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How to reduce the tax impact of alimony

On Behalf of | Mar 31, 2020 | High-net Worth Divorce |

One thing many couples fail to realize about a divorce is how it will impact their tax liability. If you are not careful, your tax liability could create some financial headaches. You need to incorporate tax planning into your divorce process and when making decisions about your settlement. Being proactive can help save you money and hassle down the road.

According to Forbes, changes in the tax laws regarding alimony have changed the way people need to manage tax liabilities in a divorce. It is essential that you make sure you understand the impact this will have on your situation so that you do not end up with a large tax burden that you could have avoided.

New alimony laws

Prior to 2019, if you paid alimony, you could deduct it as an expense on your taxes, and if you received it, you claimed it as income. This meant the tax burden shifted to the person receiving the payments. The taxes paid by the spouse receiving the alimony are less because that spouse is the lower earner and likely in a lower tax bracket than the paying spouse.

With the change in the law, though, nobody can include alimony in their taxes. If you pay support, this could mean a bigger tax bill because you lose this write off on your federal taxes.

Options to avoid taxation

You do have options for avoiding the tax pitfalls of alimony. One option is creating a trust from which to pay the alimony. You can use an irrevocable trust called a charitable remainder trust. Another option is trading retirement accounts for alimony. Instead of paying your former spouse full alimony, you can negotiate to give him or her some of your retirement account, which may work if you are close to retirement age. This may allow you to reduce alimony payments enough to lessen the tax burden.