + $5638.75 = $9853.75

So together, they pay $9853.75.

$100,000 - $12,700 - 3 * $4050 = $75,150
($75,150 - $18,650) * .15 + $1865 = $10,340

Post-marriage, they pay $10,340 if married filing jointly.

$50,000 - $6350 - 2 * $4050 = $35,550
($35,550 - $9325) * .15 + $932.50 = $4866.25

So your friend's taxes would go up to $4866.25 if married filing separately. Her friend's taxes would still be $5638.75.

$10,340 - $9853.75 = $486.25
$4866.25 - $4215 = $651.25

That's $486.25 more if they file taxes the cheaper way. Part of this is the $3000 loss in deductions. That's $450. The other part is that the married filing jointly brackets kick in lower than head of household. The borders between 10% and 15% had been $13,350 and $9325 for a total of $22,675 at the 10% rate. But married it kicks in at $18,650. That's down $4025 for another $201.25 in taxes. On the bright side, there was enough left in the 15% that married they saved $1650 in the 15% rate that used to be in the 25% rate. That's $165, less than they lost moving from 10% to 15%. And just a little more income would have put them over the $75,900 and into the 25% bracket.

Turbo tax says that she would lose the child tax credit if married filing separately. I didn't include that, as it's the same for head of household or married filing jointly which is what I compared. That's a big difference though, and tax reform may make it bigger.

Reality

The exact amount of the tax impact depends on their exact tax situation. Maybe they itemize and the standard deduction does not matter. Maybe their incomes complement better, so the bracket creep does not matter as much. Or maybe it's worse. I would encourage them to do the math themselves. They already have the 2016 information, so they could redo their actual returns and see what would have happened.

Note: there may be some circumstance under which they actually pay less taxes. However, my reading suggests that such scenarios will be rare. Perhaps if one of them does not work and therefore has no income, but you talk about jobs for both. All that said, the best proof would be to calculate the taxes based on real information rather than an example.

  • Since in the USA this sham marriage actually increases your taxes, the IRS wouldn't be interested, and there would be no laws against it. In countries like Germany where you would save taxes, the government will see this differently. – gnasher729 Nov 26 '17 at 21:07
  • Don't forget the "marriage penalty" on IRA contribution limits! – Ogre Psalm33 Nov 27 '17 at 15:53
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If you get free health insurance through a sham marriage, and then you need expensive medical treatment, guess what the insurance company will do: If they figure out that there was a sham marriage, there will be no insurance cover. Probably true for both. Maybe I'm wrong, it's not something that I would risk.

If / when the employer finds out about the sham marriage, guess what will happen to the child care discount: It will be gone, the employer will ask for back payment, most likely fire the person employed, and may press fraud charges.

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Before jumping into something like this, you should first confirm that it is financially advantageous to do so.

I recommend having the two parties do a trial run with their 2016 tax returns. They should try to fill them in again as Married Filing Separately and Married Filing Jointly to find the option that is most beneficial. The total tax owed in the best option should then be compared against the actual tax owed as filed.

The next step is to calculate the expected cost savings for tuition and health care and factor that in.

So if the following is true, it may make sense to consider this scenario:

(Best Case 2016 Tax Owed) - (Health Care + Tuition Cost Savings) < (Actual 2016 Tax Owed)

Ideally, the savings should be significant to consider this scenario. It's also important that it makes sense for each individual participant. If one person comes out way ahead and the other a little behind, this may not be a good plan.

If they have confirmed that this is still advantageous to go through with, they need to try to mitigate the financial risks.

As others have noted, first have the basics covered:

  • Both parties need to be prepared for unforeseen social and legal implications of this marriage now and in the future. Other people's comments and answers to this question show a small sampling of what to expect in terms of possible reactions from others. The partners may need to inform future romantic partner of the, possibly ongoing, relationship of convenience. Legal documents in the future typically require listing all previous marriages, etc so there will be future, possibly unexpected, reminders of the relationship and the need to document it. It may also require keeping in touch to be able to provide necessary documentation even if the relationship did not end on a good note.
  • If the parties are not benefiting equally from the arrangement, or especially if one party is actually losing out a little extra for a total net benefit, both parties should document and agree to what benefits they are entitled to as part of the arrangement.
  • Secondly, both parties should agree up front on the conditions for ending the marriage. Should end automatically after a certain amount of time or go until they want to end it? Should end be if either of them wishes to end it? Should there be a required notice period if ending (early) to allow unwinding obligations (e.g. children completing a school year)?
  • Each party should have a thorough and documented understanding of their own finances prior to the wedding which the other has reviewed. Be mindful of marrying into debt or letting someone marry into a nest egg.
  • Understand whether the state where they will be married is a Community Property state or not.
  • Understand how finances and property held before the marriage will be treated on divorce. Will they go back to their original owners or be divided equally?
  • Understand how finances and property acquired during the marriage will be treated on divorce.

If after considering all of that, they still think it is beneficial to go ahead with, then they need to plan for the unforeseen:

  • Have a plan, preferably a written plan, in place for how to deal with unexpected windfalls during the marriage. For example, one partner may not want to share part of an inheritance with the other on divorce.
  • Have a plan in place for significant changes. For example, what if one partner gets a dream job in another state or a major promotion and is no longer benefiting in the same way from the marriage? What should happen then?
  • Also, what if circumstances change negatively? For example, what if the partner working at the school loses her job or moves to a different school where the tuition benefit disappears or is smaller?
  • What if one partner finds a new (romantic) partner they would like to enter into a marriage with?
  • Similarly, document how to handle unexpected financial needs. For example, if one person's house gets flooded and they have no insurance, should the other contribute to the cost so the marriage can continue to benefit both?
  • Be prepared for the worst: what happens if one of the two dies during the marriage? Both parties will need a will for this to work well. Both parties need to ensure their retirement accounts and wills are updated appropriately to get their estates to their intended recipients, especially the partner with children.
  • This extends to things like a living will. What if one party becomes incapacitated or enters a vegetative state. The living will should ensure that the appropriate people are able to and actually are making health care decisions for the injured or incapacitated party.
  • Then there are more mundane risks like: what if the partners just stop getting along?

Lastly, but very importantly, since there are children involved, extensive planning should go into safeguarding them:

  • The partner with the children should have a plan for how to explain the marriage to the children in an age appropriate way.
  • This partner should also have a plan in place should the children be harassed in any way based on the marriage.
  • This partner should set ground rules for the other, which the other should agreed to, in terms of how the childless partner is or is not expected and allowed to interact with the children.
  • It's especially important to document how the children should be handled in the divorce.

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