Do not neglect to take tax obligations into consideration when negotating a divorce settlement.
Family law, like every area of law, is always evolving. Passage of new laws and holdings from court cases can impact divorce.
How do tax obligations impact divorce? Unfortunately, the Internal Revenue Service (IRS) will play a role in your divorce. Tax obligations can apply with the transfer of money and other assets, even when the transfer is the result of a divorce. A transfer can result in an unexpected tax bill if not done wisely. Examples can include:
- Retirement plans. The owner of a retirement account must follow specific rules to divide the asset. In addition to generally needing a specific legal document, referred to as a qualified domestic relations order (QDRO), early withdrawals can result in penalties and tax obligations.
- Education expenses. A savvy financial planner will know that there are ways to save for educational expenses and reduce tax obligations simultaneously. Use of a 529 college savings plan is one example. If children are present, the parents could include a provision within the divorce settlement agreement about funding future education expenses. This could include language that would guide the transfer of funds into a 529 plan to cover these costs while also reducing tax obligations.
- Alimony. Although child support payments are not taxed, alimony payments are subject to tax obligations. The details of the obligation have changed, discussed in more detail below.
Although one note above specifically discusses education expenses, the point is part of a broad discussion on basic bills. Various legal tools are available that can result in the transfer of funds to cover bills and potentially reduce tax obligations. Discuss these options, like use of a trust, during divorce negotiations.
How have tax obligations changed? The recent passage of the Tax Cuts and Jobs Act (TCJA) will impact divorces in 2019. For one, this new law included a provision that changed the taxation of alimony, briefly noted above. In the past, the recipient would pay tax on the alimony payment. The recipient was generally in a lower tax bracket, leading to a smaller tax obligation. The TCJA removed this benefit. As a result, the individual making the alimony payment is now responsible for the tax obligation – a change legal professionals throughout the country believe will ultimately result in lower alimony awards.
Those who have already finalized a divorce prior to the new year are grandfathered into the old rules. However, these individuals should note the new law could apply in the event of a future modification to the divorce settlement agreement.
This just one aspect of the TCJA that will impact divorces in 2019. Furthermore, the implications of tax obligations are just one consideration to take into account when negotiating a divorce settlement agreement. As such, it is wise for those who are considering or currently going through a divorce to seek legal counsel. An attorney can help to better ensure tax obligations and other considerations are covered within the agreement, reducing the risk of surprises after the divorce is finalized.