A new change in laws has added an additional layer of complexity to divorce. Alimony payments are no longer deductible by the payor nor taxable to the recipient at the federal level. At first glance, tax-neutral alimony payments seem like a good idea, but ultimately it leaves both spouses with less money after-tax. Divorcing spouses can no longer rely on the alimony deduction strategy for their divorce planning and need to utilize other tactics instead. In order to maximize the amount of money that they can keep and minimize their tax payments, couples will need to be strategic in the division of marital property. Today’s blog takes a look at some ideas on how to do just that.
Transfer Retirement Accounts at Pre-tax Values to Fund Alimony
One option is for a low-income earning spouse to take more retirement assets in exchange for reduced alimony payments. The breadwinning spouse can then fund their alimony payments through a retirement asset by transferring funds without paying tax on it. This gives the same benefit of the prior alimony tax deduction. The recipient spouse will pay tax on the retirement account withdrawal but has more assets to draw from. In this case, they would own the assets no matter what happens rather than depending on the alimony payment.
Use a Charitable Remainder Trust
A charitable remainder trust (CRT) is a trust to which a person transfers their assets to reduce the amount of taxes they pay while helping out with a charitable cause. This is ideal for a payor of alimony who has a desire for philanthropy, plus it has additional benefits. The higher-earning spouse can receive a tax deduction based on the value of contributed assets and designate their former spouse as the beneficiary for the time that the alimony payments are due. The annual income resulting from the trust will be paid and taxable to the receiving spouse. Low basis investments can fund the trust, thus alleviating the problem of figuring out who gets stuck with them.
These strategies will the best tax benefits for couples with a differential between the payor’s highest tax bracket and that of the recipient. The main reason for getting rid of the deductible alimony is to increase revenue for the government. There is a chance that the law may change again though the elimination of the alimony deduction is permanent. Each couple’s situation will be different, so it is important to hire an experienced attorney to help sort out the complexity of high net worth cases.