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Divorce is expensive. Few households live on less than 50% of their income so splitting it in two almost always results in a lifestyle adjustment no matter how much money and income the family has. For families where one spouse is the primary breadwinner, going through a divorce is about to get even more expensive. Alimony, also called spousal support or maintenance, has been deductible by the payer and taxable to the receiving spouse for decades. This tax deduction is very important as it results in less money to the government and more money to split between the two households.
The Tax Cuts and Jobs Act eliminated the tax deduction for alimony in new divorces settled after December 31, 2018. Not only will alimony payers lose the deduction, some may be pushed into a higher tax bracket without it. And, they'll still have to pay the spousal support with the fewer available dollars. For those reasons, couples going through a divorce where alimony is an issue are highly motivated to settle soon. Finalizing this year will grandfather them into existing rules allowing them to deduct alimony in future years as well.
So if you’re in the middle of the divorce, how can you finalize by New Year’s Eve?
1. Decide What You Really, Really, Really Want
The concept is simple, but the reality of articulating it isn’t. Few people stop and reflect on what they really, really, really want and why. What are the things you must have to set up the next chapter of your life? Having clarity will help you make smart decisions in settling quickly. It’s also important to consider what your spouse really wants and needs, and why. The more insight you can share with your professional team, the more effective your negotiations will be resulting in a more satisfactory outcome with less time and professional fees.
2. Make A Plan With Your Divorce Attorney Immediately
While you must have a written agreement before New Year’s Day 2019 to retain deductibility, you can modify your agreement in future years and still keep current tax benefits. Talk to your attorney about what has to happen this week and even today to come to agreement and get it through the courts.
3. Calculate Whether You Should Settle Now
While the tax benefits of settling this year are meaningful, they are not worth signing a bad deal. Make sure you work with together with both your divorce attorney and a Certified Financial Planner ™ professional experienced in divorce to understand the long-term implications of your proposed settlement. Modeling a Monte Carlo projection like the picture above will show you the likelihood you will have enough assets and income for your goals. It will help you understand how modifying your spending or working longer if necessary will give you more control over your future.
If alimony is a sticking point or you can’t finalize this year, consider strategic alternatives by structuring the property settlement tax-efficiently. The value of asset transfers in the property settlement from divorce is not taxable to either spouse. By having the higher income spouse retain taxable assets with a high basis such as cash, bonds or stocks in joint names, and transferring tax-deferred retirement assets such as IRAs or 401(k)s to a lower income spouse, the couple likely could effectively regain some of the tax benefits lost with the alimony change. The couple will need to be sensitive to age and timing restrictions and work with experts to ensure they execute the logistics properly. Strategic use of charitable remainder trusts and other advanced planning strategies by high net worth couples can minimize the pain from the loss of the alimony deduction as well. Bottom line, taxes always matter in divorce.
What are you going to do today to move your divorce closer to the finish line?
