Before U.S. tax-law changes took effect this year, the person who paid spousal support got to take advantage of the "alimony deduction." The payor of the alimony could deduct the amount paid, and the recipient had to claim it as taxable income.
The benefit of that was that the higher-earning spouse paying the alimony could reduce their taxable income, and the lower-earning spouse, who was in a lower tax bracket, would pay less in taxes. Divorce settlements took the tax breaks into account, and the two new households that resulted could share in that break.
For couples divorcing in 2019 or later, however, the situation has changed. Alimony payments can't be deducted by the payor on their federal tax returns, and the recipient no longer pays taxes.
The result is that the payor is going to owe more in taxes, which means less alimony will be awarded because the payor has less available income. Both households then have less money to spend.
So how can high net-worth couples realize any savings under today's tax laws?
Your attorney, in conjunction with your financial adviser, can advise you of the strategies in detail, but here's a brief look at some steps you can take that start at the time of divorce and property division.
For one, the lower-income spouse could be awarded more of the retirement funds, such as IRA and 401(k) accounts, and less in total alimony payments. This means the payor can transfer funds without paying taxes. While the lower-earning spouse eventually will have to pay taxes when withdrawing the funds, it will have had years to earn interest.
Or, they can use the option to split pensions under a Qualified Domestic Relations Order to transfer retirement assets, which can be particularly effective for an executive or business owner who still has time in their career to rebuild the retirement plan through tax-deductible contributions.
These are just two of the strategies that have proved popular in the wake of the elimination of the alimony deduction. There are others that your divorce attorney can discuss with you.