If high-net-worth clients are considering a divorce they might want to hurry it along – if they are the ones paying alimony.
That is because alimony will no longer reduce taxable income after this year. But that also means alimony will not increase taxable income for recipients. So, they might be perfectly happy waiting out the year for a divorce.
The new treatment is part of tax reform passed in December. As of Jan. 1, 2019, alimony will not be deductible, creating a whole new world of divorce-planning.
The new agreement means people will no longer be able to shift income using alimony, said Steven J. Weil, president and tax manager at RMS Accounting, in Fort Lauderdale, Fla.
“Because the tax shifting is no longer available, alimony will no longer have a tax advantage over other forms of property settlements and or child support,” Weil said.
If a client is taxed and income shifting is desired, get the agreement completed before year-end, Weil advised.
“If that’s not possible, consider the value of reducing or eliminating alimony in favor of a property settlement,” he said. “This may allow a discounting of the total payments to present cash value and also avoid future calls to increase or decrease payments and reduced contact.”
The handling of pension benefits in a divorce also comes into play under the new rule.
“While alimony does not play a role in transferring tax liability and income after Dec. 31, dividing up pension benefits using a Qualified Domestic Relations Order will still transfer the income and taxability of benefits,” Weil added. “Consequently, these benefits will remain an important consideration when the tax brackets of those divorcing are far apart.”
The new rules upend statutes that date back more than 30 years.
“In post-1984 divorces, alimony was taxable to the recipient and deductible to the payer,” said Jeffrey Schneider, an enrolled agent at SFS Tax & Accounting Services, in Port St. Lucie, Fla.
“This was a big negotiating angle, especially if the paying spouse is in a higher tax bracket than the one receiving it and that is usually the case,” Schneider said. “The new treatment is now no different than child support and property settlements.”
Advisors should keep their options open when working with divorcing clients.
“From a tax standpoint, the paying spouse may want to negotiate some other items that would diminish the lack of the tax benefit, like a lower amount by the effective tax rate of either spouse, or not giving up so much in their retirement assets,” Schneider added.
With the new mandate on the horizon, advisors dealing with a client divorce should take a short- and long-term view of the new alimony rule.
Brian O’Connell is a former Wall Street bond trader, and author of the best-selling books, The 401k Millionaire and CNBC’s Guide to Creating Wealth. He’s a regular contributor to major media business platforms. Brian may be contacted at firstname.lastname@example.org.
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