No one plans to get divorced. Yet for couples in their 50s and older, so-called “gray divorce” can be a particularly complex and contentious undertaking. After living together for decades, often raising a family and accumulating significant assets, couples divorcing understandably find the process of pulling their lives apart and splitting up those assets difficult and emotionally exhausting. One of the biggest challenges is preventing those emotions from overpowering larger decisions and negotiations around personal and family finance.
To add to the stresses of these emotionally charged proceedings, changes in the Tax Cuts and Jobs Act of 2017 (TCJA) have created new curve balls for pending divorces. As a first step, individuals should consider a Certified Divorce Financial Analyst who can be a valuable partner and steadying voice during negotiations.
Here are a few key tax law changes individuals should be aware of as they navigate the significant financial transition that comes with later-in-life divorce.
Taxing Alimony Gets Turned Upside Down
When it comes to divorce proceedings, the most significant change in the TCJA involves how alimony is taxed. Under previous tax law, the individual paying alimony was able to claim a deduction on that money, and the recipient was required to claim the funds as income. Under the new law, the payer can no longer claim alimony as a tax deduction, and the recipient is not required to claim it as income. This is a complete reversal of how alimony has been taxed for decades.
This is a monumental change with the potential to create significantly more contentious divorce proceedings, particularly in the cases of gray divorce, which involve individuals who are at least 59 ½ years old and have significant assets and retirement savings. In virtually all cases, the spouse paying the alimony earns more money and may be in a higher tax bracket. Under the new law, that individual and his or her legal team will work to minimize alimony payments and the tax impact that comes with them. They may negotiate for greater assets to come from retirement funds through a qualified domestic relations order (QDRO). For pre-tax retirement accounts, this money would never be taxed for the alimony payer, but the recipient would be required to pay taxes on it when the funds are withdrawn.
This dynamic creates an inherent conflict. Recipients do not have to pay taxes on alimony, but payers do. Recipients do have to pay taxes on transferred pre-tax retirement funds, but payers do not.
Given that these options have such clearly defined “winners and losers” when it comes to taxable income, it’s not hard to see why negotiations quickly become contentious. For both individuals undergoing divorce, it’s important to consider how these new tax rules will impact payouts and adjust arrangements accordingly.
Changes to Divorce Arrangements Could Make New Rules Apply
Anyone who finalized their divorce before Dec. 31, 2018 is subject to the previous tax laws when it comes to alimony payments and financial agreements. These grandfathered individuals should approach changes to their divorce agreements with significant caution. Changes could mean that agreements are subject to the new tax rules.
If these changes are unavoidable, it’s important to once again consider the full tax impact on any amendments for both parties. For individuals paying alimony, losing the deduction could have far-reaching tax consequences including increasing capital gains rates, which could put them over the threshold for net investment income tax or disqualify them from contributing to a Roth individual retirement account (IRA).
Rely on a Knowledgeable Expert and Voice of Reason
Whether you’re in the beginning stages of divorce proceedings, or making substantive changes to an existing divorce agreement, it’s critical to have the right advisors on your side. A Certified Divorce Financial Analyst can coordinate with accountants and attorneys to evaluate the total impact of any changes to divorce agreements and consider the most advantageous way for both parties to move forward.
Wescott has a Certified Divorce Financial Analyst and a team of advisors committed to helping clients navigate gray divorce and the complex emotions and financial issues that come with it. We help clients understand what they’re entitled to by outlining all of their options and how they affect former spouses. We recognize that these proceedings are emotionally changed and more often than not, these negotiations must be nuanced. Ultimately, we understand that the right approach can make all the difference when it comes to securing fair and reasonable financial outcomes for all parties involved.
To learn more, speak with a Wescott Advisor today.