Many high-asset couples may be looking at The Tax Cuts and Jobs Act and thinking that it seems one-sided, taxing the payor of alimony and providing support money tax-free to the receiver. In truth, the law could be financially beneficial to both parties under certain conditions, or it could be unfavorable for both in other situations.
Alimony during property division
If the couple agrees during negotiations that a lump sum would be best, they may want to consider whether the payor should transfer a retirement savings account to the payee. The money accrues tax-free, and the owner can transfer the account during the divorce tax-free because the payee does not have to pay the IRS when he or she receives alimony. When the payee withdraws funds, as long as he or she is at least 59 1/2 years of age, that money will be taxable, but at the payee’s tax rate rather than the payor’s tax rate, which will be presumably higher.
Spouses who are not old enough to begin making withdrawals may not do well with this arrangement, however, because they will likely have to pay a significant penalty for early withdrawal. Either that, or they will have to wait to receive any alimony benefits. For those who are fresh out of a divorce and depending on that money to establish themselves financially, a tax-free retirement account may not be a good option.
The payee may feel like taking the payments now is a better idea anyway, because it is the payor who must take care of the taxes. However, the receiver of the alimony must remember that the IRS will be taking its cut from the pre-alimony income of the payee.
Those who want to have alimony taxed under the old law still have that option if they can finish their divorce by the end of the year. The new law goes into effect for all divorces finalized after Dec. 31, 2018.