A Work Around To The Change In Alimony Deductions

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With the passage of the Tax Cut and Jobs Act at the end of 2017, Congress upended 75 years of settled law with regard to the tax deductibility of maintenance (or alimony) payments.

Previously, a spouse ordered to pay maintenance could deduct all maintenance payments, thereby reducing dollar-for-dollar that spouse’s taxable income. While the spouse receiving maintenance had to report the maintenance received as taxable income, the recipient spouse almost always had a lower tax rate, thereby maximizing total family income and enabling one spouse to continue affording supporting two households.

Under the new law, effective January 1, 2019, the spouse ordered to pay maintenance can no longer deduct payments from federal taxable income, while the spouse receiving maintenance no longer has to count maintenance as taxable income. The net effect of these changes is to reduce total family income and make it harder for a spouse ordered to pay maintenance to in fact afford the maintenance.

But the tax code has left a potential workaround for some couples.

Instead of paying maintenance, a spouse can pay in one lump sum or in several transfers overtime funds from that spouse’s IRA to the former spouse’s IRA. This method allows the paying spouse to count the transfer as a pre-tax transfer, thereby reducing taxable income, and also allows the receiving spouse to build a retirement fund immediately.

The one downside of this workaround is that if the receiving spouse needs the funds for daily living expenses, that spouse will have to pay an early withdrawal penalty and also income tax (though at a lower rate than the paying spouse). Depending on the particular needs of the recipient spouse, this method could still allow for greater overall family income because of the tax benefits to the paying spouse that would allow for a larger initial transfer of funds.

The new tax law makes maintenance a more expensive method of spousal support and all parties to a divorce where spousal support will be needed should carefully examine how to maximize overall family income.

If you have questions about maintenance and the new tax laws, contact us – we can help.

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