A Way To Avoid The New Alimony Tax?

protecting finances during a divorce

The new tax law will make all alimony, known as maintenance in Missouri, non-deductible to the paying spouse and tax-free to the recipient spouse.  So, starting in 2019, the new tax law has the unfortunate effect of reducing the overall family income by leaving the paying spouse less net income with which to pay maintenance.

Can spouses find a way to work around this restriction and maximize net income?

Yes, at least for those recipient spouses who do not need maintenance as ready cash.

In this situation, the parties can agree that the obligor spouse will pay maintenance through a sequence of IRA transfers, moving funds from the retirement account of the obligor spouse to the retirement account of the recipient spouse.  All these transfers would take place tax-free through a Qualified Domestic Relations Order (QDRO).  These transfers have the added benefit of turning into a tax deduction for the obligor spouse who can essentially use all of his or her annual contributions to pay as maintenance (this can be particularly enticing to individuals who can use an LLC arrangement to boost annual tax deductible contributions to $50,000 per year).  In this way, the obligor spouse accomplishes through retirement contributions what maintenance would have done under the pre-existing law.

How does this benefit the obligor spouse?  It becomes a built-in way to plan for retirement.  Some spouses do not have large retirement savings and may not be able to make substantial contributions because of lack of income.  And if the obligor spouse did not have as large a retirement fund as the parties anticipated during the marriage, rather than split equally a small pie together they can plan on growing two larger pies.

Could this work for spouses who need maintenance to make their monthly expenses?  Probably not, although we can think of some creative financial planning that might allow for a cash flow option.

Another possibility:  consider having the obligor spouse purchase a home for the recipient spouse.  If the obligor spouse has a home that is already paid, that spouse could use the mortgage deduction to basically fund paying the house for a period of years.  The parties could perhaps put the home in a trust and decide who would receive the home in the event of the death of one or both parties.  Using this approach as a substitute for maintenance allows wealth to stay in the hands of the parties rather than the IRS.

Given the change in the tax law with regard to maintenance, more couples will look to these types of creative arrangements if they want to really maximize total net income.

If you have questions about maintenance and divorce, contact us – we can help.