No Alimony Deduction? You Can Still Minimize Your Taxes

No Alimony Deduction? You Can Still Minimize Your Taxes.

Prior to 2019, individuals who paid alimony to their ex-spouse could deduct that amount from their income before paying taxes to the federal government. The recipient paid taxes on the alimony they received, but at their lower tax bracket.

All of that changed for couples whose divorces were finalized after 2018. From that point forward, alimony payors can no longer deduct the amount they pay, and recipients pay no federal taxes on the alimony they receive. The state of California, however, still allows payors to deduct their payments, and recipients do pay state taxes on the monies received.

The downside of this change in federal tax law is that, in many cases, both the payer and payee end up with less after-tax cash to spend. That’s because the alimony amount is taxed at the payor’s marginal and therefore highest tax bracket, leaving less income for the court to consider when deciding how much to award their ex-spouse in alimony payments.

For divorcing couples looking to lower the combined federal taxes they need to pay, there are still three sound tax planning strategies they can use to decrease their tax liability. By being strategic in how they divide their assets, couples can maximize their after tax incomes, even without the former alimony deduction.

Here’s How:

Transfer Retirement Accounts at Pre-tax Values

One way to lower their taxes is for the lower earning spouse to take more of the couple’s retirement assets (IRAs and 401(k)s) during property division in exchange for a lesser alimony payment. This enables the payor to transfer pre-tax assets to their ex-spouse to fund some of their alimony obligation. To help the payor replenish their retirement savings, they can redirect the funds they would have used to pay alimony to a tax-deductible IRA or 401(k).

Although the recipient spouse will need to pay federal taxes when they draw down the retirement assets, they’ll probably be in a lower tax bracket than the payor was, when the transfer was made. A significant benefit for the recipient spouse of this strategy is that they’ll have full control over the retirement assets they receive. If they were to rely only on alimony payments instead, their post-divorce income could be impacted, should the payor die prematurely.

Be Strategic About Splitting Investments

Many high net worth couples have seen significant gains in the stocks, bonds and mutual funds they’ve owned for some time. Whenever long term assets are sold, depending on the owner’s income and the type of asset held, the long term capital gains tax rate they’ll pay can range from 0% to 28%.

What can the divorcing couple do? During property division they can save on their combined taxes when deciding how their long term assets are allocated. By transferring the stocks, bonds and mutual funds with the largest gains to the lower-income spouse, they’ll lower their combined tax liability. The couple might also decide to transfer certain assets to the recipient spouse in lieu of partial or full alimony payments.

Use a Charitable Remainder Trust

A Charitable Remainder Trust enables individuals to help a charity, while reducing the total amount of taxes they pay. When setting up a Charitable Remainder Trust, assets are transferred to an irrevocable trust with a charitable organization as the beneficiary. The individual setting up the trust gets a tax deduction based on the value of the assets they have contributed. They also receive taxable income from the trust for a specified period of time.

To save on federal taxes, a divorcing couple can set up a Charitable Remainder Trust with the spouse receiving alimony as the trust’s income beneficiary. This strategy enables the payor to receive a significant tax deduction, as well as contribute to an organization they care about. The recipient spouse receives a dependable stream of payments from the trust, ensuring their post-divorce income, should the payor die prematurely.

Contact me for assistance

There are many reasons for divorcing couples to be strategic about how they divide their assets. One of those reasons is to be able to minimize their tax liability, whether or not alimony is paid.

If you are considering divorce and looking for sound legal advice, please contact my office for a consultation. As a San Francisco Bay Area family law attorney who holds a Master of Laws in Taxation, I have worked with many couples who wish to understand how tax laws affect their property division, as well as maximize their combined after tax incomes.

Attorney Christina Sherman is a Marin County CA family law attorney and Certified Family Law Specialist, specializing in divorce, child custody and support, marital contracts and other family law issues.

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