President Trump signed a tax bill that wiped away a 75 year old law around how alimony payments are treated for tax purposes. These changes impact both legal separations and divorces that occur after December 31, 2018.
Time is ticking…
Under the old law, the provider of the alimony was able to deduct the alimony payments on her/his tax return. The receiver of the alimony was required to include the payments as taxable income. Effective 1/1/19, you, as the provider of the alimony, will no longer be able to deduct any alimony payments on your tax return. Furthermore you, as the receiver of the alimony, will no longer need to include the alimony as taxable income.
Financial risks from this new tax law
Let’s say you are the breadwinner of the family and are in the middle of your divorce process. You and your spouse decide that you will provide your spouse alimony as part of your settlement structure. Let’s assume you are in a 30% federal tax bracket. You agree to make alimony payments equal to $10,000 per month for the next 5 years. This equates to $600,000 in alimony payments ($10,000 per month x 12 months = $120,000 per year x 5 years). Under the new law (and you can modify the numbers to apply to your situation), the tax benefits you used to obtain are no longer available. Those tax benefits amount to approximately $180,000 over the term of your divorce agreement ($600,000 in alimony taxed at a rate of 30% = $180,000 lost tax benefits). If you as the receiver of the alimony are in the same tax bracket (30%) then you gain an additional $180,000 of discretionary income — tax free.
As the provider of the alimony, if you were able to invest the $180,000 of lost tax benefits and generate a return of say 10% on your money over a 20 year period, you would have been able to amass an additional $360,000. This excludes any compounding on your investment. In other words, if this was your financial profile, this simple change in the tax laws might cost you $540,000 ($180,000 + $360,000). There are ways to manage these risks which is beyond the scope of this article.
What you may want to do (your decision, always)
If you know for sure (you need to be absolutely confident) that you are going to go through a divorce but haven’t started your divorce process, you may decide to start the process sooner than later. Why? These processes take time to work through. You will need financial clarity around your financial outcomes. You will have many questions you will need to be educated on and think about so you can make the right decision for you.
To provide insight and manage the overall costs of the process, one of the very first steps we do with our clients is profile their marital estate. This allows everyone involved to understand what the financial profile looks like. Profiling the marital estate seamlessly connects to the next step which is figuring out how to design a workable settlement structure. In this second step we help determine whether alimony is the appropriate vehicle or not for your situation. If not, then you will know you have more flexibility to make a decision after the 12/31/18 deadline.
A small, but important, rule about the change in alimony laws
If you finalize your divorce before December 31, 2018, but decide to modify it afterward you may not be able to take the alimony deduction in future years. Why? You may have re-opened your settlement structure which can impact how payments are made or received between the two parties. Therefore, if you are intending to get a divorce and include alimony as a key component in your settlement structure, it is important to get the details clearly ironed out, agreed to and signed by both parties before December 31, 2018.
About the Author
Larry Smith is a Founding Partner of Divorce Outcomes, a specialized professional services firm that manages all of the financial aspects in a divorce process. Since 2003 he has worked as a trusted financial advisor, financial advocate, divorce architect and technical financial expert; he is not an attorney. He is an alumni of KPMG and Andersen with expertise in technical accounting, forensics, sophisticated taxation, management consulting, risk management, advanced process engineering, business combinations, divorce management, multi-party negotiations, advanced quality analytics and cognitive performance technologies. Since 1986 Larry has been advising individuals and organizations about innovative financial solutions to resolve complex financial challenges that arise in life and in business.
For both personal and business divorces, Larry is considered an expert in divorce strategies, divorce process management, financial divorce architecture, financial risk management, taxation for divorces, financial divorce forensics, advanced divorce analytics, financial divorce negotiations and mediation, business valuations and sophisticated equity structures. He helps clients shape complex financial decisions, manage communication risks and ever-changing negotiating positions to strategically preserve or grow wealth from these types of transactions.
If You Have a Question
If you have a question, feel free to contact me at [email protected] or 617-680-5222. The call is free. I will spend 30–60 minutes with you. I will provide you an honest assessment as to where I think you are positioned in your divorce process or answer any questions you have. I may provide you some guidance, insight or advice that you can take with you as you wish. There is no obligation to move forward. The phone call is designed to ease your fears, provide you some options to pursue and a potential road to run on that can lead you down a path to achieve a successful outcome.
About Divorce Outcomes
Divorce Outcomes is a specialty services firm that helps people both domestically and internationally manage all of the financial decisions that arise in their divorce process. We are not attorneys. We are financial experts who partner with our clients as their personal financial advocates. We help our clients manage their divorce process, uncover hidden financial risks, architect divorce solutions, manage ever-changing negotiating positions, communicate complex financial matters and close the divorce process as soon as possible with a goal to arrive at the best outcomes possible. Throughout the process we evaluate the current state of our clients’ financial lives with an objective to best reposition their future. We do not sell any products. We simply raise issues that are in our clients best interest. Our clients share with us we:
- unfold, analyze and repackage their financial life so they are well positioned after their divorce
- preserve the value of their business or marital estate
- continuously strive to provide a return on our services
- build balanced financial solutions grounded in evidence
- find ways to make our client, and at times both parties, money through the process
- design their divorce to work for them and their family’s life
- provide mental clarity to make decisions
- reduce the total process time from start to close
- minimize the stress and unpleasant memories that can last a lifetime
As we reach an agreed upon settlement structure, we help our clients identify a fitting attorney who can leverage the financial solution to draft and record the requisite legal documents. Where outcomes are at risk from a traditional process, we function as expert financial negotiators or financial mediators to turn around the situation and achieve our client’s desired outcomes.
This communication is for general informational purposes only which may or may not reflect the most current developments. It is not intended to constitute formal advice or a recommended course of action as every person’s situation is unique and different. The information here is not intended to be, and should not be, relied upon by the recipient to make a decision without professional guidance.