Tax laws are always changing. Some offer tax cuts that help Americans, while others aim to increase taxes further. A new tax law that will take effect on January 1 will affect those who are divorcing in 2019 and beyond. It will help those who receive alimony, but cause a tax burden for those who have to pay it.
In late 2017, Congress approved the Tax Cuts and Jobs Act, which included new regulations for alimony payments. In the past, alimony payments were tax deductible for those who paid it. Those who received alimony had to pay taxes on it as if it were income.
That will change starting January 1, 2019. At that time, alimony payments will no longer be tax-deductible. Also, the recipients will no longer have to pay taxes on the amount they receive.
Any alimony agreements in place by December 31, 2018 will not be affected by these new laws. This means that if you are already receiving alimony, you will still have to pay taxes. Payers will continue to reap the tax benefits.
Changes to Retirement Accounts
Another change coming in January involves alimony and retirement accounts. Currently, the tax deductions apply to those who pay alimony in cash. However, the new rules allow those who divorce after December 31 to transfer funds from retirement accounts.
This could overwrite the new laws. This is because if, for example, one spouse makes payments through an IRA, he or she is giving money to the other spouse without having to withdraw it from the account. If the paying spouse was forced to withdraw the money, he or she would have to pay taxes on it.
The recipient spouse then takes the money from the IRA. In this case, he or she is the one paying taxes on it. This is what the new law aims to do.
Another way in which the new alimony laws can affect retirement accounts is that they could bring about limitations when it comes to saving for retirement. The money earned from alimony will no longer be considered taxable income. Therefore, it cannot be put in an IRA.
This means that if your sole source of income is alimony payments, then the money cannot be put in a retirement account. You can still put the money in a taxable account such as a 401(k). If you do have a job and other sources of income, then you can still use a non-taxable individual retirement account to save up for your future.
Understanding IRA Transfers
To better understand how this works, it helps to be knowledgeable about the IRA transfer process. To avoid penalties, a person should ideally keep money in an IRA until he or she reaches the age of 59½. If you withdraw money from the account before you reach that age, you are subject to a 10% penalty as well as fees.
A transfer from an IRA to pay alimony would have to be detailed in the divorce agreement. When deciding to use an IRA to pay alimony, both parties need to make sure this option makes sense financially. The payer takes money out of his or her retirement fund, which could affect income down the line. In addition, the recipient has to pay taxes on money withdrawn from the account.
There are some alternatives available. For example, the recipient may opt to have only a portion of the alimony payment taken from an IRA. It may make more sense to seek a lump sum at the time of the divorce. This is a situation in which hiring a financial planner can be beneficial.
Why is This a Big Deal?
Nobody enjoys paying alimony, but in divorces, the payer was more likely to agree to do so in order to reap the tax benefits. The tax deductions are substantial for those with high incomes. Now that the alimony payers no longer get tax benefits, there is likely to be more contention during the divorce process. In order to stick with the current laws, couples will need to finalize their separation or divorce by December 31, 2018.
What is Considered Tax Deductible Alimony?
Not all alimony payments are tax deductible. In order to qualify for tax benefits under the Internal Revenue Code, payments must meet these eight requirements:
- The payments must be made under a divorce or separation decree.
- The payments must be made directly to the spouse, not a third party.
- The payment must be made in cash.
- The decree cannot state that the payment is not alimony.
- The spouses cannot file a joint tax return or live together.
- The payments cannot be classified as child support.
- The payments must cease when the recipient dies.
- The payer’s tax returns must include the recipient’s Social Security number.
When alimony payments do not meet the requirements above, they are treated as child support and other post-divorce payments.
Seek Legal Help
Tax laws are always changing. If you are about to get divorced and alimony is involved, you will want to know how these laws will affect you. They can affect your retirement and tax returns for many years to come. You do not want to make any financial mistakes in a divorce.
It is important to have your finances in order after a divorce. The new laws can make or break your budget, depending on whether you are the payer or the recipient. To learn more, contact Palm Beach divorce attorney Scott J. Stadler. He can help you navigate life after a divorce. Call (954) 346-6464 today and schedule a free consultation.