Divorce is expensive. Aside from the emotional toll divorce takes on a family, both the process and aftermath of a divorce can be costly. Below we look at some of the steps people can take to help remove the tax sting out of an already challenging time and arrive at the best financial position.
Changes to Alimony
We ring in the new year with changes to alimony tax law. Prior to Jan. 1, 2019, alimony payments were deductible by the spouse who paid them and taxable to the spouse receiving them. Typically, this provided an overall benefit to the family unit as the alimony recipient, generally being the lower earner, paid a lower tax rate. Often referred to as the “divorce subsidy,” this situation was costly to the government. From 2019 and forward, alimony is no longer deductible by the payer or taxable to the recipient.
This might appear to be a win for the receiving spouse; but consider that the change will most likely mean less alimony for the receiving spouse. It could also cause non-working divorced spouses to lose their eligibility to make IRA/Roth IRA contributions since they won’t have a source of taxable income.
One note on timing: if you finalized your divorce in 2018, the alimony will still be treated under the old rules for tax purposes – and even if you modify your divorce agreement in the future, the alimony will retain this tax treatment.
Pre- and Post-Nuptial Agreements Could be in Trouble
If you have a pre-nuptial or post-nuptial agreement, it is advisable to have the agreement reviewed. Aside from the impact of the new tax provision on alimony, relevant changes since it was written and more recent court rulings could impact how well an agreement holds up in court. Additionally, knowing where you stand if your divorce gets confrontational will give you the knowledge to negotiate your best financial case via a settlement or in court.
Decide What Really Matters to You
It’s unlikely you’ve stopped and taken the time to parse out what you really want in the next chapter of your life after divorce. Going through your divorce with great clarity on this topic will help you focus your financial negotiations to arrive at the best outcome for you in less time and, as a result, lower professional fees.
Calculate Whether You Should or Not
Settling seems enticing instead of fighting it out, but it’s best to work with both your divorce attorney and CPA or other financial professional to understand the long-term implications of any settlement. On the other hand, if there is little at stake, a long drawn out divorce process might prove to be more expensive than it’s worth. Working with the right professionals will help provide an objective view of the financial situation and assist you in understanding if you’ll need to change your spending habits, work longer or take other actions.
Cindy Hale- Knight has more than 12 years of experience in tax planning and tax return preparation and specializes in the preparation and quality control of individual, business, and not-for-profit tax returns.