People with significant assets have to consider how divorce will affect their taxes. Previously, when one spouse paid alimony to the other, that alimony was tax deductible for the person paying, and the person who received the payment was responsible for paying tax on the amount. Though it seems like the recipient was at a disadvantage in this situation, it generally worked out that recipients got more money. That all changed with the new tax laws that took effect at the start of this year.
Now that the deduction for alimony is eliminated here in Kentucky, this means the paying spouse will end up paying less alimony because he or she will owe more tax. The recipient may not owe as much tax, but he or she won't receive as much money. If you're in this situation, don't despair. There are other ways to minimize your tax burden. You and your soon-to-be ex-spouse may want to utilize property division instead of alimony when creating your divorce agreement. Here are some experts' suggestions on exactly how to do that.
Make use of retirement plans
One way to reduce tax in a divorce settlement is for the higher-earning spouse to give more retirement assets to the lower-earning spouse in lieu of a higher alimony payment. Using this option means that the payor doesn't pay tax on the retirement funds. The receiving spouse will have to pay tax whenever funds are withdrawn from the retirement fund, but the trade-off is more control over the assets, since he or she owns it even if their ex-spouse passes away.
This is a particularly good option for someone who owns a business or works as an executive, as these people may have an easier time replacing those retirement assets once they are part of a divorce agreement.
Set up a Charitable Remainder Trust
A Charitable Remainder Trust is a good option because the payor can use it to fund alimony for an appointed amount of time and still take advantage of a tax deduction. The beneficiary of generated income is the receiving ex-spouse. Once the determined period of time is complete, the rest of the assets transfer to a charity of the payor's choosing. The trust is irrevocable, meaning the terms can't be easily changed, which is good news for the recipient.
Consider using investment accounts
A lump sum transfer of assets may be a good idea, but only if the spouses have large gains on investments, such as stocks, mutual funds or real estate. In this scenario, the receiving spouse may not have to pay tax on gains when selling stock. The payor can probably buy more stock with the money saved on alimony. This is also an attractive option for anyone who doesn't want the potential problem of making on-going payments, particularly if the two people in the divorce have unresolved emotional conflict.
These ideas are not foolproof, however. If the paying spouse goes into bankruptcy, property division payments could be discharged. This is not the case for alimony. Even so, for some people, making use of other options besides alimony makes sense for everyone involved in the divorce.