The big news in divorce as the New Year begins? Starting January 1, 2019, a significant change in how alimony payments are treated under federal tax law goes into effect. As part of the Tax Cuts and Jobs Act (aka “Trump Tax”), spouses who pay alimony must now claim alimony payments on their federal tax returns as taxable income; spouses who receive alimony are not required to claim alimony as income and receive this money tax free.
The new tax change represents a complete reversal of the old federal code in which paying spouses deducted alimony from their income as a tax break, while recipient spouses were required to claim payments as taxable income. Any alimony order put in place on or before December 31, 2018, is grandfathered in under these old rules.
If you are currently going through a divorce that involves alimony, or are pursuing temporary alimony during a separation, you will need to grapple with these new tax implications. If you are the paying spouse, you probably want to know… is there anything I can to avoid this extra tax burden? If you are the receiving spouse, your main question may be… what can I do if my spouse low balls alimony in our divorce negotiations?
Bari Weinberger took a deeper look at alimony negotiations under the new tax law in her piece for the New Jersey Law Journal: The 2019 Alimony Tax Change Is Here — But Is It Fair? She described how changing tax rules will necessarily mean changing tactics in reaching an alimony agreement.
Here are 3 takeaways for your own alimony negotiations.
Consider lump sum alimony payments
Under the old alimony tax rules, it was often much easier to negotiate alimony because the tax break for paying spouses was often so satisfying that it was easier to negotiate higher payments for recipient spouse — making it a win-win for both spouses.
With these days behind us, it is up to family law attorneys to come up with creative solutions for safeguarding their clients’ financial future, whether the client will be paying or receiving alimony. One tactic to consider is a lump sum alimony payment instead of smaller monthly payments for years. In the past this was generally not advisable for paying spouses, because the IRS would treat large lump sum payments as property transfers which were not tax deductible. This is now less of a concern, since a paying spouse can no longer deduct the tax on any alimony payments, regardless of whether they are lump sum or periodic.
Without the need to make continued payments, the payor spouse might be able to get the “tax hit” over in one year and move on. For receiving spouses, a concrete investment plan would be an important consideration before accepting this option.
Offset alimony tax with non-liquid assets
Another possible tactic is to look at the availability of any non-liquid assets which would be fully or partially taxable on withdrawal, such as retirement accounts, stocks, or brokerage funds which have increased in value. A higher earner may be able to transfer such assets to a lower earner in exchange for paying less alimony. If the transfer is properly executed, the recipient — not the payer — would bear the tax consequences down the road. (The recipient negotiating a higher percentage of the asset can help offset this consequence.) For both spouses, it is also important to keep in mind the downside of using retirement and/or investment assets in lieu of alimony: It may drain funds that will also be needed later in life. As with all aspects of financial settlement in divorce, this requires a careful cost benefit analysis.
Creative use of other assets
If you and your spouse have an artwork collection, a second home, or plan to sell your current family home as part of the divorce, consider whether your share of any these assets could possibly be used as a way to reduce or eliminate a future alimony taxes. Alimony, unlike child support, is not determined by any predetermined formulas. This can be good news when it comes to creative solutions. Opting to pay for a spouse to return to college, or offset other costs, such as home payments or home upkeep, could also be a way to reduce payments designated as alimony.
Your next steps
Do you have questions about alimony in your divorce? We’re here to help. Start safeguarding your future today by meeting with our divorce attorneys for a free consultation to learn your rights and get answers to all your questions. Call us at 888-888-0919, or click the button below.