During the divorce process, the financial stability of both individuals is taken into account, and the responsibility of alimony is sometimes given to the higher earning spouse, when the lower earning spouse asks for it.
Before the Tax Cuts and Jobs Act of 2017 was signed, alimony was tax deductible for the payor, and the recipient paid income tax on it. However, since the bill was signed into law, alimony payments will no longer deductible after Dec. 31, 2018.
According to Marketwatch, the law also will apply to payments that are modified after Dec. 31, 2018, if the modification specifically states that the Tax Cuts and Jobs Act of 2017 treatment of alimony payments now applies.
Legal and financial assistance
For those looking to modify their alimony payments, they will need to contact their family law attorney and go through the proper legal channels. Their attorney will understand their unique needs and how to help them through the challenges that they face every month, when it comes to large alimony payments.
For those looking to strategize a new tax strategy, in order to help with post-divorce taxes, a financial planner can be beneficial in assisting the recovery process.
Recently, a tax strategy has been discussed, in order to combat the upcoming changes to alimony that the Tax Cuts and Jobs Act of 2017 will implement.
On Wall Street, an informational resource for financial advisors, suggests that giving an IRA as alimony would offer the tax benefits, not deductions, that the payor is seeking.
“When a husband gives the IRA to his ex-wife, he’s giving money he would have paid taxes on,” said Ed Slott, a Financial Planning writer and IRA distribution professional. “He is in effect getting a deduction.”
Understanding an IRA
An IRA stands for an individual retirement account. According to CNN Money, it includes tax breaks, allowing the holder to store cash for retirement, and unlike a 401K, IRAs typically are accounts that you open on your own.
They also include eligibility restrictions based on income and employment status and features a maximum on how much you can contribute each year. There are penalties in many cases for withdrawing money before the retirement age.
The tax benefits on a traditional IRA include avoiding taxes when money is put into it, allowing for tax-free growth on the investment of the funds. Roth IRAs provide no tax breaks for contributions. However, the withdrawals and earnings are generally tax free.
By having the higher-earning spouse give the alimony recipient an IRA as a lump-sum, the income taxes that the payor would have paid on the account are being passed to the recipient, according to CNBC. The transfer itself is tax free, but the recipient of the alimony is responsible for the income taxes, after they take a distribution from the account.
The recipient also becomes responsible for the 10-percent penalty that is inflicted for withdrawing from the account before the age of 59 and six months.
While this loophole within the new tax law is applicable to those with the finances necessary to sustain a living, financial advisors and tax professionals alike do not recommend this strategy if you need the money from alimony payments, in order to sustain a living.
Issues with implementation
This can be a challenge for many in lower income brackets attempting to be responsible and paying alimony, without receiving any of the tax benefits that previously existed. They would love to utilize this type of strategy, but it may not be feasible.
In addition, ex-spouses that receive alimony payments cannot afford to take those penalties and pay the tax on the IRA, if they find themselves in a lower income bracket.
Both ex-spouses are attempting to recover from the division of assets that left them in a financial state of flux. They may require time to cut some of their costs and factor alimony into their budgets, in order to fully understand their financial straits, making them unable to take advantage of this tax opportunity.