Untangling finances in a divorce can be excruciating. And due to the TCJA, alimony deductions are no longer an option. How can you offset the axed deduction? Let’s take a look.
Pre Tax Cuts and Jobs Act: Alimony was Deductible
In the past, alimony payments were pre-tax deductions, and recipients paid income taxes on the amount as they would a salary. The former standard allowed divorced couples to shift taxable income into lower brackets, which benefited both parties.
Post Tax Cuts and Jobs Act: Alimony Isn’t Deductible
The TCJA changed things. Now, alimony payments aren’t deductible, nor does the recipient pay federal income tax on the amount. State taxation rules, however, vary.
Not paying taxes may sound like a boon for the recipient. But most analysts agree that the change will result in less money going to alimony beneficiaries. Plus, both parties will have less after-tax income.
Post-TCJA Alimony Deduction Workaround Ideas
Are there ways to recoup the alimony tax deduction elimination?
- Divide Assets Differently: When dividing assets, think strategically about the tax bracket implications. Don’t assume that 50/50 is the best option. Because of changes in the TCJA, it may not be.
- Leverage Retirement Accounts: Does it make sense for the payee to take the IRA or 401(k) retirement accounts in exchange for less alimony? Consider it. Yes, the recipient must pay taxes on withdrawals, but using retirement accounts in place of recurring payments can be a stable solution, especially in the event of death. If the recipient is under 59.5 years old, though, using IRAs and 401(k)s may not be the best option because of the 10% early withdrawal penalty. The best thing to do is talk with a tax lawyer who has experience with divorce finances.
- Working with Stocks and Dividends: Stocks can be helpful in divorce negotiations. Would splitting dividends be a tax-wise solution? Sit down with a tax consultant to explore how you can use stock and deferred compensation to offset alimony deduction savings.
- Real Estate: Signing over real estate is another alimony tax deduction replacement option. However, real estate finances vary state by state, so consult with an attorney before making any moves.
- Use a Trust: Charitable remainder trusts (CRTs) may prove helpful when navigating the new alimony tax rules. CRTs pay taxable income to a beneficiary (e.g., the former spouse), are irrevocable, and the payer may be able to get a tax deduction for funds put into the trust.
- All at Once: The most straightforward way to resolve alimony payments is with one lump sum transfer. By cleaving the financial bond, this method allows both parties to move on quickly and avoid entwined tax complications for years to come.
Don’t forget to add a clause that addresses tax law changes. Administrations swing like pendulums. What works best this year may be a nightmare in five. Don’t lock yourself into a regretful situation.
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