For approximately 70 years, the alimony tax deduction helped families reduce taxes after a divorce. With the tax reform act that went into effect at the beginning of 2019, the option for deducting alimony payments from taxable income for the paying spouse was eliminated. In light of this change, there are other ways Texas residents can help reduce their tax burdens after a high net worth divorce.
With the elimination of the alimony deduction, many believe that the issue of spousal support has become tax neutral, the same way that child support has always been treated. In reality, the changes actually increase the tax burdens, since the paying spouse has less disposable income to work with and will resist higher alimony payments. In the past, a spouse earning $500,000 could realize a tax savings of more than $22,000 based on an alimony payment of $150,000. Finding ways to reduce the tax burdens while ensuring that the lower-income spouse still receives support may lie in creative settlements.
One option may be to use pre-tax values of retirement assets to help fund alimony. This option may work well for business owners and others who have a greater potential to replenish these accounts. By transferring the assets from one spouse to the other, the paying spouse can take advantage of the tax savings, and the lower-earning spouse will have more assets to draw from in the future, regardless of future taxes. In addition, this arrangement provides more financial security without the worry that the paying spouse could die and alimony would cease.
Other solutions to reduce taxes could be through the use of special trusts and careful division of investment accounts. Spouses may also consider the merits of a lump-sum payment. Texas residents who are preparing for a high net worth divorce may be best served by consulting with an experienced attorney who can help ensure that the settlement will best meet one’s current and future financial needs.