How to Minimize Taxes After Divorce
There is no question that losing the alimony deduction has thrown a huge wrench into divorce negotiations. This deduction has, for many years, played an important part in divorce planning, allowing couples to shift taxable income and, in doing so, save on their tax bills. Therefore, the question ultimately becomes whether anything can be done to make up for the loss of this deduction, as both individuals will now have less money after taxes to spend.
The answer has to do with the strategic division of assets. Know that when there is a significant division between two individuals getting a divorce, there is an opportunity to save on taxes, as we describe below.
Going With Retirement Assets Instead Of Alimony Payments
For example, it may make sense for the individual who makes less income to take retirement assets, such as the 401(k)s and IRAs, in place of alimony payments. In this sense, the individual who makes more money is almost making the same or similar payments through their retirement assets. They can transfer the funds without ever paying taxes on them and this results in the same benefits as the alimony tax deduction. This strategy can be especially effective for business owners and executives who have the option of essentially replenishing their retirement plan; for example, executives who have stock options in companies that allow them to transfer these options to people who are not employees.
However, it is important to note that there is a 10 percent withdrawal penalty for the recipient spouse if they take these funds out before they reach a certain age (50 ½) and this needs to be documented in the divorce agreement. In addition, when it comes to pensions, you will need to look at options under a Qualified Domestic Relations Order (QDRO) with your attorney.
Charitable Remainder Trusts
Using a charitable remainder trust to set up and transfer these assets in order to reduce taxes is another option. The trust pays out income to the beneficiary for a certain amount of time and any remaining assets are distributed to a charity. This is appealing to individuals who are interested in getting a tax deduction for this particular type of donation. In addition, it can be funded with low basis investments, which neither person typically wants to walk away with.
Ultimately, you’re going to want to be strategic as possible it comes to investments taken in a settlement. For example, if the two of you have large gains on mutual funds, real estate, or stocks, a lump sum might be more intelligent than setting up actual payments. This can be especially helpful for a couple with a large investment portfolio. In addition, setting up in one lump sum instead of payments over time can help a couple move on more quickly.
Plan For Change, Even If You Have A Prenup
Finally, you will want to plan for change – including potential change with alimony – for the future. You can do so by adding provisions to account for changes in your marital settlement agreement. In addition, a couple that has a prenuptial also needs to revisit the agreement to account for any changes in the law.
Contact our West Palm Beach divorce attorney at the office of William Wallshein, P.A. with any questions. We are eager to assist you today.